Guest Speaker: Daniel Toma, Chartered Accountant
- Write-offs for people with basement apartment or another suite in their home they rent out
- What percentage of their home expenses can they write-off and how is that determined?
- Write-offs for real estate investors that own 1 or more property
- What is depreciation and how does it work when you sell your property?
- Depreciation of principal residence if it includes a rental component
- Are there any differences if someone is renting their place out on AirBNB?
- How long do you need to live in your home for it to be considered a principal residence?
- How HST works for purchase of a new condo when you are planning to live there vs an investor
- How HST works if you are purchasing a home built by a builder
- Should an investor form a corporation to purchase real estate? What are the advantages or disadvantages of it?
- Do investors need separate bank accounts for each property?
- Should parents consider buying a rental property in their child’s name?
Daniel: Hi, thank you.
Davelle: Awesome. One of the reasons I feel it’s important to invest in real estate is because of the many tax write-offs it gives you. Daniel, can you tell us what are some of the things that people can write off if they have a basement apartment or another suite in their home that they rent out?
Daniel: Sure. So, if somebody’s renting out a portion of their home, they would basically be able to take a portion of all the expenses related to the home, for the portion of the home that they’re renting out. So we would usually determine that either by area or by the number of rooms in the home that are in total, and we would take just the rental number and divide that. In terms of the expenses, you would take things like, if it was a condo piece, but if you’re talking about a home, there would be mortgage interest, mortgage insurance, property tax, all the expenses including utilities, all the expenses that you’re incurring for that home, we would take that percentage and then allocate it to the rental expenses. That can also include additional expenses such as advertising for the unit being rented, legal accounting if you’re getting accounting done on an annual basis, and then any other fees that might come up. And we’re talk about this a bit later, but you would not want to take depreciation, most likely, on that portion of the property, because there are some adverse tax consequences.
Davelle: Ah, okay. Good to know. Absolutely. Actually, do you want to tell us now, maybe, what some of those adverse … Actually, first maybe tell us what depreciation is and tell us what some of those adverse tax consequences might be.
Daniel: Sure. So depreciation is basically taking the cost of a property and allocating it over time. So if it’s a rental property, you could be taking up to four percent a year as additional expense, based on the full value that you purchased the property for. However, there are two things to consider here. If it’s a home that you own, you would also be qualifying for the principle residence exemption when you eventually sell it, which is basically allowing you to sell your home tax-free if you meet all the criteria. If you’re claiming CCA on that portion of the property, it will not be included in the principle residence exemption and you will be subject to tax on the gain for that portion. So especially in this hot real estate market, there’s a lot of value, in terms of your home going up in value, so it’s not an advice that you’d want to pay tax on that just to claim some extra expense on the depreciation portion. Yeah, so that’s pretty much the main reason why we advise not to take CCA on something like a basement apartment.
Davelle: Ah, got it. Thanks. That makes a lot of sense. Was there a recent change, by the way, in the taxes for the way the CRA views the principle residence for 2016? Was there a change or adjustment they made?
Daniel: Well, the change has been that they’re requiring everyone to disclose, in the principle residence exemption form, whereas before they were just not requiring you to file it every year. Like if you’re selling your home, you weren’t required to submit to them. And now, because there’s so much of this hot activity going on, they’re actually tracking, they want to see every transaction. If you’re claiming the principle residence, they want to see that included with your tax return. So it’s definitely becoming more under the radar, whether somebody is going to qualify for the principle residence exemption, and that is the main difference in 2016.
Davelle: Interesting. So, what kind of documentation does someone need to submit, then, to qualify for that principle residence exemption, with that documentation you were talking about?
Daniel: It’s included kind of as just an additional tax form. However, if CRA wanted to see documentation to support your claim, which is going to be a lot more common now that people are more commonly flipping properties, they would want to see original purchase documentation, how long have you been living there, whether it’s actually your principle residence, for instance does your driver’s license list that property. You have to have a case that you’ve actually been living there, because there’s some people that are claiming, because it’s a very valuable thing to claim that tax free status when you sell a property, may be claiming something that they didn’t actually live there long enough, they bought a condo, and then within a year they resold it and didn’t want to pay any tax on it. CRA is definitely watching that a lot more closely and can disallow it.
