No Tax on Net Rental Income? How to Make Use of CCA for Rental PropertiesBy CondoWong Tuesday Jaunary 22, 2019
- If you are a landlord, you need to pay income tax on the rental income you make after all the qualified expenses are deducted.
- You may claim CCA (Capital Cost Allowance) to reduce your net rental income to $0 so you don't need to pay any taxes on your rental income.
- When you sell your property, you would have to pay income tax on the total CCA amounts you have claimed over the years.
- Essentially, you may defer tax payments on your net rental income over the years and pay them back all at once when you sell the property.
- A dollar in tax saving today is worth much more than a dollar in tax payment in the future. This is the time value of money.
Net Rental Income
If you received income from rental real estate, then you have to file a statement of income and expenses in your tax return. Gross rent refers to the total amount of rent that you have received from your tenant(s). You may deduct any reasonable expenses you incur to earn rental income. Some common expenses include:
- Advertising – advertising expenses to publicize that your rental property is available for rent. This may include commissions if you hire real estate agents to list the property for you.
- Condominium Fees – if your rental property is a condo
- Insurance – premium for insurance coverage on your rental property
- Interest and bank charges – typically mortgage or loan interests. You can deduct certain fees when you get a mortgage or loan to buy your rental property, which include:
- Mortgage applications, appraisals, processing and insurance fees
- Mortgage guarantee fees
- Mortgage brokerage and finder’s fee
- Legal fees related to mortgage financing
- Professional fees – typically legal and accounting fees
- Management and administration fees – the amounts paid to a person or a company to manage your property
- Repairs and maintenance – if you pay for repairs to your property to earn rental income, you can deduct the cost labour and materials.
- Property taxes
- Travel – you might travel to collect rents, supervise repairs and manage your properties. Travelling expenses do not include board and lodging.
- Utilities – you can deduct expenses for utilities, such as gas, oil, electricity, water and cable, only if your rental arrangement specifies that you pay for the utilities.
Expenses that you cannot deduct:
- Land transfer taxes
- Mortgage principal
Net rental income is the income you receive from all your rental properties after the associated expenses are deducted.
Let’s use the monthly rental income statement from a 1+Den unit in Regent Park as an example:
The net monthly rental income is $587.15; hence, the net yearly rental income to be reported on the tax return is $7,045.81. This amount will then be added onto the total income of the landlord. Let’s say the landlord’s income tax bracket is at 40%, then the amount of tax payable on the rental income would be $7,045.81 x 40% = $2,818.32.
What is CCA?
CCA stands for Capital Cost Allowance, which is a depreciation amount you can claim on your rental property. The amount is equal to the capital cost of the property (typically the purchase price + legal fees) multiplied by a specific rate based on the property class. In general, most condos in Toronto acquired after 1987 belong to Class 1, which means a 4% CCA rate. Let’s say the capital cost for the above 1+Den unit is $400,000, then the maximum CCA amount the landlord can claim is $400,000 x 4% = $16,000. The landlord just needs a CCA amount of $7,045.81 to bring the rental income down to zero.
Effective Net Rental Income = Net Rental Income – CCA
Note that you cannot use CCA to create a rental income loss, the best you can do is to reduce the net rental income to $0.
In this case, the landlord has saved $2,818.32 in income tax this year.
The CCA is calculated on a declining balance method which means that the CCA for the next year will be ($400,000 - $7,045.81) x 4%.
Current Year CCA = (Capital Cost – CCA Claimed in All Previous Year) x 4%
Please also note that during the first year of the acquisition of the property, the 50% rule applies, which means that the CCA rate would be 2% instead of 4%.
What’s the Catch?
This sounds too good to be true! Let’s understand the concept of “recapture” before drawing any conclusions. For easy understanding, we will continue with the above example based on the following assumptions:
- Time: 25 years after the acquisition of the unit
- Original Cost: $400,000
- Current Market Price: $800,000
- Expenses Incurred in Selling the Unit: $35,000
- Landlord had been working for the past 25 years with an income tax bracket at 40%
- Total CCA Claimed: $250,000 (average $10,000 per year for 25 years)
This means that the landlord enjoyed $100,000 tax savings ($250,000 x 40%) throughout the past 25 years
- Landlord is now retired and has an income of $50,000 per year from rental properties
- For calculation purpose, use the 2019 marginal tax rates:
|Taxable Income||Marginal Tax Rate|
|Over $46,605 up to $75,657||29.65%|
If the landlord sells the unit now at the current market price, what are the tax liabilities?
1. Capital Gain Tax
Capital Gain = $800,000 - $400,000 - $35,000 = $365,000
The inclusion rate for capital gains is 50%. The capital gain will bring the landlord up to the highest tax bracket.
2. CCA Recapture Tax
The amount of CCA claimed over the past 25 years will now have to be added onto the landlord’s income and taxed at the corresponding marginal tax rate.
Let’s plug in some numbers to see the differences between the case where no CCA was claimed and the case where a total of $250,000 CCA was claimed.
|No CCA Claimed||CCA|
|Capital Gain (50%)||$182,500||$182,500|
|Marginal Tax Rate||53.53%||53.53%|
In the "No CCA" case, the net gain is $133,825 more but don't forget that this comes from an extra $100,000 tax payments in the past 25 years!
In the CCA case, you keep $100,000 with you for 25 years and you pay back $133,825 when you sell, it's a pretty good deal! We’re not going to get into a technical discussion about present value versus future value of money. In general, most people would agree that a dollar today is worth far more than a dollar many years into the future. If you are keeping your rental property as a long-term investment, we would generally recommend that you claim CCA to defer any tax payment on your rental income as a dollar in tax saving today is worth far more than a dollar in tax payment in the future. This is the time value of money and it adds onto the many reasons why you should use a rental property to generate cash flow for your retirement.
You should always consult your professional accountant in respect of your overall financial situation before deciding on CCA for your rental properties. The intention of this article is to provide general information on a possible way to maximum tax savings on your rental income. The information does not constitute to professional accounting advice and may not be appropriate for a specific individual or situation.