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Rental Income and Taxes
Have you been thinking about purchasing a rental property or renting out part of your home for income? This article will go over the basics of rental property. For more information, visit the CRA website and search for rental income.
Rental income is when you rent a property for someone else to use. Property is usually considered real estate, but it can be anything that can be rented out such as a car, snowmobiles, power tools, computer, etc. The expectation is that there will be profits because if no money is made, there would be no taxes. There would still be a requirement to report the activity in most cases, but renting something generally assumes that the money will be made over time.
Rental income versus business income
If you are only renting a property, this will be considered rental income. If you are offering a service that goes along with the property and charging for it, it would be considered a business. The classic example to show the difference is a Bed and Breakfast. Since meals and laundry services can be provided, this is considered a business rather than just having a place to stay on the property and do your own cooking and cleaning. If there is an existing business and the rental of a property is a related part of it, then the rental would be considered part of the business. For example, if you are manufacturing auto parts and rent out some of your space on a temporary basis, this rental would be part of your auto parts business rather than rental income.
What difference does it make if your activity is a business or not?
The differences between rental and business income is that rental income transferred to a spouse or child can be attributed back to the person who transferred it, while income from a business does not have this restriction. This means that whoever paid for the rented property would have to declare the income for tax purposes. If you have children involved in sharing the profit from a rental versus a business, this would mean a difference in who can declare income and expenses. Rental income is earned where the property owner lives, while business income is taxed where the business is located. If you have multiple locations for rental properties or multiple businesses with different tax rates, this can mean a higher or lower tax bill depending on where the businesses are set up. Available deductions may differ between rental and business income. There are different rules on asset depreciation or capital cost allowance (CCA) for rental properties as opposed to businesses. Rental income would not be subject to CPP deductions, but business income would be. A rental property has a calendar year reporting period, but a business can change it to any time of the year. Depending on your circumstances, these differences can either save you money or create a bigger tax bill.
How to report rental income?
Rental income is reported on form T776 – Rental Income Statement which can be found on the CRA website. This form will be submitted together with the personal tax return as an additional document. If the rental is part of a business, the form to use is the T2125 – Business and Professional Activity Statement, which is the business form. This would also be added to the personal tax return as an additional document.
Current expenditure versus capital expenditure
Both a current expense and a capital expense represent money spent during the current tax period. If an expenditure is being incurred to keep the property maintained and in the same working condition as before the money was spent, this would be called a current expenditure. Examples of this are the day-to-day costs of running the rental property, such as utilities, insurance, and property taxes. A capital expenditure is money spent on something that is expected to last more than one year and is a separate item purchased for the property or a property improvement. If the money spent would make the property more valuable or useful compared to something else, this would be called a capital expenditure. An example of a separate item would be a kitchen appliance within the rental property. This appliance is expected to last more than a year, can be moved to another part of the home so it is a separate item and is being used by the tenant so it is an eligible expense for deduction. If there are costs incurred to set up a property or make it available for rent, these costs would be considered capital expenditure and would be part of the acquisition cost rather than separate expenses. The intent behind the money and the state of the property before and after the expenditure are important in determining how the money spent should be treated for tax purposes.
Tax treatment of current and capital expenditure
The main difference between current and capital expenses is the timing of their deduction. Current expenditure is discounted in the year in which it was incurred in its entirety. A capital expenditure would be deducted over the life of the asset which would normally mean a period of years. This means that the expense would be deducted more slowly. Spreading the deduction over several years is called amortization. This is calculated by finding out the class of the item or expense, finding the related depreciation rate, and then using it as a partial deduction each year until the expense is fully accounted for. For example, if you bought an appliance and it was a Class 8 item, the associated depreciation rate would be 20% per annum. This means that if you buy an appliance that costs $1000, you can deduct 20% of that $1000 or $200 a year.
Depreciation of the property itself
Whether to calculate the depreciation of the property itself is a choice that must be made by the taxpayer. There are advantages and disadvantages to claiming this expense. The first factor to consider is that property depreciation cannot be used to create a rental loss on the property. If your property isn’t that profitable, you won’t be able to claim much depreciation even if you wanted to. The second factor to consider is that if the depreciation is claimed, you will likely have to pay more taxes later when you sell the property. Land and buildings don’t depreciate very often. When there is a sale, there is usually a capital gain and taxes will need to be paid on a fraction of that gain. If you were claiming depreciation along the way before the sale, your tax bill would tend to be higher than otherwise.
Are you using the property personally?
If you are renting something and using it personally at the same time, the rental and personal use should be split somehow. This is because anything used for personal reasons would not be deductible or reported on a tax return, but rental property is. If it is a rental property, the space would be divided into personal use and rental space, and the expenses would be prorated to reflect how much of the expense should go to the rental property.
The rules discussed in this article are very general and will apply to most rental situations. For more specific situations and more details, visit the CRA website.
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