I just finished a webinar on how to use RRSP & TFSA to split income with low income spouses and minimize overall family taxes for my clients last Friday.
It is RRSP contribution season right now. I thought I would take this opportunity to discuss the most frequently asked questions about RRSP & TFSA.
Just a friendly reminder, you have until Monday March 1 to contribute to your RRSP to qualify to claim the RRSP contribution against your 2020 tax return.
If you are considering putting money in TFSA and assuming you have NOT contributed into your TFSA account in the past, cumulative TFSA contribution is $75,500. 😊
TFSA and RRSP are both registered accounts in the eyes of Income Tax Act. You can only invest in the qualified investments as permitted by the Income Tax Act. Qualified investments generally include stocks, private loans, mutual funds, etc.
Management fees for both TFSA and RRSP accounts are both non-deductible.
Even though TFSA and RRSP are both registered accounts, there are some major differences between the two:
| RRSP | TFSA | |
| Eligibility | You would need to have RRSP contribution room to qualify to make contribution to your RRSP. Most banks would require the taxpayer to reach the age of 18 before they can open a RRSP account. | You must be over the age of 18 for you to make contribution to your TFSA account. |
| Contribution limit | Contribution limit is calculated based on 18% of your earned income. In another words, if you never receive salary (only receive dividend income), you would have never created RRSP contribution room. Annual contribution limit is capped by the government on an annual basis. In 2020, maximum contribution limit is $27,230. What this means is that even if you make $200,000 salary, 18% of your earned income would have been equivalent to $36K contribution limit, the government would lower it to $27,230 in 2020. Also, if you do not use your contribution limit, it can be added to the future years for future use. You can often find the cumulative contribution limit on your prior year Notice of Assessment. | TFSA contribution limit is granted by the government on an annual basis, regardless of whether you work or not. In 2021, TFSA contribution limit was $6,000. Cumulative TFSA contribution limit assuming you have never made any TFSA contribution is $75,500. Similar to RRSP, the unused contribution room is cumulative. |
| Withdrawals | RRSP withdrawals are taxable. | TFSA withdrawals are non-taxable. |
| Withdrawn amounts on contribution limits | When funds are withdrawn from an RRSP, your RRSP contribution room is “not replenished”. In another words, amounts withdrawn would not be added back to the RRSP contribution room to allow for future RRSP contribution. | When funds are withdrawn from the TFSA account, the amount withdrawn is added back to the TFSA contribution room in the following year. |
| Tax | When you contribute to your RRSP, contribution is tax deductible against your top marginal tax bracket income. You will reduce the amount of tax you would have to pay to CRA. | When you contribute to TFSA, contribution is not tax deductible. |
| Plan maturity | When you reach the age 71, your RRSP has to be converted into RRIF and you are required to withdraw money from your RRIF annually. | There is no age limit or plan maturity with TFSA contribution. |
| Spousal plan | You can use your RRSP contribution room to make contribution to your spouse RRSP. This can be beneficial tool to split income with your low income spouse. | There is no spousal TFSA contribution. There is no attribution rule on TFSA contribution either. |
Most Canadian taxpayers have this question. The bottom line is, RRSP is a tax deferral plan, you would have to pay tax eventually. TFSA is a tax-free plan. Money you make generally isn’t taxable.
When TFSA was first introduced, CRA did an example on whether it is more beneficial to contribute to RRSP or TFSA.
The bottom line is, if you are expecting that you will be paying the same amount of taxes as you are now when you withdraw from your RRSP, and assuming that the rate of return between TFSA and RRSP is the same, TFSA or RRSP will give you the exact same amount of return.
If you are expecting that you will be paying less tax when you withdraw from your RRSP, of course, RRSP is a better vehicle.
If you are expecting to pay more taxes in the future, then TFSA is a better investment vehicle.
If you’re unsure, this is an idea I borrow from a friend…
Assuming you’re a salaried employee, I would contribute to RRSP first, use the tax refund to contribute to TFSA. 😊
You’re creating two assets with same contribution. It might look even more favourable in the eyes of the lenders in the future.
You cannot own a piece of property directly inside RRSP and TFSA.
However, you can lend your money within your RRSP and TFSA to a real estate investor as private mortgages. You can earn 8% and above interest return lending money as private mortgages.
Alternatively, you can also invest in Real Estate Investment Trusts (REITs), public and private one as well. I personally invest in a private REIT myself.
There’re also certain land development/building opportunities structured in the form of limited partnerships. These opportunities are often structured as qualified investment vehicles as defined by the Income Tax Act for RRSP & TFSA.
You can sell covered calls, buy calls and buy puts in RRSP and TFSA.
