Do You Make These Mistakes When You File Rental Income in Your Corporation?

Happy belated Easter everyone! I hope all of you enjoyed your Easter as much as I did.

We are so fortunate that our neighborhood hosted an annual Easter Egg Hunt every Easter Sunday.  We have been participating ever since we moved here when Robin was born.

Robin is just over 3 years old and Bruce is almost 2. Robin finally understood what to do and what to expect during the hunt.  Bruce, on the other hand, held the basket and did exactly what his sister did.  

It was the cutest thing ever.  He probably didn’t even understand why there were plastic egg shells everywhere and why he was picking them up on the front lawn of our house.  He surely didn’t know that he would get a bag of chocolate afterwards.  

I count my blessing every morning.  It has always been one of my blessings to have my kids.  They’ve changed my perspective on life so much.

Seeing them playing in the court over the weekend reminded me greatly of how lucky I am.  And happiness can be as simple as running around with your children and making a funny face to make them laugh.

While we are always striving to improve ourselves, financially and professionally, don’t forget to live in the moment. Appreciate the simplest thing in our lives.  😊

Now onto this week’s topic –

Real estate investing is considered passive earning in our Income Tax Act.  You may disagree with the term “passive” given how much work it can sometimes cause, but CRA doesn’t agree with you.

In a personal tax context, rental income is reported in your personal tax return and taxed at your marginal tax rate.

Passive income is only a concept if you own the rental properties inside a corporation.  This means that the corporation is paying passive rate over 50% on the rental income, but 30% became refundable if the corporation declares a taxable dividend to its shareholders.

The proper terminology for passive income is called “Specified Investment Business”.  Specified Investment Business is defined as a business with less than six full-time employees that has the “principal purpose” of earning income from property or the leasing of property.

But if you have a small business earning “active business” income, your income is taxed at the small business rate of 15% inside a corporation for the first $500,000 net income.

The definition is very clear in the act.

Every once in a while, I get someone that would ask the question, “can I file the rental income as active income?  How would CRA know that it is not?”

I don’t know how CRA could find out, but one taxpayer did file the rental income as active income and got caught.  

In the court case, Skartaris Holdings v. The Queen TCC November 22, 2016, the taxpayer reported the rental income from residential properties in 2010 & 2011 as active income claiming only 15% tax rate on these income.

It also claimed capital cost allowance from the properties from 2008 to 2011.  

The taxpayer took the position that the principal purpose of business was to earn income from purchase and sale of real property.  

Say the taxpayer’s intention was truly to derive income purchase and sale of real properties, capital cost allowance cannot be taken on the inventory of properties that you own.

You cannot use capital cost allowance and defer the taxes, but also claim that your business is to flip properties.  

The court concluded that the taxpayer was a “specified investment business” and should not be entitled to claim small business deduction.

Lessons learned?  Make sure you file your rental income inside the corporation properly as passive income.  No getting away.  😊

Until next time, enjoy the warmer spring weather and happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your real estate accountant