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Income tax implications of renting out personally-owned property

condo Last week, I answered a reader question about what to look for in a mortgage. This week, a reader is asking: What are the tax implications of renting out a condo (or house) that you own?

Great question! If you are contemplating becoming a landlord, you need to get professional advice that is specific to your own situation. One small detail can change the entire result, so it’s important to have a qualified professional evaluate where you’re at. To help you prepare for that meeting, there are several issues to consider.

Is this a property that you have lived in at one time or another?

If the answer is yes, then you have a “change in use”. From a tax perspective, you are deemed to have sold the property and re-purchased it. The first thing you need to do is figure out the market value of the property when you move out/your tenant moves in. This number will be the adjusted cost basis of the property for the purposes of calculating the capital gain (or loss) when you eventually sell the property. For the time when you lived there, assuming that it was the only property that you owned and you meet all the required criteria, the property will be designated as your principal residence. This means that any gain during that period will be exempt from income tax.

Once you move out, you have a choice. For up to 4 years (longer in special situations), you can elect under section 45(2) of the Income Tax Act to keep this property as your principal residence even though you no longer live there. In order to be able to benefit from this election, you need to report the rental income from the property and you cannot claim capital cost allowance (depreciation) on the property. If you own another property and live there at least part of the time, then you can designate either property as your principal residence, but not both at the same time.

Regardless of which option you choose, you need to know the value of the property when the change in use occurs. Talk to your accountant about what type of documentation will suffice for the type of property that you own. Usually, a realtor’s letter or an appraisal is used for this purpose.

Reporting earnings – business or rental income?

Regardless of whether you bought the property specifically to rent it, or you lived there at one point or another, the next step is to figure out whether you have business income or rental income. If you are providing only basic services to your tenant – like heat, light, parking and laundry, then chances are you have rental income. If you are providing other services like cleaning, security or meals, then you may have business income. You can read more about this in guide T4036.

Your accountant can also provide you with an opinion specific to your situation as to whether you have rental income or business income.

Assuming you have rental income, you’re going to fill out form T776. If you have business income, you’re on another form with different rules that go beyond the scope of this post.

Filling out form T776

Like most other forms of income, rental income is taxable and needs to be reported. Form T776 is where you put those numbers on your return. You can deduct the expenses related to the rental unit – condo fees, property taxes, mortgage interest, etc. The full list is on the form, and most of the items are fairly straight forward. Some items, like maintenance costs, can be a bit ambiguous when they include items like flooring and windows. You need to determine whether these expenses are current or capital expenses. Current expenses can be deducted immediately but capital expenses must be added to the adjusted cost basis of the property. You can claim capital cost allowance (tax talk for depreciation) on the cost of the property, but if you do, you preclude the use of the election under 45(2) described above.

How do you know whether an expense is current or capital? On CRA’s web site, it says: “Renovations and expenses that extend the useful life of your property or improve it beyond its original condition are usually capital expenses. However, an increase in a property’s market value because of an expense is not a major factor in deciding whether the expense is capital or current.” There is a chart of questions and answers on the web site to consider which should help you determine whether an expense is current or capital. Your accountant can help you with this determination as well.

Another item that might look a bit odd on the form is the column for personal portion. This applies if you are renting out part of your home and living in part yourself. You need to pro-rate your expenses accordingly.

Tax-saving opportunity

Talk to your accountant about restructuring your debt such that it is against your rental property instead of your personal property in order to maximize your interest deduction.

Other complications

If you are not a resident of Canada, the property is outside of Canada or in a different province than the one you live in, then additional issues may arise, so make sure you don’t keep these details to yourself.

When you sell

If you are contemplating selling your property, please call your accountant before you sign the deal. Replacement property rules may allow you to defer the recognition of a capital gain, or there may be other tax-savings opportunities that could impact the structure of the deal. From personal experience, there is nothing worse than being brought in after the fact when you could have saved someone money if they had just called you earlier. That drives me crazy!

Do you still want to be a landlord after reading this? Let me know how it goes!

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January 14, 2013

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