Selling naked puts, naked calls and shorting stocks typically require a margin account. Banks do not allow RRSP and TFSA accounts to be setup as margin account. Hence, you are not able to trade naked puts, naked calls and short any stocks in RRSP & TFSA.
With regarding to trading in TFSA, if you’re showing day trading behavior, CRA has the right to add the income you make in your TFSA account from the day trading activities to your income instead.
So be careful with your trading activities in your TFSA account.
Many taxpayers misunderstand the tax implication of RRSP withdrawals.
Most banks withhold 10% tax from your withdrawal when you withdraw less than $5,000.
But… the actual tax owing is really based on your marginal tax rate.
If you already make $100K salary, your marginal tax rate on additional $5K of RRSP income would be 43%.
Even though the bank withholds 10% tax and send it to CRA on behalf of you, the reality is that you still owe CRA 33% tax on the withdrawal.
Many taxpayers also said… “I am withdrawing the smaller chunk multiple times to avoid withholding tax…”
Typically, if you withdraw a large amount from your RRSP, the bank likely withhold 20% to 30% on behalf of CRA.
When you withdraw smaller chunk of money from your RRSP multiple times, you might be able to avoid significant tax withholding at the time of withdrawal.
But at the end of the day, the same principle stated above still apply. The actual amount of tax payable on your RRSP withdrawal really depends on your marginal tax rate.
If you have no income, chances are, you might have some income tax refund. If you already have your job income, you might have to pay additional tax on RRSP withdrawal.
Good luck with this RRSP contribution season!
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
Happy Lunar New Year.
I spent the New Years Eve last night sharing about my journey with stock hacking. It was a tough presentation to do, given that I wasn’t the subject matter expert.
If you missed it, it’s okay. You can always join our next webinar.
It’s Chinese New Year. This is the year of Ox.
For those who are stock hackers out there, you may interpret it as the year of Bull! 😊
For the real estate investors out there, I hope you guys will all capitalize on the crazy appreciation.
Now, onto this week’s topic.
Last week, we discussed about the 3-year normal reassessment period and how the taxpayer in the court case Hansen v. The Queen 2020.
As a recap, here’s Mr. Hansen’s story.
Mr. Hansen sold one home each of the taxation years 2007, 2008, 2009, 2011 and 2012 . Mr. Hansen claimed the principal residence exemption on all of these houses.
As you can probably guess, CRA does not like that and reassessed all five years of tax returns to include a total of $989,498 in Mr. Hansen’s income.
Last week, we discussed how Mr. Hansen used the 3 year normal reassessment period to defend the sale of his homes in 2007, 2008 and 2009.
This week, we’re going to talk about the sale of his homes in 2011 and 2012 and we will debunk the myth about primary residence exemption.
Just because you live in the property, it does not necessarily mean that you do not need to pay taxes on sale of your home. It really goes back to your intention.
The Hansens sold their dream home reluctantly in 2009. They immediately regretted the decision, but they sold it anyway.
Before the left their dream home, they bought a piece of vacant land nearby Sept 2009. Their intention was to build their next perfect home there. This property was called Meadowshire 2.
After leaving their dream home in 2009, while building their next perfect house, Mr. Hansen and his family moved into a townhouse called “Cedardown” from Dec 2, 2009 to Jan 10, 2011.
Mr. Hansen got a big truck and it wouldn’t fit in a small townhouse driveway. When Mr. Hansen parked his truck in visitor parking, he also got complained by other neighbors. He even got a letter from another neighbor threatening to take him to police because Mr. Hansen hosted loud parties.
One day, Mr. Hansens passed by a Monarch sales center, saw a line up of people who were interested in buying new home. He saw a market of new built home and immediately bought one from Monarch on Kilbirnie St “Kilbirnie”.
They’re still in the middle of building their perfect house on Meadowshire.
They stayed there for 13 months and moved into their next residence Kilbirnie January 2011.
They installed a pool, installed fence, built a patio, did backyard landscaping, installed custom granite countertop in the kitchen in this home.
But they only lived at Kilbirnie for 19 months, waiting for Meadowshire 2 to complete.
Again, they sold Kilbirnie in 2012.
They moved into their dream home Meadowshire 2 since then.
The issue is whether the Hansens could claim primary residence exemption on Cedardown and Kilbirnie.
It really goes back to deciding whether a purchase and sale transactions are of a business nature or capital nature.
To qualify to claim primary residence exemption, the Hansens must
How did the court determine whether the sales were capital in nature? It’s based on the following 6 criteria:
These are the same criteria to determine whether the sale of a property is considered a flip or a long-term investment.
Long-term investment is considered capital gain, 50% of the profit you make would be taxable.
Flips are considered business income, 100% of the profit you make would be taxable. If the sale is considered as a flip, you do not qualify to claim primary residence exemption on this property, even if you live in the property before.
Since the Hansens always intended to build a house on Meadowshire 2 (they bought the vacant land before they purchased Cedardown and Kilbirnie in 2009 and 2011), Hansens always had the secondary intention to sell these properties upon completion of their forever home on Meadowshire.
The fact that Mr. Hansesn happened to see a line of people waiting for hours for a chance to purchase one of the pre-construction home offered by Monarch also provided that Mr. Hansens had the secondary motivation to operate Kilbirnie house as an operating motivation for their acquisition.
The court concluded Mr. Hansens intended to sell both Cedardown and Kilbirnie houses at a profit.
Therefore, they could not claim primary residence exemption on the sale of these homes.
Just because you lived in the properties, it does not mean that you can claim primary residence exemption and not pay any tax on sale of the properties.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
It’s chilly today.
We had so much excitement from the last week. We listed our home for sale the last week and we relocated our entire family to the hotel to accommodate all the showings.
Yes, we had to get the kids out of the house to accommodate the non-step showing appointments.
Thankfully, we were able to sell the property as planned. We’re extremely blessed.
We also did our very first real estate investor incorporation webinar last week. We got over 900 people attended. A lot of questions.
Thank you for those of you who attended. We appreciate that you spend your evening with us.
Many asked, when’s the next webinar? Well, I am going to share the new skill I learned in 2020 with all of you. This skill added another stream of income to our family, allowed us to be a step closer to where we want to be financially.
Now, let’s talk about a recent court case that I read, Hansen v. The Queen 2020.
The court case is related to the sale of houses by Mr. Hansen and his spouse during taxation years 2007, 2008, 2009, 2011 and 2012.
The couple sold a house during each of the taxation years and he claimed the principal residence exemption on each house of the house.
Yep, you count it right, 5 houses sold in 6 years.
This is what I consider low hanging fruit for Canada Revenue Agency.
A taxpayer can only claim principal residence exemption, if the intent of the taxpayer wasn’t to sell these properties for a quick profit (which is also known as “adventure in the nature of trade”).
To determine whether a taxpayer is conducting a business or engage in “an adventure in the nature of trade”, one criteria CRA looks at is the frequency of transactions.
It is low hanging fruit when the Hansens sold 5 houses in 6 years and claimed them as primary residence exemption on all of them.
You also read it right. We’re in 2021 and the appeal on this case was just heard late in 2020.
In fact, CRA made their reassessment late. So late that they made their reassessment after the normal reassessment period.
As Canadian tax residents, many of us are aware of that we need to keep our paperwork for 7 years (a minimum of 6 years).
Few of us are aware that there’re rules governing CRA as well.
In general, CRA can reassess tax returns for individuals and corporations (Canadian Controlled Private Corporation) within 3 years from the original Notice of Assessment date.
As an example, for individuals who file their tax return on April 30, 2021 and receive the notice of assessments on the same date for their 2020 tax returns, Canada Revenue Agency has until April 30, 2024 to provide a reassessment to these individuals,
Unless…
CRA’s power does not stop there, CRA is allowed to reassess a return at any time…
In the Hansen’s case, CRA reassessed them beyond the 3-year normal reassessment period for taxation year 2007, 2008 and 2009 and imposed significant tax penalty.
When CRA wants to go beyond the 3-year normal reassessment period, CRA has the burden of establishing that the taxpayer made a misrepresentation that is attributable to neglect, carelessness or wilful default.
In this court case, CRA opened up the statute-barred years (3-year normal reassessment period) because she does not agree with the manner Hansens’ reported the income.
If the taxpayer can prove that he has been reasonable in the manner that he or she has reported his or her income, CRA cannot go beyond the 3-year limit.
In Hansens’ case, if the couple can prove that they had filed their returns on what they believed bona fide to be the proper method, then there’s no misrepresentation. CRA cannot go beyond the 3 year period and reassess their 2007, 2008 and 2009 tax returns.
Did the Hansens investigate how they should report the sale of the three homes sold in 2007, 2008 and 2009?
If they did, did Hansens thoughtfully, deliberately, and carefully assess the situation and filed their income tax returns on what he believed bona fide to the proper method?
The court concluded that Mr. Hansen had a bona fide belief that the sale of the houses qualified for the principal residence.
As a result, the court concluded that the Hansens did have the bona fide belief that the sale of the houses qualified for the principal residence and CRA cannot reassess Mr. Hansen after the normal reassessment period.
In another words, the Hansens qualified to claim primary residence exemption on the houses they sold in 2007, 2008 and 2009.
Two lessons learned:
What happened to the houses sold in 2011 and 2012? We will find out in next week’s blog post.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
P.S. I picked up a new skill last year during the March downturn, when my businesses were declining as a result of COVID lockdown. I wasn’t as busy with my business and I got stuck at home worrying about my revenue drop, I thought to myself, it’s best to learn something new to distract myself. I started learning about stock trading. It created another stream of income that we didn’t have before.