Davelle: Interesting. So is there a particular amount of time that you should live in your property for before you can claim that principle tax exemption? Is it six months, is it a year, is it even defined?
Daniel: There may be a definition somewhere. I always advise clients to stay there at least two years. It’s kind of a safe time period. I think you might even be able to get away with a year, but I’d have to get back on that particular point, but two years in my opinion is kind of a good, safe time range to say that you’ve lived somewhere, it was your principle residence, and then you’re claiming the exemption. It technically might even be as low as a year. I’d have to get back to you on that.
Davelle: Got it, okay. Sounds interesting. What percentage of people’s home expenses do you think that they can write off, and how is that determined when you are looking at an investment property?
Daniel: Sorry, you mean they would be owning a separate property and then having a portion of home expenses that they would want to claim?
Davelle: Or no, if they had like a basement apartment in their property, what’s the percentage that they can write off and how is that determined?
Daniel: Oh, I see. Okay. So it would normally be based on the area. That’s like the go-to method. But you could also base it on number of rooms in the home. So, saying that that’s one room of six rooms, or something like that. Now, one point that isn’t often looked at is you can also claim amounts for shared spaced, based on the available use and percentage of time a lodger might use it. So if you were providing that shared space on some kind of basis, then there could be an argument that it’s 20, 25% use by the renter. So it’s something that accountants can discuss with you about what is the best allocation to keep things safe and not like you’re excessively claiming expenses in that regard.
Davelle: Got it. So for example, let’s say I have a basement apartment and I live in a two story house, what portion would that represent, you think?
Daniel: So it’s a basement apartment in a two story house, it could often be 25%. I’m assuming the basement is kind of a smaller area than the other two floors. But it could be an area of 25%, something like that.
Daniel: So that’s a good portion of all those expenses that you’re paying for the home.
Davelle: Got it. That makes sense. So for real estate investors that own one or more properties, can you explain what things they might be able to write off?
Daniel: Sure. So it’s going to be similar to what somebody is claiming in, let’s say the basement apartment, however if it’s a property dedicated to rental, they’re going to be claiming everything related to that property. In terms of mortgage payments, you would only be claiming the mortgage interest. The principle repayment is not part of the expenses. Otherwise, though, if you’re paying any kind of management fee for a realtor to be handling the property in terms of dealing with the tenent, all those things are things that you’re going to be able to expense, property tax, everything related to that property.
Davelle: Got it. That makes sense. So then for a real estate investor who owns just properties outside of their principle residence, if we go back to the depreciation concept, how does that work when they sell a property? How are they taxed?
Daniel: Sure, and that’s a very good question. It really comes down to the year of sale. In the year of sale, if you’ve been taking depreciation, there’s going to be a lump sum of income added which won’t be taxed at the preferential capital gains rate, it’s going to be taxed the full taxable income, and that is something that will be added as a one time amount when you’re selling. So it’s really a personal choice if somebody is wanting to save some tax every year by taking depreciation on a rental property, but then dealing with that lump sum of income when they sell, or if they don’t want to take any depreciation and avoid the lump sum of income when selling.
Now, deciding this can be motivated by how long you’re going to hold the property. So if you’re planning on holding it for many years and maybe even keeping it in the family, then you may not be as concerned about having a lump sum included when you’re selling, because that’s really far off or not even in the foreseeable future. But if you are going to be selling, let’s say, within ten years, then you may decide that you don’t want to take depreciation and avoid that income inclusion. So it’s definitely a conversation that I have with my clients who own rental properties. I make sure that they understand the two outcomes so that they can decide what’s best for them and make that decision accordingly.
Davelle: Got it. That makes sense. And I want to just sort of go back to the concept of depreciation, because sometimes I think we sort of talk about it and people are left a little bit confused as to what that actually is. So if we say that someone has a property that’s worth $100,000, and I guess, is your assumption … Let’s make an assumption of a ten year life span of that $100,000. Can you explain exactly how much you would depreciate that property, so that people have a clearer understanding of how that works?
Daniel: Sure. So, it’s not on a straight line method. It’s actually what we call declining balance.
Daniel: So if it’s a rental property, you would have a rate, typically, of four percent depreciation. However, each year after you take an amount of depreciation, now your remaining balance is reduced, and then you’re taking the four percent on that. So the amount of depreciation is going to go down every year, based on the declining remaining balance available to take addition depreciation.
Davelle: Perfect. So the first year of depreciation is going to be much higher than the subsequent years.
Daniel: Correct. And in the year of addition, there’s often a half depreciation rule that we usually follow. But you’re right. In that first year, excluding that factor, in the first few years I would say you’re getting more depreciation than later on. And as you hold it for longer, the depreciation is much less valuable.
Davelle: Perfect. That’s good. That’s awesome. So are there any differences if someone is renting out their place on AirBnB from a tax write-off perspective?
Daniel: That’s a very good question, actually. And I actually have many clients who are AirBnB hosts and have become very much aware of activity going on relating to that topic. The major difference with AirBnB is that it’s being considered as short term rental by CRA. So to answer your question, first, they can claim all the same expenses and deductions that you would claim as a normal rental property. They would often have a few other ones, maybe related to more actively managing the property, I would say. But CRA has a view that if a property is being rented out for periods of less than a month it’s classified as short term accommodation, and would be treated as a taxable supply for HST purposes, and subject to HST if you’re earning $30,000 or more in a year. That’s the threshold normally for business owners, that they would require to register for HST. At $30,000, the CRA says you need to register and start charging it to your clients. So if somebody’s doing short term accommodation and they’re making more than $30,000 a year through AirBnB, they’re actually going to be required to remit HST to CRA. Now, the problem is that the AirBnB platform in Canada doesn’t really have a mechanism to add HST as an extra line item when you’re charging it to your clients.
Daniel: So it’s a bit of a problem. And many hosts, to be honest, are not even aware of it. I think that there’s becoming more a movement to educate all the hosts about this. But they would need to include the HST in what they’re charging to the clients, and they would probably want to disclose HST numbers somewhere, in whatever way that they can, because that is technically the way you’re supposed to be invoicing when you’re charging HST. You need to disclose your HST number so that the other registrant can claim the HST if they’re also an HST registrant. So it has created some challenges, I think, for some AirBnB hosts. And a number of my hosts have actually registered for HST based on it.
Davelle: Interesting. So for example, I have a friend who recently started renting a place out on AirBnB. So what if he has no idea if he’s going to make $30,000 or not this year, because it’s the first year that he’s tried this? Should he just register for that HST number regardless, because he doesn’t know if he’s going to hit that $30,000 gross threshold, or not?
Daniel: I would say no. Because it’s to his benefit if he is staying under $30,000, because he’s not going to be required to register for HST. I would say that he should watch his income coming in, and then if he’s approaching that $30,000 mark then he should look at registering, and once he’s registered you can’t go back to being unregistered. Like let’s say he exceeds $30,000 this year and then is under $30,000 the following year, once he’s registered, he’s registered, and he needs to charge it and remit it to CRA. So that would be my approach, just because I wouldn’t want him to register if he was choosing, especially if he was choosing to stay under $30,000 for the purpose of not needing to be registered.
Davelle: Wow. Interesting. Okay, that’s good to know. Do you think investors who have different properties need to have separate bank accounts for each property? Do you think that makes a difference?
Daniel: It can be beneficial, in terms of tracking the income and expenses for each separate property. Because, typically somebody’s owning the properties personally, it’s not a requirement that each property have a separate bank account, but for all intents and purposes it’s going to make it easier to track each property. If you do have like, say, one account that handles all your rental income and expenses, you would just need to make sure it tracks what is for what property, because when we’re reporting it, we’re reporting each property separately in the tax return.
