Building laneway houses have become a popular investment strategy in Ontario.
Most investors buy a house on a big lot, convert the original house into two units and build a brand-new laneway house in the back.
These strategic investors essentially convert one housing unit to three, creating new rental supplies and significant equity for their investment.
When you build something brand new, you’re considered a builder in the eyes of the Excise Tax Act, the tax act for GST/HST.
When you’re a builder, you have to pay HST to CRA on the fair market value of the newly built laneway house.
In most cases, you can also claim the HST you pay to your contractors to build your house for you.
This applies even if you build it to rent out.
However, you might also be eligible to claim HST rebates on new homes.
Here are a few common scenarios and the HST implications on building laneway houses provided by CRA’s information sheet.
If you build a new laneway house in an existing lot and rent it out to an unrelated person as their primary place of residence, you’re required to:
Your next question may be – would you be making money or losing money from filing all self-assessment on HST and claiming the residential rental rebate?
It really goes back to the valuation of your laneway house and the amount it costs you to build.
If the fair market value of the laneway house is close to the cost of construction, chances are, you will be getting some help from the government through the HST rebate.
If the fair market value of the laneway house is substantially higher than the cost of construction, even with the HST rebate, you might still be paying additional HST to CRA.
The determination of the fair market value of the laneway house is complicated.
There are few comparable available in the Ontario market. It will be interesting to see how appraisers are going to value these additional laneway houses.
On the other hand, you might simply build a new laneway house in an existing lot and provide a place for your elderly parents to live in as their primary place of residence.
In that case, the HST implication on this newly built laneway house is very different.
If you buy a new house, together with a laneway house built, as your primary residence, you’re not considered a builder in this case.
If you occupy the main house as your primary residence, you can GST/HST New Housing Rebate on the portion related to your main house.
If you rent out the laneway house to an arm’s length party as their primary place of residence, you can claim New Residential Rental Property Rebate on HST paid on the laneway house.
If your elderly parents or relatives stay in the laneway house as their primary place of residence instead, you can claim a GST/HST New Housing Rebate on the portion related to the laneway house.
It might sound complicated, and it can be quite complex.
Make sure you speak to a real estate accountant before your build to understand the tax implication on the laneway house better.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
We bought a turnkey legal secondary suite home on Hamilton market last week.
It was one of the easiest purchases we have done.
I’ve only invested in single family home, legal secondary suites and student rentals.
We believe in cash flowing properties, just to mitigate our risk.
We don’t want to generate negative cash flow when we don’t have to, especially with our real estate investment.
This is why we opted for legal secondary suites and student rentals most of the time.
But…
A turnkey legal secondary suite home in Hamilton is around $850K.
With this type of pricing, it’s almost impossible to get cash flow, unless we get top of market rent.
One thing we look at is the cash flow of our overall portfolio.
We don’t want to purchase a property that requires us to put money in, but… as long as my other properties are generating sufficient cash flow to cover this new property, that is sufficient for me to make the purchase decision.
Many of my clients purchased negative cash flow properties and had great success with them.
As long as you have planned ahead and know where you could pull money from to supplement the investment, who says you can’t make money with negative cash flowing properties?
Many of my investor clients are buying properties in multiple cities. Some even go as far as buying out of province properties.
I personally like to restrict my investment to an area that I already have a team built, such as the handyman, the roofer, the plumber, the HVAC guy, the cleaners, the property manager, etc.
We want to simplify our lives, not to complicate our lives. Hence, we continue to purchase in Hamilton. 😊
The key is to understand your own investment objective.
If you want a cash flowing property and the only place you can get it is New Brunswick, by all means, go for it.
It just means that you will have to rely on your local team more and manage your properties remotely.
The flights and hotels costs incurred to manage your properties are deductible by the way. 😉
I opted to work with a B-lender this time around.
I didn’t even try an A-lender. I already knew that I had the best chance with a B-lender if I want a mortgage at 80% loan to value.
Yes, I am paying 3.99% interest rate and I’m okay with it.
You might prefer to work with an A-lender (and typically I prefer to work with A-lender with lower interest rate). Quite frankly, who doesn’t?
But rate isn’t everything.
The amount of down payment required comes into play as well.
Some real estate investors often want to pay themselves “more” salary just so that they can qualify for more mortgages in the future.
With more salary reported, you will have to pay more personal taxes.
Personal taxes aren’t deductible for tax purpose.
But, higher mortgage rate with B-lenders is 100% deductible assuming your property is used for investment purpose.
Something to think about before you make your next purchase.
I bought this property in my corporation, using my small business income to fund the purchase.
I qualify for the mortgage directly in the corporation as well. Because I own the property in the corporation, I’m required to pay an additional 0.25% interest.
But… I’m using my high after-tax small business income to invest. I’m okay that the bank is charging me slightly higher interest rate.
Everyone’s situation is different, be sure to consult someone that understand your situation before purchasing a property.
