• June 30, 2021

Rental income and taxes

Have you been considering acquiring a rental property or renting part of your home for income? This article will explain the basics of renting a 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 generally considered real property, but it can be anything that can be rented, such as a car, snowmobile, power tools, computer, etc. The expectation is that there will be profits because if no money is made, no taxes will be owed. In most cases, there would still be a requirement to report activity, but renting something generally means that money will be made over time.

Rental income versus business income

If you are only renting one property, this would be considered rental income. If you are providing a service that accompanies the property and charges for it, then this 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 simply having a place to stay on the property and do your own cooking and cleaning. If there is an existing business and renting a property is a related party, then the rental would be considered part of the business. For example, if you are making auto parts and renting part of your space temporarily, this rent 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 rent and business income are that rental income transferred to a spouse or child can be attributed to the person who transferred it, whereas income from a business does not have this restriction. This means that whoever paid for the rental property would have to declare the income for tax purposes. If you have children involved in sharing the profits from a rental versus a business, this would make a difference in who can report income and expenses. Rental income is earned where the property owner lives, while business income is taxed based on where the business is located. If you have multiple locations for rental properties or multiple businesses with different tax rates, this may mean a higher or lower tax bill depending on where the businesses are based. Available deductions may differ between rent and business income. There are different rules regarding asset depreciation or cost of capital allocation (CCA) for rental properties compared to businesses. Rental income would not be subject to CPP deductions, but business income would. A rental property has a calendar year reporting period, but a business can change it at any time during the year. Depending on your circumstances, these differences can save you money or lead to a larger tax bill.

How is rental income reported?

Rental income is reported on Form T776 – Rental Income Statement which can be found on the CRA website. This form will be sent along with a personal tax return as an additional document. If the rental is part of a company, the form to use is T2125 – Declaration of commercial and professional activities, which is the commercial form. This would also be added to a personal tax return as an additional document.

Current spending versus capital spending

Both a current expense and a capital expense represent money spent during the current fiscal period. If there is an expense being incurred to keep the property maintained and in the same state of operation as before the money was spent, this would be called current expense. Examples of this are the day-to-day costs of operating 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 a year and is a separate item purchased for property or a property improvement. If the money spent would make the property more valuable or useful compared to otherwise, 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, it can be moved to another part of the house, so it is a separate item and the tenant is using it, making it a viable expense for the deduction. If there are costs incurred to establish a property or make it available for rental, these costs would be considered capital expenditures and would be part of the acquisition cost rather than separate expenses. The intention behind the money and the condition of the property before and after the expense are important in determining how the money spent should be treated for tax purposes.

Tax treatment of current and capital expenditures

The main difference between current and capital expenses is the time of your deduction. Current expense is deducted in the year in which it occurred in its entirety. A capital expense would be deducted over the life of the asset, which would generally mean a period of years. This means that the expense would be deducted more slowly. The distribution of the deduction over several years is called depreciation. 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 has been fully accounted for. For example, if you purchased an appliance and it was a Class 8 item, the associated depreciation rate would be 20% per year. This means that if you buy an appliance that costs $ 1000, you can deduct 20% of that $ 1000 or $ 200 per year.

Depreciation of the property itself

The calculation of the depreciation of the property itself is a decision 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 keep in mind is that if you claim depreciation, you will likely have to pay more taxes later when you sell the property. Land and buildings don’t lose value very often. When there is a sale, a capital gain is generally incurred and taxes are paid on a fraction of that gain. If you were claiming depreciation down the road before the sale, your tax bill will tend to be higher than otherwise.

Are you using the property personally?

If you rent something and use it personally at the same time, the rental and personal use portion would have to be divided in some way. This is because anything used for personal reasons would not be deductible or reported on a tax return, but rental property would. If a home is rented, the space would be divided into personal use space and rental space, and any expenses would be prorated to reflect how much of the expense should be allocated 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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