Anything that reduces your tax bill, may it be a tax deduction or credit, is worth learning about. Wouldn’t you agree?

When politicians are claiming that they are “putting more money back into the pockets of Canadians”, not every policy carries the same amount of impact as others. 

Some put more money into your pockets and while some appear to be big, the impact can be extremely small.  

Real Estate Investors often confuse tax credit with tax deductions and ask me, what’s the difference and which one is more beneficial to them? 

While they both sound very similar, they provide significant differences in impact. 

What is a Tax Deduction?

Tax deductions are basically the eligible expenses you claim to reduce your taxable income. For example, if you made $100,000 last year and claimed $10,000 in approved deductions, you would only have to pay tax on a reduced taxable income of $90,000. 

To truly understand the impact of a tax deduction, we need to first get a better understanding of how the Canadian personal tax system works. 

Progressive tax system

How does the government increase Canadian housing? The government does the biggest thing that they can do – set a ban on foreign investment in Canadian housing. Yes, they are going to impose a ban on foreign investment on resid

The Canadian personal tax system is a progressive tax system.  The more income you earn, the more taxes you will have to pay. 
The chart below shows the marginal tax rates for Canadians residing in Ontario in 2022:

Income rangeMarginal tax rate
$0 – $11,141
0%
$11,141 – $14,3985.05%
$14,398 – $46,22620.05%
$46,226 – $50,19724.15%
$50,197 – $81,41129.65%
$81,411 – $92,45431.48%
92,454 – $95,90633.89%
$95,906 – $100,39237.91%
$100,392 – $150,00043.41%
$150,000 – $155,62544.97%
$155,625 – $220,00048.35%
$220,000 – $221,70849.91%
over $221,708
53.35%
Source: http://www.taxtips.ca/taxrates/on.htm

I have simplified the above chart to summarize all major marginal tax rates. However, there are additional income ranges and marginal tax rates. 

The best way to explain this system is to use an example.  

In this example, we’ll assume a real estate investor earns employment income of $150,000. To calculate the tax payable, we have to go through the entire list of marginal tax rates.

Here’s how it works:

Between $0 and $11,141, you get taxed nothing.  

Between $11,141 and $14,398, you get taxed at 5.05% Ontario tax rate.  

=  ($14,398 – $11,141) x 5.05% = $164.48.


Between $14,398 and $46,226 you get taxed at 20.05%.  

=($46,226 – $14,398) x 20.05% = $6,381.5.

And so on. We have to go through the above calculation for someone who earns $150K employment income. Then, add them all up in the tax payable column, and we will come up with a total tax payable of $44,642. 

See the table below:

How does Tax Deduction Work?

Now that you get a better understanding of how the Canadian personal tax system works. 

We can explain how tax deduction works. 

Tax deduction is used to reduce your tax income.  For someone who’s earning $150,000 in his personal tax return, having an extra $10,000 deduction means that he only pays tax on $140K. 

The $10,000 deduction means that he can save $10,000 x the highest marginal tax rate he belongs to, and in this case, it is 43.41%.

Tax savings = $10,000 x 43.41% = $4,341

Total tax liability is $40,301, instead of $44,642.

As you can see, a tax deduction is used to shave off the taxable income from the top marginal tax rate

The higher your income, the higher your marginal tax rate would be, and the higher the saving extra tax deduction would give you.

Common tax deductions:

Now another thing that t

First of all, as real estate investors, the biggest tax deductions we get to apply are the ones we discussed in the past blog post – top 10 tax deductions real estate investors can make in this blog post

We also discussed how you could deduct moving expenses and deduct travel expenses here before. 

Another commonly used one is child care expense deduction.  Rules surrounding child care expense deduction are a bit more complicated.  But similar to all other tax deductions, child care expense deduction is deducted against the top marginal tax rate of the lower income spouse, up to a maximum based on the age of the kids.  

As a real estate investor, you’re probably already familiar with Registered Retirement Savings Plan (RRSP) Deduction as one of the best tax-saving strategies in Canada.  

Another commonly used one for investors is interest expense deduction.  If you borrow money to invest, the interest expense you incurred for the purpose of earning investment income is generally deductible as a tax deduction.  

These are common tax deductions that shave the income tax off the top marginal tax rate, giving you most tax benefits. 

What is a Tax Credit?

The CRA defines Tax Credit as an amount that reduces the tax you pay on your taxable income. The more tax credits that apply to you, the more you can reduce your income tax. 

The federal, provincial and territorial governments each provide tax credits, which you can use to lower your taxes.

Unlike tax deduction, tax credits are given to you using the lowest marginal tax rates – rather than the highest.  

If you get a $10,000 tax credit and assuming the tax credits are offered by both the Federal and provincial government, the tax credits are usually calculated using the lowest marginal tax rate and in our example below, it is 20.05% combined.  Federal lowest marginal tax rate is 15% and Ontario lowest marginal tax rate is 5.05%.

So a $10,000 tax credit is equivalent to a tax saving of $10,000 x 20.05% = $2,005. 

If you compare the tax saving from a $10,000 tax credit to a $10,000 tax deduction, you can see that tax saving from a $10,000 tax credit would only give you $2,005 tax saving, whereas a $10,000 tax deduction would give you $4,341 tax saving for someone earning $150,000.

Tax credit gives you tax savings calculated based on the LOWEST marginal tax rates.     

Tax deduction gives you tax savings calculated based on the HIGHEST marginal tax rates.

Commons Tax Credits

Refundable vs. Non-refundable Tax Credits

Tax credits are not always equal either.  Some tax credits are refundable, some aren’t.  

As an example, the first time home buyer tax credit is a non-refundable tax credit.  It can be used to reduce your tax payable.  But if you do not have a tax payable, then you’re not entitled to a refund. 

Similarly, medical expenses, tuition, donation, disability, digital news subscription, interest on student loans are examples of non-refundable tax credits.   They are all used to offset against your tax payable.  If you have more non-refundable tax credits than your tax payable, then no refund would be issued.  The excess tax credit is then unused. 

On the other hand, a refundable tax credit, such as the Working Income Tax credit, are credits that will be paid to you whether or not you have paid taxes.  Ontario Energy and Property Tax credit is a commonly known refundable tax credit that’s available to taxpayers that qualify.  

Would You Always Get a Refund?

The First-time Home Buyer Incentive is an incentive provided by the federal government with the help of CMHC, w

For tax deduction, you won’t always get a refund.  You will only get a refund if your tax payable, after taking the tax deduction, is greater than what you have paid to CRA. 

I had a couple of clients who are brand new real estate investors who quit their jobs and doing real estate investing full-time, they spent a lot of money and effort on renovating their properties.  When the tax time comes, they are expecting a huge amount of tax refund.  

First of all, major renovation is rarely considered a tax deduction.  

Secondly, even with legitimate tax deduction, if they had never paid any taxes to begin with, 

Since they were brand new investors, not earning income to begin with, there were no taxes paid.  

Difference between Federal and Provincial Tax Credits

Some tax credits are available federally while some are available provincially.  

As an example, Ontario Energy and Property Tax Credit and Staycation Tax Credit are available strictly in Ontario only.  The calculation is based on the qualification criteria as set out by the Ontario government. 

Some tax credits, such as tuition tax credit as well as digital news subscription expenses tax credit are available Federally.  The tax benefit is calculated based on the lowest marginal tax rate imposed by the Federal government at 15%, not the combined tax rate of 20.05%.  

Now that you have got a firm understanding of the differences between a tax deduction and tax credit.  It’s almost safe to say that if you’re making money and paying taxes, it’s always better to get tax deductions, rather than tax credits. 

There’re ways to convert some tax credits into tax deductions for business owners.  Stayed tuned for another post.

Until next time, Happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Real Estate Investors often ask me, “Can I deduct travel expenses, and if yes, then how?”.

Generally speaking, you can deduct expenses that you incur to earn business income/rental income, subject to a bunch of exceptions, as specified in the Income Tax Act.

Whether you are eligible to deduct a trip, you need to answer the primary question – did you incur these travel expenses for earning a business income?

You can watch my video on this here

Can you Deduct Expenses?

To deduct your travel expenses you need to show that your trip was for the purposes of earning a business income.  In simpler terms… it must qualify as a “business trip”.

Things you need to consider:

How Guy Laliberté tried to deduct expenses and failed

Some of you may remember the infamous court case involving the founder of Cirque du Soleil. Let’s use his case as an example:

Cirque du Soleil’s majority shareholder, Guy Laliberté tried to deduct expenses related to his travel to space as a business expense back in 2018. He claimed deduction of his entire trip in Cirque du Soleil’s operation, stating that this trip increased publicity and provided media coverage that would otherwise cost over $300million to achieve.

His trip cost roughly $42million. 

Maybe he was aware that the expenses aren’t deductible.  It was not deducted in his business’s tax return.  He expensed the travel expense on its financial statements (not for tax deduction), paid $38million of the $42 using business money, and left  $4million as shareholder benefit.

Even though he didn’t deduct the $38M on its tax return, the $38M paid for by Cirque du Soleil for the benefit of its shareholder is still considered taxable benefit in Guy Laliberte’s personal tax return.  

Since the expense was NOT necessary or reasonably justified as being paid by the company, he had to report this $38million in his personal tax return, resulting in personal taxes of $19million. 

Yikes! No wonder CRA denied this claim.

The judge acknowledged the increase in media exposure to Cirque du Soleil because of his trip to space. However, the judge concluded that the primary purpose of the trip was for personal purpose rather than for business purpose based on the following reasons:

In conclusion, the judge found that the primary purpose of the trip was purely personal, so he disallowed the deduction but allowed the actual costs incurred by Cirque du Soleil and One Drop Foundation to promote the trip.

Was I (Cherry Chan) able to deduct expenses on a trip to my home country?

In the same year, I went to Hong Kong, to attend a family funeral. As you will note, the primary purpose of my trip was personal.

I did spend some time doing work, but the business-related reasons were very minimal compared to the primary objective of my trip.

The simple answer to the question is no. I couldn’t deduct the flight and hotel costs of the trip.

But I was able to deduct the incremental costs I incurred for working on the business while I was there.

I didn’t incur any expenses for my video recordings and book writings. If I did as well, those incremental expenses would have been deductible too.