A client purchased a pre-construction condo in his personal name years ago. Now, he wants to setup a corporation and closes in the corporation.
This simple transfer can trigger potential capital gain tax, land transfer tax, and even HST.
When plans weren’t done right from the beginning, this can pose significant tax impact.
Be sure to consult with someone at the time of purchase so you can setup the right structure from the get-go.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
P.S. I recently started a TFSA video series on my Youtube channel. If you’re interested in learning more about how to use your TFSA more efficiently, make sure you subscribe to our Youtube channel.
P.P.S. I’m also going to do a live demo showing everyone how I earn extra income in my TFSA and RRSP account using stock options. If you’re interested, make sure you sign up for the free demo on August 19.
We had some fun this week.
Our team, together with our extended Stock Hacker team and iWIN Real Estate team, came together and spent a day on the water at the Toronto Waterfront.
When I see the picture of our entire team, it triggered a moment of reflection for both Erwin and I.
We rarely get to see everyone all at the same time, so this is pretty much the first time most of us were included in a picture together.
I’m in awe how much we have grown, it reminds me of Drake’s song’s lyrics …. Started from the bottom, now we’re here.
It also reminds me of the great responsibility that we have. They are beyond just Erwin and I and our families.
We’re responsible for the clients we serve and our team members who make our businesses reality.
I’m beyond grateful for what we have built.
This would not have been possible without real estate investing. We would not have made the business moves without the security of our real estate investments.
Speaking of investments, many of you are using real estate investments as a tool to fight against inflation.
Government printing money = paper money declines in value = it costs more to buy groceries today than yesterday
One way to prevent our hard-earned money to lose its value in relation to our purchasing power is to invest in hard assets.
Hard assets include real estate, gold and other precious metal.
Some includes bitcoin as the supply of bitcoin is limited. This is also the reason why bitcoin price has increased substantially over the last little while.
This is also the exact same reason why I’m buying a Hamilton duplex end of this month. Cash is losing its value every day. Hard assets, as a minimum, can store some value in the long run.
When I sell the property 10 years or 20 years down the road, the capital gain that I would make will be a combination of real capital appreciation + inflation.
Real appreciation comes from increase in demand of housing in the Greater Toronto Area.
Immigration number increases in the next decade
= more people who need housing near where there’re employment opportunities
= higher demand in housing
= increase in housing prices
= true appreciation of the house
Second component is inflation. Inflation is the decrease in the purchasing power of a currency.
When there is a general increase in price level, your dollar can buy less in aggregate.
The increase in the properties price, expressed in term of dollar figure, represent inflation.
They aren’t true appreciation of the properties. They just represent inflation, the lost of purchasing power in terms of dollar figure.
But…
When I sell the property in 10 years or 20 years down the road, I will be taxed on the entire appreciation.
In another words, I would be taxed in the true appreciation and the fake appreciation – the inflation part.
This is exactly what this article of Globe and Mail is referring to.
In this article Canadians are taxed on illusory capital gains, the author Tim Cestnick pointed out this exact problem.
Part of the capital appreciation that we get taxed on isn’t true appreciation. It’s just a representation of inflation.
As investors, we aren’t gaining anything at all. Why should we be paying tax on inflation?
The author is in the same opinion that we should not be taxed on the fake appreciation (the inflation), but rather, we should only be taxed on the amount of real appreciation.
He’s right.
He also pointed out that the proponent of current tax system would quickly point out that capital gains is only 50% taxable, not 100% taxable.
The proponents would suggest that because capital gain is only 50% taxable and the 50% non-taxable amount should be more than enough to cover the tax we pay on the fictional appreciation.
He did the math.
He calculated the after-tax return on a fictional investment adjusted for inflation rate of 2% and the return is 50% taxable with investment horizon of 10 years.
He then compared that to the after-tax return on the same investment in an inflation free environment but the return is 100% taxable with the same investment horizon.
The result is shocking.
The after-tax rates of return on both investments are the same, even though one is 50% taxable and the second one is 100% taxable. ☹
What’s the conclusion here?
Our tax system isn’t taxing us fairly. Even with capital gain taxation whereby only 50% of the return made is taxable, as Canadians, we’re still pocketing less with minimal inflation of 2%.
If inflation rate is higher, which many believe will happen in the next few years, our true after-tax return on investment will be substantially lower in 10 years return.
The 50% non-taxable portion of capital gain is simply not enough to cover what we would have to pay.
But…
Saving is always better than not saving.
Investing is always better than not investing.
We’re still investing, with or without tax, the money is still losing its value.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
Many of our clients are real estate investors and real estate agents.
They often asked me how they could potentially lower the tax liabilities and how they could use their registered funds to invest in real estate.
What they are really asking me is … how do they maximize the return on investment using their registered funds.
Here’re the top 5 investment vehicles I’ve seen many of our investor clients used with their registered funds.
Many of our clients have great success at lending money privately using the funds in their registered accounts.