Davelle: Got it. That makes sense. Now, what about, should an investor form a corporation to purchase real estate? What are the advantages and disadvantages of doing that, of holding the property in a corporate name versus their personal name?
Daniel: That’s a very good question, and one that I get fairly often. So, generally there are limited advantages to holding rental properties in corporation, the reason being is that there’s a reduced tax rate for small business income in Canada that is 15% roughly, and that is only based on active business income. So rental income is considered passive, and it doesn’t get that preferential low business rate. So if you’re holding a rental property in a corporation, the income is going to be taxed at a much higher rate, and there will be incentive for you to pay it out yourself personally so that the corporation is not retaining the income and being taxed at a higher rate. So as a result, the corporation is really just flowing the money through to the shareholder and in that case the benefits then are limited if it can’t hold the income in there. It would be similar to you just holding it personally.
Now, that being said, there can be some benefits to a corporation holding real estate, if, say, an operating company is using profits and funneling it to a holding company which invests in the rental property and you’re not needing to take money out of the corporation and get taxed personally on it. So if we’re using pre-tax dollars, there can be case by case scenarios like this where we’ll look at it and say, “You know what, it could make sense to retain the properties in a corporation.” In many cases we would have a separate corporation so that the active and passive income are separate from each other. And then there could be other legal benefits if a lawyer considers that your exposure, personally, is a concern, then there can be benefits like that. But generally, there are limited advantages, and we would look at it carefully, but in many cases holding it personally is easier and less costly, because you will incur more accounting and legal fees for property being held in a corporation.
Davelle: Got it. That makes sense. And I’ve also heard from a lot of mortgage brokers too, that the banks prefer people to hold properties in a personal name versus a corporation name. They make it very difficult for people to get the mortgage in the name of a corporation, unless it’s an ongoing corporation that’s actively making money. So yeah, I think that definitely makes a lot of sense. Can you tell us a little bit about the HST and how that works when you purchase a new condo, whether you’re planning on living there or renting it out as an investor? How does HST work in a pre-construction condo?
Daniel: Sure. So, there’s a special program offered to people buying properties for living in and renting out called the New Housing Rebate and the New Residential Rental Property Rebate. So the government will give a portion back of the HST paid in this special rebate, and it really depends on what province you’re in in Canada. But if you’re in Ontario, there’s a federal provincial portion that you can qualify for up to $24,000 provincially, and they will be 75% of the provincial portion of HST, and then up to $6,300 for the federal portion, however it’s phased out between market values of $350,000 and $450,000, and then above that there’s no federal portion, and it’s also 36% of the federal portion of the HST that’s refunded to you. So at the end of the day, we do a calculation and figure out what rebate you’re qualifying for and file to the government. It actually happens that both the GST HST New Housing Rebate and the New Residential Rental Property Rebate come out to the same dollar value of a rebate, it’s just that different paperwork is filed for each one separately.
Now, what actually happens is if you’re buying a property to live in, the builder is normally automatically filing for the rebate on your behalf and crediting the transaction so that you’re getting the rebate through them. They’re basically either including it in the price they already quoted you, or adjusting the final statement of adjustments accordingly. Now, if you’re going to be buying a property as rental property, then the builder can’t actually file that rebate for you, and you need to do it separately, in which case someone like myself can file it for you instead of the builder.
So you need to communicate to the builder if it’s going to be used as a rental property. Because if they file for you and then it’s later determined that’s a rental property, CRA can come back and say, “The wrong rebate was filed. We want that repaid. And by the way, you owe us interest and penalties on the amount that you received in error,” even though you’re eventually going to file the same rebate and get the same amount back, hopefully. They’ll still charge you that interest and penalty on the rebate that you were holding under the wrong application. So I actually have had a number of calls about this within the past year, and it’s something that I always advise clients about.
