How rental income is taxed in Canada really depends on the type of ownership structure you have.

The most common form of ownership structures are:

• Corporation
• Partnership
• Joint venture
• LP/GP
• Personal
• Real Estate Investment Trust
• Family trust

How rental income is taxed will really be driven by the form of ownership you have.  Today, we’re going to focus our effort on personal ownership.

Cash basis vs accrual basis of reporting

You first have to select the choice of reporting.  Canada Revenue Agency, CRA, accepts two choices of reporting – cash basis or accrual basis.

Cash basis

• You are eligible to report your rental income on a cash basis, provided that you almost have no receivables and no expenses outstanding at the end of the year.
• You can only use cash method if your net rental income or loss is almost the same as if you were reporting it as accrual income.
• This means that you have to report income when you receive the cash from your tenants.  If you report a month of deposit from your tenant as last month’s rent, that month would have to be reported as income the moment you receive it.  
• This also means that if you’re one of the lucky landlords and received 12 months of rent in advance, you would also have to report the 12 months of rental ahead.
• But…this also means that you get to deduct the current expenses the year that you incur them.  You might incur insurance expenses at the end of the year – but it is 100% deductible

Accrual basis

• Accrual basis means that you’re reporting income as they were earned, not based on when you receive the money. 
• For example, according to your lease, you would have rented your property for 12 months, hence you are required to report 12 months of income.
• However, you might have only received 10 months of income.  The two months of outstanding rent is considered accounts receivable.  You have the right to collect the money at the end of the year but you have not collected it yet.
• As a result, you can end up in a situation whereby you need to pay tax on an income you have not yet received ☹ , though you can still deduct the uncollectible amount as bad debt expense against your income.
• On the flip side, you are also entitled to deduct expenses that you have incurred, but haven’t paid yet. 
• For example, you might have incurred the property tax throughout the year.  Everyone knows that we get charged our property tax bill on an annual basis.
• You might choose to ignore your property tax bill and not pay for it for the full year, but you still get to deduct the property tax on your tax return. 
• This is often the choice of reporting for all businesses, not just rental.

Rental income tax implication

• Eligible to deduct all reasonable expenses you incurred for the purpose of earning property income, subject to a bunch of exceptions.
• For a detailed explanation on the type of income & expenses you are eligible to deduct, make sure you refer back to the video below

• In personal name, you can report income in your personal name.  Net rental income is taxed as regular income. 
• If you are reporting net rental income, it is taxed at your own marginal tax rate.
• If you’ve already earned $100,000 from your day job, additional rental income will be subject to 33% and up.
• If you’ve already earned $150,000 from your day job, additional rental income will be taxed at 45% and up. 
• You also have the option to claim capital cost allowance against your rental income to reduce your rental income to zero – thus deferring the taxes to future years to claim.
• If you incur a net rental loss, which can be the case for many real estate investors in the current year, the net rental loss can be offset against your other income, dollar for dollar.
• If you already made $100,000 from your day job and assuming your employer has withheld the proper amount from your paycheck, the losses you incurred would be given you 34% refund or less.   Say you incur a loss of $10,000, this would typically give you a refund of $3,185.
• If you already made $150,000 from your day job, incurring a $10,000 loss could give you $4,341 tax refund based on 2023 tax rates. 
• If you incur a net rental loss, you cannot use capital cost allowance to create a bigger loss.

If you earn rental income in a corporation, rental income is considered Specified Investment Business Income and it is subject to a higher tax rate, but a portion of taxes is refundable when you declared a taxable dividend to its shareholders. 

Sales of rental properties

Two streams of taxable income – one from profit made on sale of property, another is from recapture on capital cost allowance claimed.

Here’s how profit from sale of property is taxed:

• The sale of each rental property is analyzed separately to determine the tax implication. 
• In the past, prior court cases established 12 criteria to help CRA and us to determine whether a sale is considered on income or capital.
• If it is considered income, 100% of the profit is taxable. 
• If it is considered capital gain, 50% of the profit is taxable.  You can potentially pay 50% less in terms of taxes.
• CRA also introduced the newest bright line rule requiring that a profit from sale that happens within 365 days, even with rental income reported, is considered income.  100% of it is taxable.
• This test is applicable to all sale happens from Jan 1, 2023 and onwards.
• Now, if you’ve owned your property for more than 365 days, you still have to go back to the 12 criteria to determine whether the transaction is considered capital or income.
• If the property is considered income, 100% of the profit is taxable.
• Let’s use an example to explain.   Say you already earned $100,000 job income, you made another $50,000 from the sale of your rental property. 
• If it is determined to be on the income side (you either sell within 365 days or conclude that you are trading properties as a business based on the 12 criteria), 100% of the profit is taxable.
• Since you already have a base of $100K from your day job, the additional $50K will be subject to 34% to 43% income tax rate, yielding a total of $21,250 income tax payable. ☹
• On the other hand, if you conclude that the property sale is considered capital gain, only 50% of the $50,000 profit you made from sale of your rental property is taxable, so only $25,000 is taxable.  Tax payable is $10,397, less than half of what you would otherwise pay if the sale is considered on income side.

What if you have a loss….

• If you have a loss, regardless of the ownership duration, you would still need to go through the 12 criteria to understand whether your transaction is considered on income account or capital account.
• If it is on income side, the loss can be used to offset against other source of income 100% on your personal tax return.
• Using the similar example as above, if you incur a loss of $50,000 from sale of a rental property, this $50,000 can be used to offset against your $100,000 job income, resulting in only $50,000 of taxable income on your personal return.
• Assuming your employer has withheld enough source deductions to offset against your job income, this $50K losses on sale of property could result in just under $15K of tax refund.
• However, if the rental property sale is concluded to be on the capital side, losses incurred would only be capital losses. 
• If you incur a terminal loss, you are not allowed to claim capital loss again.  See section below to understand how you could potentially incur a terminal loss.
• Capital losses, like capital gain, are half taxable.  And you are only eligible to offset against capital gain reported.
• If you have no capital gain reported, unfortunately, here’s no tax saving. 
• Capital losses, however, can be carried backward for 3 years and carried forward to be applied against future capital gain indefinitely.  You might be able to carry back some losses to the past to offset against capital gains reported previously. 
• You can also choose to wait until you report capital gain and use it to offset against future gain.

Recapture and terminal loss on sale of rental property

If you have a property on the income account, technically speaking, you are not allowed to use capital cost allowance to offset against the rental income you have received.

If you have ever claimed capital cost allowance, when you sell your property, you are required to claim all the capital cost allowance that you have claimed over the years into income.

Kind of similar to RRSP in a sense.  RRSP contribution is tax deductible.  And CCA claimed is tax deductible against rental income.

RRSP withdrawal is taxable.  CCA claimed is taxable upon the sale of the particular property.

Say if you’ve claimed a total of $30,000 CCA over the years (more often than not, we have to revisit prior year tax returns to verify the amount claimed each year), you would have to take $30,000 recapture income on your personal tax return, assuming the property is sold for a gain.

If you are not making money from the sale of your rental, you could still incur recapture income – assuming sale price allocated to building is greater than the undepreciated capital cost amount.

In certain situations, if the sale price allocated to the building is lower than the undepreciated capital cost of the property, you can result in a terminal loss situation.

When you have a terminal loss, the terminal loss is similar to that in net rental loss.  You can use the terminal loss to offset against other income.

If you have incurred a terminal loss, no capital loss can be reported.  You can’t double dip.

Hopefully, this helps you understand the ins and outs of owning a rental property.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant