A New Frontier for Real Estate Investors
A New Frontier for Real Estate Investors
Owning property can be profitable if you understand the tax laws that apply to real estate investments.
There is no residency or citizenship requirement for buying and owning property. You can occupy a residence on a temporary basis, but you will need to comply with immigration requirements if you wish to have an extended stay or become a permanent resident. Non-residents can also own rental property, but need to file annual tax returns with the Revenue Agency (CRA).
When you buy a property, you pay a provincial transfer tax that varies from province to province, but can be around 1% on the first $200,000 and 2% on the balance. Some exemptions apply if this is your first property purchase.
Municipalities also levy annual property taxes, based on the assessed property value, which reflects the market value. School and other taxes are included in this municipal tax. Information on the current municipal tax on a specific property is generally readily available.
New home purchases are subject to the federal Goods and Services Tax (GST), but a partial rebate can be obtained for new or builder-renovated homes if you plan to live in the home. The GST doesn’t apply to resale homes.
Taxes on Rental Property
The Income Tax Act requires that 25% of the gross property rental income is remitted each year. However, non-residents can elect to pay 25% of the net rental income (after expenses) by completing an NR6 form.2 If the rental property incurs net losses, then you may reclaim previously paid taxes. Your income will be treated differently depending on whether you’re a co-owner or a partner and whether it’s considered rental or business income.
You can deduct two types of incurred expenses to earn rental income: current operating expenses and capital expenses. The latter provides a longer-term benefit. The cost of furniture or equipment for a rental property cannot be deducted against your rental income for that year. However, the cost can be deducted over a period of years, as these items depreciate in value. The deduction is called the capital cost allowance (CCA).
Property taxes and mortgage, bank loan, or line of credit interest are tax-deductible if the property is an investment property.
When a non-resident sells a property, the government takes 50% of any sale as a withholding tax.
American residents must also report the capital gain to the Internal Revenue Service (IRS). However, if the gain has been taxed, it can be claimed as a foreign tax credit. When a non-resident sells a property, the seller must provide the buyer with a clearance certificate prepared by the CRA. Without this certificate, the buyer can keep a portion of the purchase price, as the buyer could be personally liable to the CRA for any of the non-resident’s unpaid taxes.
If you are a resident and the property is your principal place of residence, you aren’t taxed on the capital gains when you sell the property. You can designate any residence as a principal residence as long as you “ordinarily inhabit” it. The designation can apply to seasonal dwellings such as a cottage or mobile home. For a family unit, only one principal residence is allowable each year. This requirement has important implications. For example, if you own more than one property, you must decide which to designate as a principal residence based on the capital gains for that year.
If you are a resident, but the property was not your principal residence for all the years you owned it, you must prorate the capital gain for the years in which you didn’t designate the property as your principal residence. A change in use, from rental to principal residence, could result in a “deemed disposition,” triggering taxable capital gains. However, you could elect to defer recognizing this gain until you actually sell the house.
When you leave, there’s a “deemed disposition” of capital property. In other words, if you owned assets that have appreciated in value, you’ll pay tax on those gains if and when you leave the country. This “deemed disposition” also may apply when a non-resident property owner dies or when a property is transferred from an individual to the individual’s company or relative, even though no money has been paid.
Home Equity Loans
You can get equity out of your residential property with a reverse mortgage or home equity line of credit (HELOC).
A reverse mortgage isn’t for everyone, but they allow homeowners who are 55 years or older to take out regular payments that total up to 55% of the home’s current appraised value. No repayment is required and proceeds are tax-free. The funds can be invested; the interest expense can be written off (if the funds are invested in an income-producing asset), and the homeowner can live in the home as long as desired. The loan ends when the homeowner dies or sells the house, at which point it is paid off with the proceeds of the sale.5
A HELOC is a second mortgage on your home to secure a loan or a credit line. It offers greater payment flexibility than a conventional mortgage as you can pay off any amount of the principal at any time, without penalty. The interest rate on a line of credit is generally higher than mortgage rates but is usually lower than unsecured debt.
Alternative Real Estate Investments
Real estate investment trusts (REITs) are publicly traded companies that invest in a portfolio of real estate assets. Most based REITs trade on benchmark Toronto Stock Exchange (S&P/TSX).
As trusts, they must distribute most of their taxable income to shareholders. In 2007, federal government legislated that income trusts must convert to ordinary tax-paying corporations by January 1, 2011, but many REITs were spared from this legislation. The new trust rules require a REIT to maintain 95% of its income from passive revenue sources (rent from real properties, interest, capital gains from real properties, dividends, and royalties), and 75% of its income from the rent and capital gains portion of the previous rule. If the REIT maintains this structure, it will remain under the previous trust tax laws.7
The Bottom Line
In sum, laws are quite liberal when it comes to owning real estate. You don’t need to be a citizen or even live in the country, and property taxes and interest expenses are tax- deductible. To invest profitably, however, you should be aware of the tax implications of every stage of the investment, from owning the property and inhabiting or renting it to eventually selling it.
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