What are the Tax Considerations of Real Estate Investing?
With tax season upon us, many real estate investors assess the tax implications of owning real estate. How does your real estate portfolio impact your taxes? What do you need to consider?
Regardless whether you own one investment or multiple properties, managing your real estate portfolio is like a small business. You need to file a statement of revenues and expenses for your rental properties with your return each year.
This month, I’ve asked my accountant, Bruce Hurst of Reid Hurst Nagy Inc. to offer some insight and discuss the impact of real estate investing on your investment portfolio.
From a tax perspective, owning real estate and rental properties can offer some clear advantages. We all know the benefit of your tenants paying rent to cover the mortgage, but here are some other advantages:
- The mortgage interest and most operating costs are tax deductible against the rents received.
- If there are any losses the losses are deductible against other income.
- When the property is eventually sold the appreciation in value is treated as a capital gain and only half the appreciation is subject to tax.
- You can claim capital cost allowance (CCA) on appliances within your property as well as the building itself if the income is positive. This should be considered if you are in a higher tax bracket now compared to when you retire. Later, when you retire and your income is lower the capital gain on sale and the recapture of CCA can be taken into income at lower tax rates.
- Unlike interest income and dividend income, you can include rental income in your total earned income calculation on your tax return to determine the maximum amount you may contribute to an RRSP.
- Upon death, you can transfer the property to your surviving spouse without triggering any tax consequences until the surviving spouses dies.
- If you have several apartments and your spouse helps you take care of maintenance or administration, they can claim a reasonable salary, thus benefiting from income-splitting. Income splitting can also be achieved by holding the properties in joint names.
Of course, there are also some important things to consider when investing. Understanding your propensity for risk and market conditions is an important part of selecting your investments.
Here are some things to avoid:
- Avoid properties where rental increases are restrictive but operating costs are free to increase with the market. This is especially so in condos where the owner is responsible for utility and heating costs as part of the maintenance fees.
- Avoid markets where there is high likelihood of vacancies or that attract a poor quality tenant.
- Avoid markets where there is limited opportunity for capital appreciation.
On a more technical basis rental income earned inside of a corporation is generally taxed at the highest corporate rates of approximately 45%. However if you have a sufficient number of properties to support at least 5 full time arms-length employees in addition to the owners the rental income would be considered active business income and subject to the lowest tax rate of 13.5%.
Seeking professional advice is the first step in understanding how you can support decision making to improve tax outcomes. From a financial planning perspective, real estate is a good solid asset to have in your asset mix. It not only provides income but it can also add considerably to your net worth.
My thanks to Bruce for his valuable insight and thoughts around tax.
BRUCE HURST, FCGA, CFP – Shareholder and Director of Reid Hurst Nagy Inc. Certified General Accountants.
As a Shareholder and Director of Reid Hurst Nagy Inc. Certified General Accountants, Bruce Hurst has extensive experience in managing and directing RHN’s business advisory and accounting services for a number of investors of real estate holdings, Personal Real Estate Corporations (PRECs) and income tax preparation for real estate brokers.