If I had met up with a prospect to discuss future business opportunities, the meal costs for taking this prospect out would have been deductible.

What is deductible, if these two scenarios the expenses were not entirely deductible?

Although the cost of my trip to Hong Kong was way less ($1,500) than the cost of Guy Laliberté trip ($42million), the rule here is the same.

The main takeaway is this –  to deduct expenses, the primary reason for your trip must be a business purpose.

If the primary purpose of the trip is to attend a business-related conference or to meet with suppliers/prospects/clients – make sure you have the right documentation to prove so, (such as email communications) before you plan to deduct expenses of the trip.

The sequence of events matters.

If you also want to take a tour, have some R&R while you’re there, timing and evidence would matter.

Room & board, however, would be deductible if the trip is for business. Expenses incurred for personal enjoyment would not be deductible.

On the other hand, if you plan your vacation first, then tag on some business activities afterwards. The timing of your email communication and planning will be completely different.

Publicity may be good or bad, be careful with what you publish online.

Whenever I tell people that CRA auditors use google search as well, people always laugh.

It’s true. If you can search for the information, CRA auditors can do the same thing. And trust me, they would!

If you are telling people on social media that you are taking your family for a Disney cruise, chances are, they can also find out!

What you publish online matters.

Family can come along but be careful and deduct only what’s business related.

If your family is coming along and they do not participate in the business, you probably should keep their expenses as personal.

If the primary purpose of the family making the trip was to help at the tradeshow, you may be able to deduct expenses made on this trip.

Just be mindful with the key consideration here: is the primary reason for your trip business related or personal purpose?

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Did you move this year?  Or, are you planning to move this upcoming year?

During the pandemic, a large number of Canadians have moved from the cities to the suburbs, trying to find more space in and out of their homes. 

As it turns out, the few thousand dollars of moving expenses can be deductible, provided that you meet certain criteria. 

In some cases, you may even be able to deduct the realtor expenses you incurred to sell your old homes as a part of your moving expenses!

We talked about the HST rebate on New Home recently, and you loved it. This week we will look into deducting the moving expenses you make when moving to your new homes.

I have created a video for you as well, where I talk all about how to deduct moving expenses the right way.

According to the CRA, you can generally claim moving expenses you paid in the year from the employment or self-employment income you earned at your new work location. Provided that you meet both these requirements.

To be able to deduct moving expenses:

  1. You must have moved to work or to run a business at a new location,
  2. Your new home must be at least 40 kilometers closer (by the shortest public route) to your new work location 

Let’s use an example to explain. 

I moved in 2021 from Burlington to Oakville so that I could have a shorter commute to the office.  The drive from my old house to the office location is 20km.   The drive from my new house to the office is 11km.  My new home is only 9km closer to my office.  Therefore, I would not be qualified to claim any moving expenses. 

Let’s use another example to explain. 

You got a new job in Kitchener where you grew up.  Your old job was in Toronto and you lived close by.  With the new job, you decided to move back to Kitchener.  It will only take you 10km to drive to your new job location.  If you were to stay in Toronto, the commute each way would have been 120km.  

You’re close to your work location by 110km.  Therefore, you’re eligible to deduct moving expenses on your personal tax return against your income. 

Now that you know the criteria to deduct moving expenses, let’s discuss the type of moving expenses that are eligible for a deduction.

What moving expenses can you deduct?

However, you cannot claim these costs during a period when the old home was rented. This means that these costs must have been incurred when your old home was vacant. 

Cost of buying the new home
The cost of buying your new home can also be tax deductible. This includes legal or notary fees you paid to buy your new home, as well as any taxes paid (other than GST/HST) for the transfer or registration of title to the new home.

As always, in Canadian taxpayers, we all need to earn our deduction.  This means that you would be required to provide documentation and receipts for all expenses deducted. 

If you don’t have receipts, you aren’t eligible for deducting the expense.  Even if you have all the receipts, there are some exceptions to the deduction.  Here’re a few as an example:

The Catch

The maximum amount you can deduct moving expenses is capped by the amount of income you are getting from your new job/new self-employment income. 

You cannot use the moving expenses to deduct against investment income or other sources of income. 

Don’t worry though.  If your moving expenses are greater than the eligible income that you can deduct against, the extra can be carried forward for future years for deduction. 

If you receive any reimbursement from your employers for the move, you will have to report the reimbursement as income, offset against the net moving expenses for the deduction. 

What if your tax deductible moving expense incurred in the year after you moved?

Let’s say you moved to your new residence that’s closer to your new workplace (by 40km at least) close to the end of the year, and you have incurred a portion of the moving expenses in the year after the move. 

You can then claim these expenses on your return for the year you paid them against employment income earned at the new work location.

The same rule applies if you sold your old home after the year of your move. In this situation, the CRA may ask you to submit a form with receipts and explain the delay in selling your home. But bear in mind that you cannot carry back moving expenses to a prior year.

For instance, if you have moving expenses (e.g cost of maintaining your old home when vacant) that you paid for in the current year, for a move that you made last year, you cannot claim the expenses paid in the current year on your prior year return. This is the case even if you earned employment income at the new location in the prior year.  You can simply deduct the expenses in the following year. 

