So you have decided to take the plunge. You have a house and lot picked out. The price is right and it looks like you will have a positive cash flow. Perhaps you even have some renters in the pipeline all ready to move in. But you still have questions about the tax implications.
A little tax planning now can save you headaches and money down the road.
The Home Buyers Plan (HBP)
The home buyers plan (HBP) allows each taxpayer to withdraw up to $20,000 tax free from their RRSP to purchase a home in Canada. To qualify you must be a first time home buyer (i.e. you have not owned a home that you lived in as your principal residence in any of the five preceding calendar years before the withdrawal) and the home acquired must be your principal residence. For more information, see my article on the Home Buyers Plan.
In order to use the HBP to acquire your property, you must occupy the home when you take possession within the requirements of the HBP. There is no limit on renting another portion of the property (i.e. the basement) to supplement income or offset home ownership expenses nor are there any restrictions on a future conversion to a fully rentable property (although you should be aware of the impact of a change in use can have and discuss the rules and elections available with your accountant).
Deductions from Rental Income
As a general rule, you can deduct any reasonable expenses against your rental income. This would include maintenance, utilities, mortgage interest, and costs to source renters for the property.
If the property is fully rented you can take the full amount of the expenses related to the property. If you only rent out a portion of the property you are only allowed to take a portion of the expenses against your rental income. This is typically taken as a percentage of the size of the building, either the percentage of the square footage rented or the percentage of the number of rooms rented.
Capital Cost Allowance (CCA)
The Canadian Income Tax Act allows you to deduct a portion of the original cost of a property (the capital cost) from your rental income. The rate to which you can take the deduction is fixed by the income tax regulations and is limited to the “depreciable” portion of the property (i.e. the buildings and not the land).
As of the time of writing, newly acquired property is allowed an annual deduction of 4% of the declining balance of the original cost. Note that in the year of acquisition, you are only allowed to take 1/2 of the allowable CCA (or 2% in the first year).
CCA on rental property is subject to special limitations that further restricts CCA. As a general rule, you cannot use CCA to produce a rental loss. In other words, if you have taken all other expenses before CCA, you can only claim enough CCA that would reduce your rental income to zero.
Like other expenses related to property rental, you can only claim the portion of the property you are renting. Thus if you are renting the second floor of a two story home, you can only claim 50% of the expenses including CCA for tax purposes.
Capital Gains Exemption on Your Principal Residence
If you are renting a portion of your principal residence (i.e. your basement) and you claim CCA, be aware that you will be required to pay tax on a portion of any capital gain on the disposition of your residence. For example, if you were claiming CCA on the rental of your basement apartment and the basement was 40% of the total square footage, you will be required to pay tax on 40% of any capital gain on the sale of your principal residence. This may not always be a bad thing as you may be able to increase your cash flow and reduce your overall taxes by claiming CCA and paying the tax on a subsequent gain on disposition. Carefully review your options and consider professional advice!
If you have questions about this information or have another question, you’d like me to address, please contact me via my feedback form.
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{ 4 comments… read them below or add one }
Can you please elaborate the pros and cons of this CCA for Rental property.
We had a condo that was principle residence for 2.5 years. Last year mid, it was converted to a full rental property.
I am gathering the income and expense for that now for tax filing this year. I did not think about this CCA to be used for deduction. I have some minor income after deducting expenses. So should I think about using CCA to reduce that income ?
@Kevin: Using CCA on your rental property will reduce taxable income. On the negative side it cannot be used to create a loss on rental income and it can affect your ability to use the principal residence exemption if you intend to move back into the property.
Boy oh boy, I have been reading the T776 guide and still don’t get the CCA thing. One good thing is your note about “it can affect your ability to use the principal residence exemption if you intend to move back into the property”.
We might do this, so I might as well stay off. We have negligible income from the condo in 2009, so understanding and doing CCA is difficult. As it is I still haven’t figured out the Class to use for CCA. The building was built in 1994 and we purchased it in 2007 as a principle residence first and then converted to rental in 2009. This building does not seem to fit the definition for Class 31 and 32 and I don’t see any other class defintions in teh guide.
I am a do it yourself type of guy and even if I get it done from someone else, prefer to understand atleast at a high level what’s being done. At this point I understand the definition of CCA, but am unable to figure out how to use it.
Kevin,
I can’t say for sure if it makes sense or not to claim CCA. I will say that this is complicated stuff and I would strongly recomend you hire an accountant for the first year or 2 to do your taxes. The cost will save you thousands down the road: Once the accountant does it for a year or two, you can easily do it yourself. In fact, I would suggest you tell the accountant this when you hire them. They will tell you when you should seek their advice.
I think many fear seeking professional help more than they should.