Davelle: Awesome, that’s good to know. So if you were an investor buying the pre-construction condo, and you’re now going to file for that HST rebate, do you need to show any additional documentation, for example like a copy of the lease? Is it okay if the lease is around for a year? Is it okay if it’s six month? What are some of the rules and regs about that?
Daniel: Sure. Yes, for the rental property rebate you need a lease that is a year long period. Now, that lease could have started before the closing date. So it could be started during the occupancy dates, prior to closing, as long as you have a lease agreement that goes past a year. There’s some other standard documentation like the purchase and sale agreement, the statement of adjustments, other standard documentation that we need. But other than that, those are the only documents that need to be filed to CRA.
One other point that I want to bring up, and this is very important, is that if somebody is buying something pre-construction and are flipping this property, they’re not going to qualify for the rebate. And this has actually been very closely watched by CRA lately. They’re going after a lot of rebates which people are claiming or have already received and then they become aware that somebody flipped it, either lived there a very short time, let’s say under a year, and then flipped it. Because to qualify for the rebate, it needs to become the primary place of residence for either yourself or a close relative to qualify for the new housing rebate, or it’s being rented out as a rental property. But if you’re flipping within that year period, you’re not doing either. And CRA is going to deny the entire rebate.
Davelle: Wow. Okay, that’s good to know. Can you tell us a little bit about how HST works with a renovation project? So if someone’s doing a significant renovation of their home, can you tell us the difference between if it’s the significant renovation on a principle residence versus a significant renovation on a real estate investment property? What sort of implications are there for HST and getting rebates in those scenarios?
Daniel: Sure. That’s also a very good question. So the rebate for what is called a substantial renovation, and this needs to be considered a renovation 90% plus of a home, or a condo for that matter, that would usually involve replacing the walls, floors, gutting the place essentially, and in that case CRA considers it really to be like a new home. And they’ll actually provide what they call the new housing rebate through similar paperwork, however you actually need to provide a schedule showing a summary of the expenses incurred, and a similar calculation goes. However, one thing I should point out is that the maximum rebate in most cases would be $16,080, because there was no HST paid on the land, they’ve limited it to that amount. So it’s a lesser rebate, however there’s a lot of home renovation going on, and people are often not aware that they can qualify for that rebate.
Now, if it’s a rental property that’s being renovated, it’s a bit of a different situation, because CRA is going to require you to assess that the fair market value of the property at completion is like a new property, and they’re going to basically require you to self-assess the HST on that amount and remit it to the government. And then you could claim the tax credits on the cost that you put into the renovation and the HST rebate. But in this housing market I find that a lot of the time you’re coming out behind, when you need to, let’s say, assess HST on a million dollars, let’s say that’s the fair market value of some property you just renovated, and then if you’re claiming the input tax credits on the cost and even the rebate, you’re often coming out behind on that HST. So it can be to somebody’s disadvantage to be substantially renovating and filing the rebate accordingly. The CRA could require it, though, if you’ve essentially redone a home, they could say, “Well, you’ve redone a home and you need to self-assess.” So that’s the general way things are done with that.
Davelle: Wow. It’s all so complicated. Oh my God. Very interesting. Can you tell us how HST works if you’re purchasing a home built by a builder? So in the north Toronto area, there’s lots of builders who sort of take a bungalow, bring it down, and build up a new house. So how does HST work if you’re purchasing a house built by a builder?
Daniel: So a house built by a builder … So you mean that the builder has built the home themselves and then they are going to be selling it to you?
Davelle: Yeah, exactly. They’re kind of like a house flipper. When I say builder, they’re not sort of massive corporations. We’re just talking about sort of an individual builder, we’ll say “builder”, that has bought a bungalow, knocked it down, and is now completely changing that property and building a brand new built house. So how does HST work in that scenario?