Again, it’s not all black and white. That’s why we are here to help you navigate through it. So that you can make the most out of your tax deductible moving expenses. 

Book a consultation with us at Real Estate Tax Tips today! We’re here to help you real estate investors decide if your moving expenses are tax deductible. 

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

As a landlord and taxpayer, you may wonder how to claim tax deductions on gift cards?

Being a landlord myself, I too like to give gift cards to my tenants as a gesture of goodwill. After all, no good deed goes to waste. When you treat your tenants nicely, they will take good care of your home as well.

Generally speaking, any expenses you incur for the purpose of earning income is tax-deductible (subject to certain limitations as specified by the Income Tax Act).

Limitations, such as subsection 67.1(1), that reduces the meals and entertainment expenses to 50% deduction instead of 100% as a result of human consumptions of food or beverages or the enjoyment of entertainment.

This means that if you take your tenants out for dinner, only half of the meals are deductible. You can spend $50 for both of you, but only $25 is deductible. This is stated in the Income Tax Act to eliminate the personal enjoyment portion of your meals.

You may then wonder if you can deduct 100% of your meals expenses if you purchase restaurant gift cards entirely for the enjoyment of your tenants without any of your participation?

A taxpayer in 2006 had already brought this scenario to court (The Queen v. Stapley, 2006 DTC 6075). The taxpayer was a self-employed real estate agent. The taxpayer often bought gift certificates for food and beverages and tickets of various sporting events to his clients. He did not attend the dinners and the sporting events and hence he deducted 100% of the costs.

Initially, the Tax Court ruled in favor of the taxpayer, based on the fact that the purpose of subsection 67.1(1) was to eliminate the personal enjoyment component from the deductions and the taxpayer did not participate in any of these events.

Unfortunately, the Minister appealed the decision made by the Tax Court to the Federal Court of Appeal. Based on the literal translation of section 67.1(1), expenses for food, etc. are 50% deductible in respect of human consumption of food and beverages or the enjoyment of entertainment.

Just because the taxpayer did not get to enjoy the entertainment or the food and beverages, someone else did. And just because the objective of section 67.1(1) was meant to eliminate the personal enjoyment portion, the section was not written in such a way that it wouldn’t be applied if there was no personal enjoyment.

The judge reluctantly ruled in favour of the Minister. This means that all the gift certificates issued from a restaurant would be 50% deductible, not 100%.

Furthermore, in 2014, Judicial and CRA Interpretations of Canada Tax Law and Transactional Implication stated that if the gift certificates are issued by the supermarket, a permanent establishment that is primarily engaged in selling food and beverages, section 67.1(1) applies and only 50% of the expenses incurred are deductible.

Say, you are buying a Home Depot gift card, even if you have a home depot promo code, for the purpose of earning the property income, since Home Depot is not an establishment that is primarily engaged in selling food and beverages, you should be able to claim the expenses 100% as tax deductions.

On the other hand, if you purchase a Tim Hortons gift card (restaurant) or a No Frills gift card (grocery store), you may spend $100, but you only get to deduct $50.  Only 50% is deductible. 

So… when you are selecting your gift card to say thank you this year, you know which ones give you the maximum deduction!

Until next time, happy real estate investment!

Cherry Chan, CPA, CA

Can you believe it’s November already?

Our team is preparing for tomorrow’s client only webinar to go through our bookkeeping procedures with clients.

It got me thinking, we should reiterate with everyone what real estate investors can deduct against their rental income.

Watch today’s video on the top 10 tax deductions you shouldn’t miss as Canadian Real Estate Investors.

  1. General deductibility rule

Canadian Income Tax Act allows Canadian taxpayers to deduct reasonable expenses that incur for the purpose of earning business income or property income, subject to a bunch of exception.

This means that as long as you’re able to establish the cause-and-effect relationship between incurring the expenses and earning the particular stream of income, you can potentially deduct the expense.

Next time, when you are incurring an expense that helps you earn your property income, make sure you keep the receipt. 

Compile all of them and have a conversation with your accountant at year-end to see if you can deduct these expenses. 

  1. You gotta earn your deduction

I always mention in my blog that in Canada, you gotta earn your deduction.

This means that, as a minimum, you need to keep receipts to support your expense deduction.

If you have a tenant who failed to pay you, make sure you have written confirmation email done to chase him/her for payment.

This also means that if you pay cash to a contractor and never receive the receipts, chances are, the deduction won’t pass through a CRA audit.

As a word of caution, credit card statement and bank statements are generally not sufficient to substantiate your claim.  

  1. Sample of direct expenses incurred for your property

Based on the general deductibility rule, here’re the most incurred expenses that real estate investors incur to earn property income.

These include but not limited to the following:

  1. Mortgage interest
  2. Property tax
  3. Utilities
  4. Insurance
  5. Property management fees
  6. Everything you think it helps to earn rental income (within reasons)

Make sure you keep the mortgage statement, property tax bill, utility bills, insurance policy, invoices, etc. to support your deduction.

  1. Finance charge

Finance charge are the cost that you incur to secure the mortgage on your investment property to allow you to earn rental income.

Some common examples of finance charge include mortgage insurance and its provincial sales tax that you paid and mortgage broker fees.

Mortgage insurance and its provincial sales tax are typically added toward your mortgage amount at closing.  You pay for this expense as part of your monthly mortgage payment.

Lender fees and mortgage broker fees are typically one time expense that you pay out of your pocket at the time of closing.

Finance charge can be deductible over 5 years regardless of when you pay for it.

Sometimes, they are not picked up as an expense deduction against income as they only show up at your closing documents.

  1. Line of credit interest

Many of our clients start investing by tapping into the equity accumulated in their own primary residence.

They borrow against the primary residence to pay for the down payment of the rental properties that they purchase, and some may use the line of credit to finance the renovation as well.

Whether the borrowing is in the form of line of credit or mortgage, the interest related to the portion that you use to earn investment income is generally tax deductible.

Make sure you keep the documentation of cash transfer, payment, etc. so that you can earn your interest expense deduction!

  1. Auto mileage

Going back to the same general deductibility rule, if you drive your car to manage your rental portfolio, you’re eligible to claim the business portion of your motor vehicle expenses.

This includes the following:

  1. Gas
  2. Auto insurance
  3. License and registration
  4. Maintenance and repairs
  5. Other costs such as CAA, 407 ETR
  6. Interest expense on car loan
  7. Parking (directly incurred for the purpose of earning income) and it is 100% deductible
  8. Capital cost allowance (deduction against your car purchase)

or

  1. Monthly lease payment

And yes, this means that you must keep the receipts of all these expenses.

On top of it, you are also required to keep a logbook to keep track of the business mileage you have incurred. 

Say if you incur 6,000km to manage your properties during the year, and you drive 10,000km the entire year, 60% of all automobile expenses are tax deductible, subject to some restrictions.

For those investors who love to track everything electronic, Quickbooks Online app and MileIQ are some common apps used in the marketplace to assist investors and business owners to track their mileage.

  1. Home office expense

If you happen to use your home for the purpose of running your rental portfolio, you can deduct a portion of your home against your income.

This means that you get to deduct the business portion of:

  1. Primary home mortgage
  2. Primary home insurance
  3. Primary home utilities
  4. Primary home internet
  5. Primary home maintenance & repairs
  6. Primary home property tax

You are required to keep all the receipts and documents to support your claim.

On top of that, you’re required to keep a copy of your floorplan and the area that is designated as the office space to manage your property.

Say, you have a 1,000 sf house and you use one of the bedrooms that is 100 sf as the designated office to manage your rental portfolio, 10% of all the expenses mentioned above are tax deductible. 

A word of caution though, if you use your home for employment purpose and rental purpose as well, claiming additional home office expense against your rental properties can potentially affect your claim as primary residence. 

Make sure you speak to your accountant before making this claim to understand the pros and cons.

  1. Membership/Education

I am a big believer in training and getting coaching.  I believe that we can avoid many mistakes that other people made in their journey by having someone guide us through.

Real estate education and meetup are very commonly held in the Southern Ontario area.

Some of these cost a couple hundred dollars a year.  Some cost tens of thousands of dollars.

Based on the general deductibility rule mentioned above, as long as investors can establish a cause and effect relationship between paying for these education and membership charges to earning rental income, they have a case to deduct the expenses.

This goes back to how fast the investors take action after they take the education course.  If they spend $10K to learn how to invest in real estate, but do not make take any action for a couple of years, it is challenging to convince CRA that there’s a cause and effect relationship between incurring the expense and earning the rental income.

Typically, a real estate investment takes a year or two to stabilize and show net rental income. When an investor deducts tens of thousands of educational cost and does not show sufficient income, the deduction may trigger a CRA audit.

Bottom line, they are deductible provided that you can prove the cause and effect relationship.  You might just have to deal with the increase risk of being audited if the expense is high.

  1. Capital cost allowance

CRA also allows investors to claim the wear and tear of the building as a tax deferral called capital cost allowance (CCA).

Capital cost allowance is calculated as a percentage against the building cost.

Similar to RRSP contribution, claiming CCA is a tax deferral, not a tax deduction.

With RRSP contribution, the year you make the contribution, you don’t have to pay taxes on the amount you contribute. But the year you withdraw from your RRSP, the withdrawal amount has to be taken back to income.

With CCA, the year you claim CCA against your rental income, you don’t have to pay taxes on the net rental income.  The year you sell the rental property, you have to take all the CCA you’ve claimed over the years as income

Make sure you watch our Youtube video to get a better understanding of what it is and how it works.

  1. Repairs and maintenance

Repairs and maintenance that are incurred as a result of the day to day maintenance and rental operation without improving the property life can typically written off against the rental income.

Renovations or capital improvements that are incurred to improve the property life cannot be written off against rental income.  They cannot be written off as an expense immediately against your rental income.  These capital improvements are added to the cost of your building. 

They can be claimed as capital cost allowance (CCA) and added to the cost base of your building, which eventually claim against the sale price your property when you sell.

But… the capital gain on sale of rental properties is 50% taxable, whereas rental income is 100% taxable.  When an expense is considered capital improvement, it means that the capital improvement is only 50% deductible.

Logically, many investors would prefer to argue that an expense is repairs & maintenance, rather than a capital improvement.