The return on investments ranges from the current mortgage rates offered by the bank to north of 15%.
The rate of return is driven primarily by the risks involved.
The lower the risk involved, the lower the rate.
Interest on first mortgages secured by a rental property usually is lower.
Rate of return is usually higher for unsecured promissory notes offered to a builder (as construction loan is generally riskier than a rental property with steady cash flow).
Benefit of doing private lending is that you see cash flow depositing in your account consistently.
Private mortgages are usually facilitated by a mortgage broker/lawyer.
I personally have a very small investment in a private real estate investment trust (“REIT”).
This private REIT invests in the Buy, Renovate, Rent and Refinance (BRRR) strategy on multi-unit residential buildings in Southern Ontario and it provides 6% return annually and has increased in value since.
Minimum investment is usually $25,000.
Usually, to invest this much in a company, you would have to be an “Eligible Investor” in Ontario. This means that you either would need to have net assets of $400K or you make more than $75K income in the last two calendar years.
You don’t have to qualify as an Eligible Investor to invest in a private REIT, you can simply purchase Real Estate Investment Trust unit trading in the stock market that provides consistent return as well.
We also use our registered funds to invest in land development deals.
Typically, these land development deals are setup as limited partnership. Each investor would purchase one limited partnership unit.
Typically, minimum investment is around $25,000.
Similar to investing in private REIT, you are required to be an “eligible investor” in Ontario.
Upside of investing in land development deals is that you get to share the upside of land development or being the builder WITHOUT all the work involved.
Typically, the upside is significant.
Downside is that you won’t see much cash flow during the investment period. And as you know, land development usually requires a number of years to complete. This means that your money is tied up for the entire investment horizon.
Another downside is that you might not be able to liquidate your investment easily.
If you have no intention to withdraw your RRSP or TFSA anyway, investing in these land development deals can significantly enhance your return.
We all know that we can invest in the stock market using our TFSA/RRSP funds.
What you might not know is that you could enhance your return by selling options against the shares that you own in your registered account.
Say you own 100 shares of AMD, which is currently trading at $87.
AMD is a stock that does not really pay dividends.
If you want to enhance your return on investment, you can choose to sell an option called “Covered Calls” against the 100 shares that you own.
By selling the covered call option, you agree to sell the AMD shares at a predetermined price at a specific date.
Say, you want to sell AMD at $100. You can choose that $100 as a “strike” price and then choose an expiry date. Someone may be willing to pay you upfront for the right to buy your AMD shares at $100.
Let’s say they pay you $0.50 per share for the right to buy AMD at $100 by October. $0.50 x 100 shares = $50 deposited into your account immediately.
If AMD is above $100 when the expiry date arrives, you keep the $50 and your shares are “called away,” you’re paid $100 per share.
If AMD is below $100 when the expiry date arrives, you keep the $50 and the shares stay in your account. Then you can write another covered call.
It’s like a rent-to-own. You collect an option consideration up front and agree on the future sale price. If the tenant buyer carries through with the sale, you’ve made money on the option consideration fee and profit on the sale price.
If they don’t buy, you could find another tenant buyer and collect another option consideration fee.
Back to stocks and registered funds. Doing covered calls over and over again effectively reduces your cost basis for AMD.
Your purchase price: $87
Your Covered call Premium: $0.50 per share
New cost basis: $86.50
When you eventually decide to sell your AMD shares, the return on investment will be higher.
There is a way to profit from stock price growth in your TFSA without actually owning stocks.
And this strategy actually lets you control the stocks at 50% – 70% of the stock price.
It’s called a deep-in-the-money call.
In the previous example, you sold covered calls using your shares as collateral.
Well, you could BUY a call too, but you don’t have to have shares in your account for that. Let’s stick with AMD for this example.
If the current price of AMD is $87, you may be able to buy a call at the $45 strike price. That call contract may cost you $42.00 per share. Because every options contract is 100 shares, the total cost of that call contract is $4200.
You now have control of 100 shares of AMD and you’ve only paid $4200 vs. $8700 it would have cost to buy shares outright.
As the price of AMD rises or falls, the value of your contract will rise and fall with it.
The best outcome in this case is that AMD “goes to the moon.” Maybe it doubles in price to $174. Your call contract would roughly double as well and you could sell it at $8400.
You just captured all of the movement of AMD (100% return on investment) but only invested about 50% of the cost of actual AMD shares.
And because you bought and sold that call in a TFSA or RRSP, that profit isn’t subject to tax.
Cool little strategies, right? This is why we call it stock “hacking.”
And this is also why Erwin and I teach Stock Hacking to as many people as we can. We want everyone to know these strategies.
These are only a couple strategies that we use.
If you want to find out how we use these option trading strategies to enhance our return, sign up for the Stock Hacker Academy free demo.
Until next time, happy Canadian Real Estate investing (and stock hacking 😉).
Cherry Chan, CPA, CA
Your Real Estate Accountant
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