Part One:
My Dad's accountant always tells him that it's not a bad thing to have to pay taxes because it means you are making money. I have no problem paying what's owed to the government, but I will do everything I can to make sure I am paying ONLY what is owed. After nearly eight years of building a multi-million dollar real estate portfolio I've learned a few pointers to minimize taxes on residential real estate investments.
Let's start with the basics. As a real estate investor, you will pay tax on the rental income you earn on the property as well as on any capital gains when you sell. The amount of tax you pay on rental income can be reduced dramatically by expenses such as maintenance, property management, capital cost allowance (depreciation), interest on your mortgage (but not the principal pay down), and other money spent to run your property. In another edition we will come back to some of the elements above. For this edition, let's focus in on the second major area you will pay tax on, and that is on Capital Gains when you sell your investment.
A Capital Gain occurs when you sell your property for more than you paid for it. You do not realize your capital gains until you sell.
To calculate your capital gain take the:
Money from the sale of your property
SUBTRACT
Costs of disposition (real estate agent fees, lawyers etc.)
SUBTRACT
What you paid for the property.
You will owe tax on 50% of the amount from the above calculation if the resulting number is positive (a capital gain). This amount gets added (or subtracted if it's a net loss) to your personal income and you are taxed accordingly.
If the property you are selling is your principal residence, then it is exempt from tax. According to Canada Revenue Agency, a property qualifies as your principal residence if in that year of filing:
* you acquire only to get the right to inhabit
* you own the property alone or jointly with another person
* you, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year
* and, you designate the property as your principal residence.
Now, what if you live in the home for a few years, and then move out and rent it out for a few years as I did with the condo that I owned in Toronto? In that situation, the answer for me was that the condo could still be considered my principal residence for four years after I changed it's use. The catch is that I could not claim capital cost allowance on the condo, nor could I claim any other property as my principal residence at the same time. For me, this choice was easy because I moved into a property Dave and I already owned and had been treating as a rental property from the accounting sense of things. It was easier to keep the condo as my primary residence and continue to treat my new "home" as a rental property for accounting purposes. It's important to note that you and your significant other (including common law or same sex partner) cannot own two principal residences at the same time for tax purposes. You must choose one during the over-lapping period.
It's complicated and that is why my husband and I have accountants that we consult with on a regular basis to get the best advice.
PART TWO:
It felt like I won the lottery at tax time last year. My cheque from the government was five figures. I am not bragging about this, because the reality is that the sale of my Toronto Condo happened at a net loss to me after real estate agent fees and our Toronto women's coats tri-plex cost us almost $30,000 last year in unexpected repairs. So, the money I got from the government didn't come close to easing the financial pain I experienced in 2006, but it did make me glad they were investments and not solely my homes. Had they been only my homes, that money would have been gone for good.
So, how can you maximize the tax write offs from real estate investments? Personally, I always consult my accountant. In over 15 years of using an accountant, I have only once paid him more than I have gotten back from the government. But, I don't just rely on him, I do have a decent understanding of what qualifies as current and capital expenses.
First, the definitions. An easy way to think of a CAPITAL EXPENSE is that it provides a lasting benefit and improves the property beyond it's original condition as most renovations do. If it's a separate asset like a new stove or fridge then it can usually be treated as a capital expense. Typically these expenses are significant (in the thousands of dollars). Usually these expenses must be deducted over several years versus current expenses which usually get fully deducted in the year they are incurred.
Some examples of capital expenses include:
* The purchase price of rental property,
* Fees associated with the purchase of the property such as legal fees,
* Purchase of furniture or appliances to go in the property,
* The addition of a deck to the property, or the addition of another bathroom.
A CURRENT EXPENSE is generally something that repairs the property to its original condition, for example a coat of paint or repairing stairs. The expense is usually one that recurs on a regular basis and provides a short term benefit. Some common current expenses include:
* Costs of renting the property out (property manager, advertising, cleaning costs),
* Insurance on the property,
* Interest on your mortgage (note that your principal repayment is not deductible),
* Maintenance and repairs that restore the property or item to it's original condition,
* Property taxes,
* Your hired help: accounting fees, property manager fees, cleaning people's wages, consultants, lawyers),
* Utilities,
* Travel costs to collect rent, view or work on the property (note that this includes transportation costs but not typically lodging or food),
* And office expenses that are directly related to your investment (things like long distance fax charges and telephone bills we have expensed but pens and paper we have not, although you can if it's directly related to your investment activities).
THE DISCLAIMER: We do not have any legal training, nor do we have extensive accounting training. We are not experts and we always consult with our accountants and legal counsel before we make decisions. We pay money to get quality advice when we need it and always advise our friends, family and readers to do the same.
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