Canadian Rental Income Tax: Rules on Write Offs (Part 2)
In part 1, Sumeet Sangha shares some basic tips on the most common tax write-offs related to a rental property business. Here, in part 2, some tips and advice are offered around business use of home and the rules around what can be claimed as expenses on your tax return.
Q: What is the rule around using part of your home as an office to manage your rental property business?
A: If you are managing a rental property business and claim management income on form T2125 you are eligible to deduct home office expenses if you run the business from your home and do not have access to another office. Generally you are able to deduct maintenance cost such as heat, insurance, electricity and cleaning materials as well as your property taxes, mortgage interest and CCA. This deduction is prorated by taking the square footage of the home office over the total square footage of the home to determine the eligible portion of home office expenses deductible.
Q: Do I need to be a managing my rental properties full-time to write off a portion of my home?
A: You don’t need to be a full time property manager but you do need to be considered to be running a business or professional activity in order to claim these expenses and report your income on form T2125. If you are unsure of whether or not you qualify as a business or professional activity your accountant will be able to help you make that determination.
Q: Why is the mortgage you pay to your bank not considered as an expense and only the interest paid on the mortgage is recorded as an expense?
A: When you purchase your rental property the cost is the purchase price however you usually only incur a direct cash outflow of your down payment with the cash shortfall coming by way of a mortgage. The principal payments on your mortgage are a repayment of this cash shortfall that you financed. When you sell the rental property in the future the gain is calculated by deducting from the proceeds the original cost and other selling expenses. This original cost is your purchase price of which a portion was paid by way of mortgage, even if you have an outstanding mortgage balance the gain is calculated using the original purchase price as if you bought the property outright.
Conceptually the CRA does not want you to have the ability to deduct mortgage principal as well as utilize the original cost to calculate your gain on future sale. The mortgage principal therefore is not classified as an expense just a repayment of debt. Mortgage interest on the other hand is a cost of borrowing and is a deductible expense as you had to incur this additional cost to receive financing in order to purchase the income producing property. Note that mortgage interest is deductible only if the mortgage funds were used to earn income, this is why mortgage interest on your own home is generally not deductible unless you have a rental suite.
Q: Can you claim GST as an expense if it is related to operating your rental property?
A: Yes only if you are registered to collect GST. If you become a GST registrant you will have to collect and remit GST on rental revenue but also have the ability to claim a credit for GST paid on qualifying purchases. Not all landlords need to register for GST but there are certain instances when it is required, this is a complex area and if you are concerned with GST consult with your accountant first.
Q: What value can a real estate accountant offer?
A: A software product, like PendoRent ,can really ease the burden of collecting and retaining information required to file your annual tax return. Once you own rental properties the complexity of your return increases and the requirement for more information to support deductions increases as well. Tracking your rent and expenditures throughout the year using PendoRent can help reduce the pain of filing your T776 or T2125 forms.
The other piece of the puzzle is an accountant that understands the eligible deductions and rules surrounding rental income and property management income in order to ensure you are compliant with your filings and to also assess the need to register for GST or if it makes sense to claim CCA among other things. Landlords and property managers may want to track a number of expenditures throughout the year to manage their portfolio of properties. But, an accountant familiar with the tax rules surrounding real estate income can sort through these expenditures and claim only the deductions allowable by the CRA.
Disclaimer: consult a chartered accountant or your local tax authority for the most accurate and updated rules and regulations.