The line drawn between these two concepts is fussy and there’re frequent court cases about the determination between these two.

Typically speaking, if your expense is incurred to upgrade/improve the property, it’s considered capital improvement.  For example, replacing carpet floor with hardwood floor is considered capital improvement.  Replacing carpet floor with the same quality of carpet is considered repairs.

There’re some exceptions though…

One exception relates to a common investment strategy called BRRR (Buy, Renovate, Rent, Refinance).

The idea is to buy an older house, do a bunch of renovation to upgrade the value, get the best tenants in and refinance with the banks to pull out initial capital.

When you purchase an older house with the intention to renovate to get the property ready for rent, the expenses you incur to get the house ready for rent are typically considered capital improvement. 

Similarly, when you spend money to freshen up the house to get it ready for sale, the expenses that you incur to get the house ready for sale are also considered capital improvements.  They are added to the cost of your building and deducted against the sale price to lower your capital gain tax. 

Hopefully this provides some pointers for you when you get ready for next year.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

A handful of my self-employed clients recently reached out to ask us about Health Spending Accounts (HSAs). 

HSAs are essentially self-insured health plans that allow employers to provide health care benefits to employees’ tax free. 

Employers get to deduct the expenses and employees get to enjoy the benefits tax free.

If used properly, real estate agents and real estate investors can write off their medical expenses against their business income, which can provide significant tax benefits.

What is a Health Spending Account?

Health Spending Accounts (HSAs) are essentially self-insured health plans arranged by employers for employees in Canada.

Back in the days when I was working as an employee for Deloitte, we used to have HSAs as part of the benefit package.

Each employee is allocated a fixed amount of spending.  Employees get to choose what they use the money for, can be massage, dentist, optometrist, etc. 

This allows the employers to deduct the money they spend on funding the HSAs.  Employees get to receive the benefits tax free.

What type of Health Spending Accounts is deductible in the eyes of CRA?

Not all HSAs are born equal.  Some are tax deductible and some aren’t.  To qualify for a tax deduction as per CRA, all of the following conditions must be met:

In addition to it, only certain HSAs are acceptable:

Sole proprietorship with no arm’s length employees CANNOTdeduct money used to fund HSA as private health services plan against his/her business income.

How does Health Spending Accounts work?

When employees incur medical expenses, they first pay for it using their own fund.

They then mail the receipt and support to the Health Spending Accounts administrator.

Employers send the same amount of money to the Administrator.

Administrators issue a cheque to reimburse the employees.

Money sent by the employers to the HSAs Administrators are tax deductible against revenue, provided the plan and employers both qualify the criteria mentioned above.

Employees receive the medical benefits tax-free.

How does it benefit real estate agents and real estate investors?

When my family and I incur medical expenses, we pay for them ourselves out of pocket.  We have our own businesses, and we did not have medical plans coverage before.

We keep the receipts.  At the end of the year, we would tally them all up, enter them into our personal tax returns.

If your medical expenses qualify for medical expense tax credit and the total amount incurred is greater than 3% of your earned income or up to a maximum of $2,397 in 2020, you get to claim the excess as a tax credit.

Let me use an example to explain.

Say you earned $100,000 of net income; you want to see how much you can claim as medical expense tax credit…

CRA takes your net income $100,000, multiply that by 3% = $3,000, which is greater than the threshold of $2,397. 

This means that you need to incur MORE than $2,397 medical expenses BEFORE you get any tax credit benefit from the medical expenses.

If you only incur $500 medical expense, your claim will not give you any benefit.

If you incur $3,000 medical expense during the year, only the EXCESS amount $3,000 – $2,397 = $603, is used to calculate the tax credit. 

And this $603 does not come off your income as a tax deduction.  It is claimed as a personal tax credit.

You get $603 x 20% (basic combined tax rate in Ontario) = $121 tax credit against your personal tax.

However, if you incur the medical expenses via a Health Spending Accounts and assume that your HSA qualifies as a deduction with CRA…

If you operate as a sole proprietor and you have an arm’s length employee, you can claim this $3,000 as a tax deduction.  If you net $100,000, you can offset the $3,000 against the $100,000 net income and now you save $3,000 x 43% = $1,290. 

$1,290 is a lot better than $121!

If you are an incorporated real estate agent, as long as you are working as an employee receiving salary, with the use of Health Spending Accounts with a proper administrator, you can deduct the medial expenses against the business income reported in the corporation, essentially having your corporation paying for all medical expenses incurred. 

The amount of taxes you can save when you’re an incorporated employees can vary, depending on the amount of remuneration you draw out from the corporation. 

Bottom line

Health Spending Accounts can provide tax benefits if HSAs are setup in accordance with the CRA guideline.

Make sure you speak to your accountant to see if this is right for you.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

P.S. For the record, my businesses already have a benefit plan setup.  Our plan is NOT a HSAs so I do not have personal experience with any HSAs provider.

P.P.S.  I’m going to host my next incorporation webinar on Nov 16 at 8pm.  If you want to find out more about incorporation, please register here.

A few weeks ago, we discussed the CRA criteria to deduct renovation expense – How to Write-off Renovation the Right Way

Someone comment on social media that the rules are “clear as mud”.  😂😂

I mean, it is a fair comment.  It isn’t simple.  This is why CRA and taxpayers fight with each other in court.  