Today is a special day. Today is the day my own home is listed for sale. Yes, we’re moving!
I’m no stranger to moving. I moved from Hong Kong to Toronto over 20 years ago. I stayed in North York for two years before I went to Waterloo. I moved twice before I headed to Waterloo. With the co-op program there, I moved between Waterloo and Toronto numerous time in the five year period.
I graduated. Moved out from my family, moved to a condo then to a townhouse. I met Erwin and all of a sudden I found myself living in Hamilton. When we decided to start our family, we moved to our current place.
Moving had not been easy, but it was never emotionally draining for me.
Yet, it feels so different this time.
We started our family in this house. We moved into this house before we had kids. It’s full of memories.
For a veteran “mover”, I would have never expected how difficult this move had been!
Some decisions are easier than other though.
Recently, a fellow entrepreneur, who also owns a handful of multiplexes in Toronto, asked me about my take on whether a corporation should be setup to own properties.
She saw a comment in a group that she belonged to – “I regretted putting any properties in our corp. It costs more money to maintain the corporation. It costs more to finance, even building permits cost more.”
It isn’t an easy question to answer. But it certainly is an easier decision to me than moving. 😉
The truth is that, it depends… I provided a “brief” answer to her…
If you are thinking of growing to 5 to 10 properties or even beyond, and you own everything in your personal name, you can max out your credit fairly quickly.
By taking advantage of a corporate structure, you can grow beyond that five to ten properties, as the mortgages are registered in one corporation.
If your plan is to buy a couple, a corporate structure might not be as important.
Yes, it might cost more in financing (I signed up for 2.54% five year fixed for my latest rental properties), but it also frees up some of the credit in my personal name.
How much is it worth for you to be able to get to that 10 properties?
I have a client who owns a small business. He used to leave $20K in the corporation and paid everything out to his personal name. At the time he made about $180K “salary” from his business.
He paid a lot of personal taxes and he didn’t need the money in his personal name. So we stopped paying him $180K, instead we paid him $40K. The corporation kept all the profit and paid only 15% corporate tax rate (small business rate was slightly higher back then). He used all the retained earnings in the corporation to purchase properties.
For small business owners who have successful businesses in the corporation, they could be benefiting from the low corporate tax rate environment and have more available to invest.
Why do you think our Prime Minister Justin Trudeau target doctors, dentists and other professionals in 2017? That’s because doctors and dentists are using this exact same strategy to invest in stock and real estate. 😉
If you are a small business owner, but aren’t interested in using CRA’s money to invest for your future, corporation isn’t for you.
If you’re doing flips and some other real estate strategies, flips are considered 100% taxable. If you own these flips in the corporation, you could be paying as little as 12.2% corporation tax rate.
If you do the flips in your personal name, you’re subject to the marginal tax rates …which can be as high as 53.5% in Ontario.
It also goes back to what you want to do with the money you make from the flips. Some investors simply want to reinvest the profit into the next project.
If reinvesting into the next project is the goal, you pay less tax in the corp and have more for your future project reinvestment.
Size of your real estate project and type of real estate project matter.
My best friend owns a few commercial plazas. Her insurance company refused to renew her insurance policy because there was a small fire happened in one of the tenants’ store. This small fire was covered by the tenant’s insurance directly. She had to rush to find another insurance provider and operated her plaza without insurance for three nights.
If you own all your properties in your name, technically ALL your personal assets are exposed to the risk associated with running a rental portfolio.
When I say ALL, it means your stock portfolio, your primary home mortgage, may even be your future earnings.
I had a client whose rental got “blown up”. Tenant in the basement was burning some marijuana oil, it somehow went wrong, and the entire house got lifted up for a second or so (according to the news report). The house was deemed not to be in a liveable space afterwards. It was a triplex.
Thankfully no one was there at the time. The insurance did pay for the entire bill, but you really don’t know what you don’t know. From that point on, she always puts her properties in the corporation just for risk segregation purpose.
If you want an extra layer of protection, you have to pay for it.
If you are comfortable with the risk exposure, corporation is definitely not needed.
Typically in the tax world, when a high net worth individual decides to pass their asset to the next generation on a tax efficient way, many accountants would suggest an estate freeze.
This estate freeze is normally done through a corporation. If you transfer your assets to the corporation at that point, you would trigger land transfer tax at fair market value at the time of transfer.
Land transfer tax can be quite costly, especially if your portfolio is all in Toronto.
Of course, everyone’s situation is different.
This is why we host the FREE webinar to share with you insights from meeting with hundreds of real estate investors.
Wish me luck on my listing!
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
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