Daniel: So typically that’s going to fall in within resale. And under the resale homes, you would not pay HST. As a buyer, if they’re selling it to you and they are an individual builder who is not registered with Terion and going through the process, they’re saying, “We’re selling you a new home. Here … ” They would either charge it to you as selling you a new home, but in most cases this is going to be a builder doing a resale. So that would be my approach to that transaction.
And one thing I should mention on the previous topic we discussed, is that with renovation, to be considered substantial renovation, then it would need to be that 90% plus. So if you’re doing a renovation on a rental property, it would be if you’re doing 90% plus renovation. But if you’re just doing half the house or something, then it wouldn’t be considered substantial. So that’s really the test, is whether it’s substantial or not.
Davelle: Got it. That makes sense. Do you think that parents should consider purchasing a rental property in their children’s name?
Daniel: No. That’s generally not advisable for a few reasons. One, if they’re minors, under 18, there’s going to be attribution of any income from the property. So it’s not going [inaudible 00:27:42] avoid paying tax on a property. And secondly, transferring property to a family member who, if it’s not your spouse, like you’re transferring to them at fair market value and it’s going to be a deemed disposition, when somebody is deciding to put their adult child as a joint owner on their home, there’s really a deemed disposition of half the value of that home is now occurring, and there will be a tax consequence for that. So in that case, there’s going to be a tax consequence that arises even though no cash has changed hands. So that’s why, any time there’s planning around acquiring property within the family, it’s definitely something you want to talk with an accountant about to avoid undesirable tax consequences.
Davelle: Right. That makes a lot of sense. Is there anything else you think our listeners should know about when it comes to accounting in real estate?
Daniel: Sure. I would say one thing is to watch the budget, which should be coming up very soon, from the federal government, to see if there’s any changes. One thing that has been whispered, and we don’t know if this would occur, is that there could be a change to the capital gains rate in terms of the percentage that’s taxed. It may not occur, but there’s been talk that that is some area where tax could be changed. Because if they’re cutting tax for lower income earners, they need to be adjusting tax elsewhere.
Another area would be just to be more attentive to property flipping, because CRA is watching it a lot more. It’s a very political matter now, with the markets the way they’ve heated up. So if you’re going to be claiming something as your principle residence, just ensure that you’re living there for a certain time period and then later selling or filing the right rebate, whatever you’re doing just make sure that you’re adhering to whatever the guidelines are.
And in general, if you’re acquiring property, it’s always good to talk to an accountant and/or a lawyer about the long terms goals, to make sure that the appropriate plans for passing on that property within that family, maybe, is done appropriately, so that the end strategy is there in terms of how assets are passed on.
Davelle: Perfect. That sounds great. Thanks so much, Daniel. You know, I always like to ask my interviewees if they rent or own and which part of the city they live in and why. Can you let us know what your situation is?
Daniel: I live in the Younge and Eglinton area right here where my office is located. And I’ve actually been renting, and interested in buying at some point, but the housing market’s gone up tremendously lately. So it’s something that has been on my mind in terms of what type of place should I buy and I’ve been very closely watching it.
Davelle: Makes sense. How can our listeners reach you if they have more questions and want to reach out?
Daniel: Sure, they can find me online at www.danieltoma.ca where you contact through the website, you can email email@example.com or feel free to call. I’ll be happy to speak, have a free consultation. My number is 416-655-1050, and as I mentioned, our office is located right near Younge and Eglinton. We’re very conveniently located near the subway, and we’d be happy to have you in.
Davelle: Awesome. And do you want to give our listeners your email address as well?
Daniel: Sure. My email is firstname.lastname@example.org .
Davelle: Awesome. And Toma is spelled T-O-M-A, for those who are curious. Thank you so much for speaking with us today, Daniel. It’s been great. And thanks very much, and have a great day.
Daniel: It’s been my pleasure. Thank you, Davelle.
Daniel: Bye now.
Thanks again for joining us for some Toronto real estate market insights. You can visit my website at MorrisonSellsRealEstate.com , or visit MorrisonTalksRealEstate.com for more episodes of the podcast. Thanks for listening.