If you are paying taxes, it means you are making money.If you are paying a lot of taxes, then it stands to reason that you are making a lot of money. However much you make, it doesn’t make it any less painful to pass it along to the government though. Unfortunately I haven’t been faced with the problem of paying a big bundle of tax to the government (but I am hoping I have that problem really soon!!), but I have been through enough in the last seven years to give you a few pointers on some ways to minimize taxes surrounding residential real estate dispositions.
I know taxes might seem boring, but we know someone out there is interested in it because we are going down this long and dusty road at a reader’s request. There is so much to cover that this will be part one of a series. To roll it out, let’s start with the basics. As a real estate investor, you will pay tax on the rental income you earn on the property as well as on any capital gains when you sell. The amount of tax you pay on rental income can be reduced dramatically by expenses such as maintenance, property management, capital cost allowance (depreciation), interest on your mortgage (but not the principal pay down), and other money spent to run your property. In another edition we will come back to some of the elements above. For this edition, let’s focus in on the second major area you will pay tax on, and that is on Capital Gains when you sell your investment.
A Capital Gain occurs when you sell your property for more than you paid for it. You do not realize your capital gains until you sell.
To calculate your capital gain take the:
Money from the sale of your property
Costs of disposition (real estate agent fees, lawyers etc.)
What you paid for the property.
You will owe tax on 50% of the amount from the above calculation if the resulting number is positive (a capital gain). This amount gets added (or subtracted if it’s a net loss) to your personal income and you are taxed accordingly.
If the property you are selling is your principal residence, then it is exempt from tax. According to Canada Revenue Agency, a property qualifies as your principal residence if in that year of filing:
- you acquire only to get the right to inhabit
- you own the property alone or jointly with another person
- you, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year
- and, you designate the property as your principal residence.
Now, what if you live in the home for a few years, and then move out and rent it out for a few years as I did with the condo that I owned in Toronto? In that situation, the answer for me was that the condo could still be considered my principal residence for four years after I changed it’s use. The catch is that I could not claim capital cost allowance on the condo, nor could I claim any other property as my principal residence at the same time. For me, this choice was easy because I moved into a property Dave and I already owned and had been treating as a rental property from the accounting sense of things. It was easier to keep the condo as my primary residence and continue to treat my new “home” as a rental property for accounting purposes. It’s important to note that you and your significant other (including common law or same sex partner) cannot own two principal residences at the same time for tax purposes. You must choose one during the over-lapping period.
It’s complicated and that is why both Dave and I have accountants that we consult with on a regular basis to get the best advice.
THE DISCLAIMER: Neither of us have any legal training, nor do either of us have extensive accounting training. We are not experts and we always consult with our accountants and legal counsel before we make decisions. We pay money to get quality advice when we need it and always advise our friends, family and readers to do the same.