Sometimes, even the Tax Court judge found it confusing to apply the rules. 

In the court case DiCaita v. The Queen, 2021, the tax court judge made a comment that “determining if any particular expenditure is capital or current in nature can be difficult to apply.”

This is a court case about a Toronto taxpayer and his 2012 and 2013 tax returns.  He owned two rental properties, one in Vancouver and one in Phoenix, Arizona.  

The Vancouver property was a condo townhouse that was built in 1970’s.   This Toronto taxpayer owned the unit since 1989 and has always rented it out as a rental property.  

In April 2010, the condo board decided to undertake major remediation of the condo complex to deal with issues of rot, mold, asbestos, water leakage and structural issues.  The project involved only the exterior common area and had nothing to do with the interior of any of the units. 

This project was expected to last over 20 months and the cost to complete the project was in excess of $6M.  

I don’t know about you, I live through my new home’s kitchen renovation.  We tried to complete all the “dusty work” before we moved in to limit the amount of dust and disturbance.  It isn’t the easiest thing to do with my family.  Bruce has an eye allergy as a result. ☹ 

As we could all imagine, this $6 million condo complex project would be a lot more disruptive for all occupants of the complex than my small kitchen reno.   

As a result, the tenant living in the Vancouver condo wasn’t happy and asked for a rent reduction.  Taxpayer declined and the tenant vacated the unit sometime in November 2010. 

He tried to re-rent it again.  It wasn’t easy with the construction going on.  No one was interested. He believed that that if the remediation project had not occurred, his unit would have remained rented. 

During this period, the taxpayer decided to take advantage of this period and renovate the property.  The property was always rented in 1989 and there was simply not enough time in between tenancies to do much repairs.  

He took the opportunity in January 2012 to replace some fixtures and appliances caused by wear and tear over time.

The repairs to the unit consisted of:

The cost of repairs was about $24K.  

He did not obtain any permit as the work done was not reconstruction or rehabilitation of the structure.  No permit was required. 

All items replaced were of similar quality and value to what was replaced.  There was no upgrading of any of the items. 

After the repairs, the unit was rented for $2,200 per month December 2012, an increase of $700 per month, in line with comparable units. 

As you can imagine, he reported no rental income from January 2012 to November 2012, only $2,200 of rent in December 2012, and yet claimed $22K of the repairs incurred.  

On top of it, he also claimed condo fees, mortgage interest, property tax, management fees and other expenses totally $46,499.  

If my math is right…this would have been in this taxpayer’s 2012 tax return…

                  Income                         $2,200

                  Expenses                      $46,499

                  Rental loss                   ($44,299)

😱😱😱😱

Reporting multiple years of losses often trigger a red flag in the eyes of CRA.  

CRA disallowed $41K of the expenses claimed on the following basis: 

  1. the taxpayer was not earning income from January to November = no source of income, no deduction
  2. the repairs and maintenance claimed, specifically to the $22K deducted, was capital in nature and it should not be claimed as current expense.  They could be added to the cost of building, but not as a one-time write-off. 

Taxpayer appealed. 

The judge analyzed the case with respect to CRA’s position:

  1. Was the Vancouver property a source of income?  
  1. Can he deduct the repairs & maintenance of $22K?

Bottom line, the judge sided with the taxpayer on the deducting $22K worth of repairs.  😊

Reading court case is interesting, using them and applying them to our clients’ situation just make it a lot more useful.  

Hopefully you have some takeaways as well. 

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Recently, our team has been getting a lot of questions about cash damming and how to turn a non-deductible primary mortgage into a deductible mortgage, also known as smith maneuver.

It would be nice to take today’s blog post to talk about how to turn a non-deductible primary mortgage to a tax deducible mortgage. 

The bottom line is, interest is not deductible when it is not incurred to earn taxable income. You can always refer back to this Youtube video.

Here’re the few requirements that must happen to allow your primary residence:

  1. Having a re-advanceable mortgage as your primary residence mortgage
  2. You have to invest outside of your registered plan (outside of RRSP/TFSA/RESP etc.) or
  3. You must have a small business in your personal name

It gets more complicated when you own your small business in your corporation name.  That’s a topic for a one-on-one consultation. 

If you don’t know what a re-advanceable mortgage is…

The most important concept to keep in mind is that interest is deductible if the loan is borrowed to earn investment income.

If you can somehow paydown your mortgage, your line of credit is increased. You then draw the funds out from your line of credit for investment.  Line of credit interest is deductible. If all of this seems a little overwhelming, try to work with an expert broker who can explain everything to you in layman’s terms.

The key here is that you must invest.  If you don’t invest, you can’t turn your primary home mortgage as a tax deductible mortgage. 

Here’s a general process how a real estate investor can turn their primary home mortgage to a tax-deductible mortgage:

  1. Collect rental income 
  2. Use the gross rental income to paydown primary home mortgage
  3. Line of credit is increased by the same amount
  4. Draw money out of the line of credit into the dedicated bank account for rental purpose
  5. Pay mortgage, insurance, property taxes, etc. from this dedicated bank account

Yes.  Gross rent.  We’re using gross rent to pay down your primary home mortgage. 

