Real Estate investing and Taxes

The real estate market

Real estate investing can be a very lucrative venture, if done correctly, and allows the average Canadian taxpayer to leverage other peoples' money to create wealth with very little down, relatively speaking. A first time home buyer, for instance can leverage up to 95% of the cost of his home.

The real estate market is a multi-billion dollar industry and affects every area of the economy. It affects it directly and also through the many related industries. Financial institutions, mortgage brokers, property taxes, construction, home repairs and maintenance, appliances and utilities are all influenced by real estate investing

Did you know that more millionaires have been created in this industry than in most other industries?

Did you know that a great many of the world's wealthiest women and men hold investments in real estate?

Most Canadian investors get involved in one of three ways or a combination thereof.

  1. Ongoing positive, passive or partially passive income such as rental income,* rental income mortgage interest, property management fees, etc.
  2. Capital gains from appreciation in value of property
  3. Business use of property

Each is taxed** differently and has its associated risks and rewards.

Here are some of the fundamental differences

1.

  •  Income from rental property and other passive income are taxed 100% at the taxpayer's marginal tax rate.
  • Canadian taxpayers are taxed on 50% of their capital gains from real estate at their respective marginal tax rates
  • Real estate business income is fully taxable. Capital appreciation will be subject to capital gains taxes, on disposition of the property.

 

Example:Taxpayer in highest tax bracket (Ontario MTR 46.1%)

Taxpayer has gross rents of $100,000 and expenses of $50,000. Taxpayer pays $23,000 ($50,000x 46.1%) in taxes on net income of $50,000 (100,000-50,000)

Taxpayer has capital gain of $100,000. Taxpayer pays taxes on $50,000 (50% of $100,000) of $23,000

Taxpayer makes $50,000 net income from business. Taxpayer pays $23,000 on $50,000

2.

  • Ongoing, positive income increases  cash flow and is realized immediately, allowing further usage of funds
  • Capital gains is not taxable until property is disposed of and may take time to appreciate. Furthermore there is no cash flow.
  • Business income from real estate investing increases cash flow

3.

  • Ongoing passive income depends on the quality of the tenants, not the property
  • Capital income depends on the quality of the real estate property, not the tenants.
  • Business income depends on the quality of the business.

4.

  • For rental and business incomes, losses can be applied against all other types of income
  • Capital losses can only be applied against capital gains.

 

*Rental income is considered earned income for RRSP purposes

**Taxable income is based on net income which is the gross income less the expenses incurred to earn it.

When buying and selling real estate, is an occupation, then the capital gains or exempt gains may not apply and all gains may be considered business income and fully taxable


Real Estate investing and Principal Residence

Most Canadians hope to own their home one day and for many real estate will be their largest purchase. Eventually for some this will become their biggest asset and for others their biggest liability.The principal residence has the huge tax advantage in that accrued capital gains are tax free. Furthermore these gains are not jeopardized even when your home is used to produce income as in rental income. A taxpayer can buy and sell real estate over and over again without incurring taxes on the gains and thus build considerable wealth along the way.

A taxpayer can own many principal residences in her lifetime, although she can only designate one as a principal residence in any one year. If more than one residence is owned the taxpayer has the choice to designate the one that is most favourable, as the principal residence. The taxpayer may also choose to sell at different times.

For Canadian income tax purposes, the principal residence can be out of the country, so the condo in Florida could be designated as your principal residence even if you only visit once a year, for a couple of weeks. As long as you ordinarily inhabited the dwelling in that year it can be your principal residence.

Unlike in the U.S., Canadian mortgages are not tax deductible, nor are the repairs and maintenance, property taxes, utilities etc.There are some circumstances, however, where some of these personal expenses can be made partially tax deductible. These include

  • Business use of home
  • Rental income from principal residence
  • Employment expenses if your job requires you to work from home
  • Mortgage loan interest on loans used for investments
  • Real estate investing can play a very important role in helping Canadians build wealth Investing in Rental Property

    How to Build Your Real Estate Business


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