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How to Calculate Tax Payable on the Sale of Your Rental Properties?

Hi fellow Canadian Real Estate Investors,

It was my birthday weekend last week.

facebook_1470672080045Erwin arranged a surprised celebration party on Sunday with my best friends.

He knows that I’m a geek so we once again went to an escape room. This time we manage to escape in less than 35 minutes and that was the fastest time I had ever done!

We even made the best escape time for the week! Woo-hooh!

Now onto this week’s topic.

The Tax Man is often the most ignored partner in our business.

He usually gets a big chunk of our return.

For those of you who are considering selling their principal residence, you can be reassured that you likely won’t have to pay any tax on your home provided that you meet certain conditions.

For those of you who are considering selling one of their investment properties, the tax implication can be a bit more complicated.

There are two steams of income you would need to pay tax on: (1) capital gain and (2) recapture.

Capital gain

This is an easy one. Let’s use an example to illustrate.

Say you purchase a property for $250,000, and you sell it for $350,000 and assuming the property is buy and hold.

Capital gain = $350,000 – $250,000 = $100,000.

In Canada, only 50% of capital gain is taxable, hence 50% of $100,000 is taxable = $50,000.

If you own the property in your own personal name, this $50,000 is added on top of your other income and is subject to the marginal tax rate for the respective tax brackets you are in.

For simplicity’s sake, we use the HIGHEST marginal tax rate in Ontario in our calculation – 53.53%, round it down to 50%.

Hence tax liability is roughly $50,000 x 50% = $25,000.

Keep in mind that if you make less than $220,000 personally BEFORE you add in this $50,000, you will be subject to lower tax.

$25,000 is MAXIMUM you would have to pay on the capital gain.

If you own the property in your corporation, the numbers would pretty much the same. 50% is taxable but the taxable portion is considered passive income.

Passive income is taxed at slightly over 50%.   Hence, you do the same calculation as above. Take $100,000 x ½ (50% taxable) x 50% (rough tax rate on passive income) = $25,000.

Next time when you are trying to estimate the amount of taxes you would owe when you sell a property, simply take the gain and multiply it by 25%. This will give you a really good idea of how much you would have to pay.

Recapture

As a taxpayer, you are allowed to claim the wear and tear on the property to defer your rental income.

The wear and tear is called capital cost allowance.

Use the same example as above, you purchased a property for $250,000.

Assume that 90% of the value belongs to the building and 10% of the value belongs to the land, capital cost of the building is therefore 90% x $250,000 = $225,000.

You can then claim $225,000 x 4% against your net rental income every year to defer the tax. The amount of claim is capped by the amount of net rental income you make from your portfolio.

In a previous blog posts that I wrote last year, I discussed whether you should use capital cost allowance to defer your rental income before. Feel free to check this out.

What’s the catch then?

You will have to take all the deductions you claimed throughout the years into income the year you sell your rental property!

For those of you who are unfamiliar with the concept, concept of capital cost allowance is similar to that of RRSP. You deduct the contribution you make against your income but you will have to report them in your income the year you take it out.

Say year 1 you had $5,000 net income after deducting all the qualified expenses against the rental income. You can take the lower of:

  • $225,000 x 4% x ½ (first year only ½ is deductible) = $4,500
  • $5,000

In this case, you can choose to deduct $4,500. But this also means that the year you sell it you will have to take this $4,500 into your income.

Now year 2 you had the same net income of $5,000. You can again take the lower of:

  • You can only take 4% on the undepreciated amount ($225,000 – $4,500) x 4% = $8,820
  • $5,000

In year 2, you will take $5,000 of capital cost allowance.

Say year 3, you decide to sell and it was sold for $350,000.

On top of the capital gain tax that you would have to pay, you are also required to take all the capital cost allowance into income.

In our example, you’ve taken $4,500 in year 1 and $5,000 in year 2, total of $9,500.

You will have to take $9,500 into income.

Similar to the calculation of capital gain tax above, we use the highest marginal tax rate of 50% to estimate the tax.

Therefore, tax payable on recapture is 50% x $9,500 = $4,750.

Total tax liability = capital gain tax + recapture tax = $25,000 + $4,750 = $29,750.

Are there ways to reduce these tax liability?

Absolutely!

Recapture tax can be reduced by using capital cost allowance of another property against the property being sold.

If you don’t have a second one, you can consider buying another property in the same calendar year.

Capital gain taxes can be reduced by any capital assets that you own that already have unrealized capital losses, such as, loss on any stock or mutual funds in any unregistered accounts.

Until next time, happy Canadian Real Estate Investing and enjoy the heat.

Cherry Chan, CPA, CA

Your real estate accountant

12 replies
  1. Syed Kamal
    Syed Kamal says:

    In the example you used the capital gain was $100,000. What if I developed basement, made repairs to drainage system, bought furniture and appliances for the rental home etc etc. Would these costs not be expenses deductible against capital gain. What kind I be required to have at hand.

    Reply
    • Cherry
      Cherry says:

      If you made repairs to drainage system and they were truly repairs, expenses should be considered a write off against rental income. On the other hand, if the expenses were incurred to improve the property, these expenses would be added to the cost of the building, and you can claim them against the future sale price (and also claim capital cost allowance on these expenses).

      For all the expenses, you are required to keep all the receipts incurred.

      Reply
  2. Rakesh
    Rakesh says:

    Some one buy home plot for 2,00,000 now selling it 9,00,000 profit is 7,00,000. Now how much he is liable to pay as tax to BC govt.

    Reply
    • Cherry
      Cherry says:

      Rakesh, it’s a complicated question. If you buy the house with the intention to flip, you are liable for tax on $700K. Depending on the ownership structure, you can pay as low as 15% and as high as 50%.

      If the intention is to buy the house for long term investment and earning rental income, you can use the capital gain calculation done in this blog post for your tax estimate.

      If you purchased the home and have lived there as your primary residence, your tax balance can be nil.

      So depending on your situation and make sure you consult with a professional accountant for your particular situation for the proper advice.

      Reply
  3. Colleen Smith
    Colleen Smith says:

    You state that recapture tax can be avoided by using the UCC of another property or by buying another property in the same year. This deals with the concept of pooling assets in one class. However, I’ve been told by a tax person that rental properties in excess of 50k have to be put in separate classes and that when a property is sold, tax has to be paid on any recapture, even though the taxpayer owns other properties with UCC balances or replaces the asset in the same calendar year. What is the correct answer?

    Reply
    • Cherry
      Cherry says:

      Hi Colleen, rental income is viewed on a portfolio basis and hence CCA taken on one property can be used to offset against rental income incurred on another property. Recapture is viewed as rental income and CCA on a new property can then be used to reduce the rental income (partly created by recapture) and provide further deferral.

      Hopefully this helps.

      Reply
    • Cherry
      Cherry says:

      Generally speaking residential rental property resale is not subject to HST. I would still check with a qualified accountant with your specific situation though.

      Reply

Trackbacks & Pingbacks

  1. […] If you sell a property and make substantial gain during the year, make sure you are putting aside sufficient amount of money to pay your taxes at the end of the year. You can refer to how to estimate the tax liability in this blog post. […]

  2. […] Based on today’s tax law, 50% of this capital gain is taxable, so you have $5million taxable income in your personal name. (You can easily refer to my previous blog post on how to calculate tax payable on sale of properties here.) […]

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