Top 3 Real Estate Investing Tax Benefits For Toronto Real Estate Investors In Canada!
When it comes to investing, it’s all about the numbers. And because income taxes in Canada are pretty hefty, you’ll want to look at the full picture including tax consequences if you want to put your investment dollars to highest and best use.
We believe real estate is a great investment asset class. Not just because you can get the lowest borrowing rates out there. Not just because you can get the best leverage out there. But also because real estate investing offers attractive tax advantages. So in this video, we’ll dive in and share the top three tax benefits that we see as real estate investors in Canada.
Disclaimer: Everyone on our team are real estate investors, and along our real estate investing journey, we’ve learned quite a few things and this video is just us sharing our experiences with you. Note that we are not professional accountants so please be sure to verify this any tax info with your accountant before you proceed with your investment decisions.
1. Refinance & Reinvest
As the price of your investment property continues to go up, you will start accumulating equity in the form of appreciation gains and principal paydown as you pay your monthly mortgage payments. There’s two main ways to access this extra equity in your property.
The first way is of course to sell it and take profit, but when that happens you will be subject to income tax and fees. If you’re at the highest tax bracket, your gains will be subject to around 25% tax plus around 6% of the property’s price in fees so these expenses eat into the money to reinvest.
Now instead of selling your property, an alternative is to refinance your property at fair market value and take out the equity this way. By doing this, you’ll maximize the leverage you have on you first property, and you’ll also get to reinvest gains in the most efficient manner, without having the extra money reduced by taxes and fees.
You can take refinancing & reinvesting one step further by employing the Smith Maneuver on your principal residence as well. The name sounds fancy but it’s really actually simple. Normally, mortgage interest on your principal residence is not tax deductible. However, as you build more equity in your principal residence, you can get a HELOC so that you can pull out extra equity on your principal residence to reinvest. When you do it properly, the interest from the HELOC from your principal residence can be attributed to your investment, which then makes it tax deductible.
2. Capital Cost Allowance (CCA)
The second real estate tax benefit is that your rental income can also be deferred to the time of sale if you take advantage of capital cost allowance (CCA). According to the CRA, property such as a building wears out over time, so you can deduct the building’s appreciation as an expense.
There’s a few caveats here. As we know, real estate doesn’t actually depreciate over time, and if you sell for a profit, the CCA that you deducted will be recaptured, which means the total depreciation expense will be added back to your income and taxed at the time of sale.
So in essence, you’re not saving on the tax, but rather deferring your tax obligations to later down the road. And if you’re in a high income tax bracket this will make a lot of sense because the same dollar today is worth a lot more than what it will be in the future and using CCA to defer tax allows you to save more money, reinvest more of that earlier, and then essentially pay less tax overall when you take into account time value of money.
3. Capital Gains Exemptions
If you own your own home in Canada, there is no capital gains on your principal residence and I even have a video that compares real estate returns on your principal residence versus how returns look like as a rental property. The quick summary is that even though rental properties are a great investment because you benefit from both rental income and appreciation, you can actually get really great long term returns on a principal residence too because you save on capital gains tax.
But besides strictly rental properties and strictly principal residences, there’s of course hybrids where you might decide to buy a bigger property – live in part of it, rent part of it out and this is where tax issues might be a bit trickier depending on more specifics.
If you’re coming at it from more of an investment standpoint, e.g. you buy a property, have multiple units, and you only live in a minor part of the building, then the CRA will perceive the main use as an investment, and you’d only get the capital tax exemption on the small percentage that you live in.
On the other hand, the government is not opposed to secondary suites and understands that many people rent out a small part of their home, for example, a basement out to help with pay for their home’s mortgage. So if the main reason you own the property is for your own principal residence use, then you may get the capital gains exemption on the entire building even if you rent part of it out.
The conditions that need to be met are a bit vague, but these are the three conditions:
- Your rental or business use of the property is relatively small in relation to its use as your principal residence.
- You do not make any structural changes to the property to make it more suitable for rental or business purposes.
- You do not deduct any CCA on the part you are using for rental or business purposes
The main takeaway here is that intent is key for the CRA, and your rental unit needs to be small enough. There’s no clear percentage here. Some accountants say principal residences should be more than 50%, others say more than 60% and it’s best to speak to your accountant about this if this is something that you’re thinking of doing.
Another thing to note is that CCA is consideration here. If you are thinking of using CCA to reduce your rental income, make sure to check that you won’t be taking advantage of special capital gains tax breaks first. In this case, you cannot deduct CCA on your rental income in your principal residence if you’re looking to get the capital gains exemption on the entire home.
There’s also a 4 year rule that not as many people know about either. If you own a rental property, but didn’t own a principal residence during the same period, you might save on capital gains tax on your rental property for up to 4 years. Again if you want to take advantage of this capital gains exception, then you also cannot CCA on your rental property. I also want to mention here is that it’s crucial to capture the fair market value on your property at the start and end of the exemption period, so CRA can calculate your taxes properly and the best way is to get a formal appraisal for this.
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