I made a mistake in the past thinking that we would only use the net rent to paydown the mortgage.  Using gross rent speeds up the process tremendously. 

Here’s a general process how a stock hacker can turn their primary residence mortgage to a tax deductible mortgage:

  1. Generate income in your stock investment account
  2. Draw out the income from stock investment account, use it to paydown primary home mortgage
  3. Line of credit is increased by the same amount
  4. Draw money out from line of credit into your investment account
  5. Continue to make more money 

All of these get more complicated when a corporation structure involved. 

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

Today is a big day.  

Today is the first day of 3-day full day training for our March Stock Hacker Academy beginner course.

We added in an all-new day to make sure our students can get the most out of it.  As always, I am going to present on the tax implication of stock options trading.  

Today is also the closing day of our new home.  We’re not moving yet, we’re doing some small renovation before we move in.  

I smiled when I typed up the word small.  We usually start with something small, then the next small thing and then we end up also updating the kitchen as well. 

Oh well… 😊 

It’s also March, which means that tax season is here. 

I want to take this opportunity to recap on the top 10 tax deductions a real estate investor should not miss.  

Mortgage interest, not the mortgage principal

Many real estate investors think cash flow as their net income and they think that they get taxed on their net cash flow. If you would like to learn more about real estate investors.

Monthly mortgage payment consists of mortgage interest and principal pay down. Mortgage interest is a deductible expense but principal pay down is not.

The breakdown between the two can usually be found on your annual mortgage statement you receive at the beginning of next year.

When you estimate the tax liability owing, you need to add your net cash flow to the mortgage paydown to compute your taxable income.

Insurance

Insurance coverage for rental properties is different than the home that you live in. Make sure you notify the insurance company about the change of use and that appropriate coverage is taken.

Generally speaking, insurance premiums on rental properties are more expensive than your personal home.

Make sure you do have sufficient third party liability insurance.

Advertising

Any advertising cost incurred for the purpose of renting out the property is deductible. This includes all the Kijiji ad costs, ‘for rent’ signs that you purchase from Home Depot or specifically made for your property, etc.

Property management fees / commission you paid to fill the property

If you hire a property manager or use a realtor to fill the property for you, these are all deductible expenses.  Make sure you get the invoice from them to support your expense. 

Repairs & maintenance

Repairs & maintenance are generally deductible expenses. The tricky part is to determine whether an expense incurred should be capitalized or should be expensed. 

Expenses incurred to repair are deductible.  Expenses incurred to improve the property should be capitalized. 

If you paint the house, generally speaking it is a deductible current year expense. 

If you pay for the stamp concrete for your driveway which did not exist before, this will be capitalized and appropriate capital cost allowance can be taken on it.

Property taxes and utilities

Municipal property taxes and utilities are generally deductible against the rental income. One of the most missed property tax and utilities deduction is at the year of purchase or the year of sale. Some of the adjustments are handled by the lawyers and many investors would miss these deductions.

Specifically for investors who converted their primary residence to a rental property, only the expenses related to the rental period would be deductible.

Financing charge

Financing charge is usually one of the most missed deductions for real estate investors. Some real estate investors incur mortgage insurance expense or finder fees for their mortgages. 

These expenses can be deductible over five years, even though these fees might be added to the mortgage.

Auto mileage

This one is tricky. Different criteria apply if you own one property versus when you own more than one property.

For investors who only own one property, you are only allowed to deduct motor vehicle expenses if

But you cannot deduct the expenses you incur for the purpose of collecting rent if you have only one property.

Now for investors who own more than one rental properties, on top of the expenses incurred for repairs & maintenance and transferring tools & materials as mentioned above, you can also deduct the following expenses:

To qualify for the multiple properties criteria, they must have at least two different locations than your principal residence. This means that if you rent out your basement apartment and have one single family detached home as rental property, you still cannot deduction any expenses incurred for collection of rent, supervision of repairs and general management of the properties.

Capital cost allowance

Capital cost allowance is the tax term Canada Revenue Agency uses to represent the wear and tear on the building. It is a deferral mechanism allowed by CRA to defer the income on your properties until the year you sell it.

You can deduct capital cost allowance to reduce your net rental income to zero.  

However, capital cost allowance is somewhat similar to RRSP.  It’s a tax deferral, not a tax deduction. 

When you sell it, all capital cost allowance taken against your rental property throughout the year are reported as income, assuming the amount you sell it for is higher than the amount you pay for the property. 

You don’t pay tax not, but you pay the tax when you sell. 

Line of credit interest

Many real estate investors start out by refinancing their own home to obtain the downpayment of their real estate investment.

As a general rule of thumb, any interest expenses you incurred for the purpose of earning income are deductible subject to a list of exception in the Income Tax Act.

Earn your deduction by keeping full documentation

In Canada, you have to “earn” your deduction.  What it means is that documentation matters.  

Whether you are claiming home office expense or automobile expenses, you are required to keep the actual receipts or the invoice.  

VISA card statement and bank transactions are not enough to prove that the expenses were incurred for earning income.  CRA does not accept bank statements as a proof of deduction. 

Make sure you keep all the receipts and all relevant documentation. 

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant