Rental property tax question

[mustache ride]

For the accountants of CP, I was hoping to get an opinion on this scenario.
Doing my taxes today and the lady offered me two scenarios for paying tax on my rental

The first was to pay it as i normally have, just paying the percentage of principal paid plus profit in my normal tax bracket like always.

The second was one i have never heard before
Depreciate it on a given percentage based on the length of my mortgage which would allow me to write that amount off each year.

In the first scenario i pay about $600 and the second i receive a $1600 refund added to my return. However fifty percent of the portion that was written off now incurs capital gains taxes in the event i sell. So in the future if i sell my property, i would pay capital gains taxes on fifty percent of the profit over what i bought it for and fifty percent of the portion written off which would be paid at my yearly tax rate. This could be a huge tax bill offset by a yearly swing in actual taxes paid on the rental so in the long term profitable.

But then i was told that if i move back into the rental before i sell for a period of time, the rental reverts to being my primary property and the previous percentage of the house written off no longer applies thus saving a massive chunk of money. This could easily end up in the mid 5 figures if i kept the property until the end of the mortgage. Everyone in the office seemed to agree this was true but when i asked to see an actual rule in the tax code anywhere that confirms this, or that even sets a period of time where you would have to live in the property, no one was able to produce anything. I just cant believe that the government would let me walk away from taxes owing. So is this to good to be true or is this a real thing with rentals in general?

Obligatory no i don't know what a write off is, but they do and they're the ones writing it off

[CorsiHockeyLeague]

Erm, I'm pretty sure when you do a change of use you get a deemed disposition at FMV and this would trigger the re-capture of any claimed capital cost allowance. So any amount you depreciate would be re-captured into income at the time you moved back in and made it your primary residence, and then 50% the delta between the adjusted cost base and fair market value would be included in your income as a capital gain. Then your ACB gets re-set to fair market value as of that day.

So I believe what you're describing is wrong. Moving back into your property is basically treated, for tax purposes, like selling it... except you don't get the cash to pay the attendant tax.

[mustache ride]

Originally Posted by CorsiHockeyLeague

So I believe what you're describing is wrong. Moving back into your property is basically treated, for tax purposes, like selling it... except you don't get the cash to pay the attendant tax.

So under your interpretation, whether i depreciate my rental property or not, i would owe the difference in fair market value anytime i chance the status of my rental to primary?

[squiggs96]

I'm not sure I understand either scenario, and I'm an accountant, in real estate, and I have personal rental properties.

Originally Posted by mustache ride

The first was to pay it as i normally have, just paying the percentage of principal paid plus profit in my normal tax bracket like always.

Why are you calculating the amount of taxes on a percentage of your principal paid? The formula for net rental income is to take all of your rents collected and subtract all of your expenses. Your expenses are typically mortgage interest and property taxes, plus they could include strata fees, property manager fees, utilities, cleaning, and repairs and maintenance. The principal you pay has absolutely nothing to do with your income statement.

At the end of the year, assuming you hold the rental property personally, there will be a net profit from the above calculation. You now have the option to take CCA (capital cost allowance) on your rental property. I can't tell from your scenario whether this is a stand alone property, like a condo, or it's a basement that you are charging rent on. Which one it is will affect how you do it, and future consequences, but either way, you can only take CCA up until the amount the will give you a net income of zero. You cannot take CCA to give you a rental loss.

If you take CCA on your rental property, and sell it for more than the UCC, you will have recapture on the amount you took CCA of. This is the same as if you moved into it personally. There are ways to reduce this burden, including a proper split between land and building. These are scenarios that a good accountant, well versed in this field, could show you. You should ensure you are speaking with one of them, and not solely relying on internet information. Based on the scenarios you have given us, I'm not sure your current one understands accounting or tax law very well.

Originally Posted by mustache ride

The second was one i have never heard before
Depreciate it on a given percentage based on the length of my mortgage which would allow me to write that amount off each year.

This is not correct anywhere. You can take depreciation for accounting purposes, but it is based on the useful life of the asset, not based on how the mortgage is calculated. You can absolutely take a fixed percentage over a set period of time. This is called the straight line method. You can also use the declining balance method, which CCA is an example of. Either way, this is for accounting purposes only, and when you have your tax books done, you can't create a net rental loss.

Originally Posted by mustache ride

In the first scenario i pay about $600 and the second i receive a $1600 refund added to my return. However fifty percent of the portion that was written off now incurs capital gains taxes in the event i sell.

As stated above, you can't create a loss, which then gives you a refund on rental properties. Based on your figures, you can either pay taxes of $600, or reduce that amount to zero by taking CCA. You don't have to take all the CCA if you don't want to. You don't have to take any. That amount is optional from zero up until your net rental income before CCA.

[mustache ride]

Originally Posted by squiggs96

Why are you calculating the amount of taxes on a percentage of your principal paid? The formula for net rental income is to take all of your rents collected and subtract all of your expenses.

I have always been instructed that the principal paid on the mortgage is considered profit and gets added to the net income from the rental at the end of the year. This is the number i have always been taxed on.

Originally Posted by squiggs96

I can't tell from your scenario whether this is a stand alone property, like a condo

Its a townhouse in a condo corp

Originally Posted by squiggs96

You cannot take CCA to give you a rental loss.

They added my personal return to the rental return. I would have a refund of $8400 without the CCA and $10,000 with the CCA. The rental was quoted around $600 owed in taxes so what else what else would explain the difference in amount?

Originally Posted by squiggs96

This is not correct anywhere. You can take depreciation for accounting purposes, but it is based on the useful life of the asset, not based on how the mortgage is calculated.

This could have just been me not understanding but how is the useful life of a rental property determined?

Originally Posted by squiggs96

As stated above, you can't create a loss, which then gives you a refund on rental properties. Based on your figures, you can either pay taxes of $600, or reduce that amount to zero by taking CCA. You don't have to take all the CCA if you don't want to. You don't have to take any. That amount is optional from zero up until your net rental income before CCA

I am supposed to meet with their accountant tomorrow to discuss this. This was all second hand for the people doing the taxes but it didn't make sense to me at the time

I will listen to recommendations if you know a good tax accountant haha

[CorsiHockeyLeague]

Squiggs, my understanding was always that you could take CCA on a rental property to the extent of your i come from that particular property. Which is depreciation for tax purposes, not just accounting purposes. I didn't understand him to be saying he'd have enough CCA to create a net rental loss.

[CorsiHockeyLeague]

Originally Posted by mustache ride

So under your interpretation, whether i depreciate my rental property or not, i would owe the difference in fair market value anytime i chance the status of my rental to primary?

Close - 50% of the difference between whatever its value was when you bought it or turned it into a rental property, and its value when it ceases to be a rental property, is included in your income as a capital gain.

Meanwhile, if you take CCA (depreciation deduction), 100% of the depreciation will be included in your income as CCA recapture.

In other words, in your situation, CCA will be more of a tax deferral than tax savings. You save tax now but have to pay it when you sell the property or change its use from rental to primary residence.

[squiggs96]

Originally Posted by mustache ride

I have always been instructed that the principal paid on the mortgage is considered profit and gets added to the net income from the rental at the end of the year. This is the number i have always been taxed on.

This is 100% wrong. Let's suppose a situation where your marginal tax rate is 30%, and you prepay your mortgage on your rental property by $50,000. In what world does it make sense that you should have to pay $15,000 in taxes because you paid down the principal of your outstanding debt? It doesn't make any sense.

Originally Posted by mustache ride

They added my personal return to the rental return. I would have a refund of $8400 without the CCA and $10,000 with the CCA. The rental was quoted around $600 owed in taxes so what else what else would explain the difference in amount?

It may sound like splitting hairs, but your net rental income is added to your personal return, as long as you hold it personally. First off, if your personal return is $8,400, you have done some horrible tax planning. You should never want a refund that high, as you are just giving the government an interest free loan. Assuming a normal distribution, you are cheating yourself of an extra $800 per month that you could be spending, saving and/or investing.

Let's suppose without your rental, you are entitled to an $8,400 refund. Assuming a 25% marginal tax rate, your net rental income is $2,400, which gives rise to the $600 taxes owing. This should drop your refund to $7,800. If you take CCA, as explained it can't push you into a net rental loss. Your refund would stay at $8,400. There is likely something missing from your story and/or the accountant is doing something wrong. The key point here is you can pay taxes on your net rental income, at your marginal tax rate, on the amount before CCA. If you take CCA, it can only go up to your net rental income. No matter what you do with CCA, it will never give you a bigger refund than as if you didn't have a rental property.

Originally Posted by mustache ride

This could have just been me not understanding but how is the useful life of a rental property determined?

Based on what has been explained to me in the thread, it sounds like you are understanding it properly as explained to you, but the person explaining it to you doesn't understand what is right and wrong. I'd recommend giving Locke a shout. His fees will be offset by the comfort in knowing your taxes are correct, and you won't be on the hook for large fees, penalties, interest, and back taxes.

[squiggs96]

Originally Posted by CorsiHockeyLeague

Squiggs, my understanding was always that you could take CCA on a rental property to the extent of your i come from that particular property. Which is depreciation for tax purposes, not just accounting purposes. I didn't understand him to be saying he'd have enough CCA to create a net rental loss.

Your understanding of CCA is correct. To me it seems like he is taking CCA well past his net rental income, giving him a net rental loss, which generates the increased refund. If I saw his actual documents, I could have a concrete answer, but as explained to me in the thread, that's how I interpret it. He might only be taking it to a net zero rental income, which would be correct, and his wording of his refund could be off. Without seeing the documents, I'm not sure which is happening.

[CorsiHockeyLeague]

Tough to say for sure, and I can't recall the CCA rate for this, but would it not be 4% DBB? In which case, I mean I don't know what the ACB of the property is, but let's say it's $500,000, then your CCA is $20,000 the first year, which on a $500k property isn't a ton of rent (1650/mo or thereabouts). So if he's actually creating a rental loss for the year, it's not by much. I assumed that the CCA was simply wiping out this source of income more or less, which combined with other stuff on his return is what's generating the increased refund. All speculation of course.

[squiggs96]

Originally Posted by CorsiHockeyLeague

Tough to say for sure, and I can't recall the CCA rate for this, but would it not be 4% DBB? In which case, I mean I don't know what the ACB of the property is, but let's say it's $500,000, then your CCA is $20,000 the first year, which on a $500k property isn't a ton of rent (1650/mo or thereabouts). So if he's actually creating a rental loss for the year, it's not by much. I assumed that the CCA was simply wiping out this source of income more or less, which combined with other stuff on his return is what's generating the increased refund. All speculation of course.

My rental condo started with a UCC of about $325,000. To take the full CCA, after year one, would be abut $13,000, assuming I didn't split it into land and building. My net rental income before CCA/amortization was around $5,000 (that's just rent less expenses), so if the rule wasn't in place, I could create an $8,000 loss, giving me a $3,200 reduction on my personal taxes. You can't go past zero, so my CCA is $5,000.

[bizaro86]

Is not splitting it into land and building an option? I thought you had to, since land is non-depreciable.

[CorsiHockeyLeague]

I think you can split it basically any way you think you can defend but you're right, unless it's a condo you're probably doing more land than building. And yeah Squiggs it's a good point that the "net" part may be more or less important depending on his regular expenses. As you say, no way to tell just from the info posted here.

[squiggs96]

Originally Posted by bizaro86

Is not splitting it into land and building an option? I thought you had to, since land is non-depreciable.

CHL is correct that you can split it, but you have to defend it. The easiest way is to just do a split based off the property tax and/or bank assessments. It's also in your benefit to split it, but some people aren't aware of this, and thus pay more taxes by not giving any to land.

[loob job]

Originally Posted by squiggs96

CHL is correct that you can split it, but you have to defend it. The easiest way is to just do a split based off the property tax and/or bank assessments. It's also in your benefit to split it, but some people aren't aware of this, and thus pay more taxes by not giving any to land.

The Tax partner of the accounting firm where I work says put 10% as land and 90% as building when it is a condo unit.

[bizaro86]

Originally Posted by squiggs96

CHL is correct that you can split it, but you have to defend it. The easiest way is to just do a split based off the property tax and/or bank assessments. It's also in your benefit to split it, but some people aren't aware of this, and thus pay more taxes by not giving any to land.

Oh sure, I'm not concerned about defending my splits at all, I've used various kinds of appraisals, and with condos it does work out mostly building.

I'm trying to understand the advantage of having anything in land. I'm claiming the 4% CCA (class 1) for the building portion of my condos in class 1 (or enough to get my rental income to zero). I'm not claiming anything for the land, other then keeping it in my adjusted cost base when I sell. Am I missing some advantage?

It seems to me if I didn't have to split I could claim 4% on a higher number...

[squiggs96]

Originally Posted by bizaro86

Oh sure, I'm not concerned about defending my splits at all, I've used various kinds of appraisals, and with condos it does work out mostly building.

I'm trying to understand the advantage of having anything in land. I'm claiming the 4% CCA (class 1) for the building portion of my condos in class 1 (or enough to get my rental income to zero). I'm not claiming anything for the land, other then keeping it in my adjusted cost base when I sell. Am I missing some advantage?

It seems to me if I didn't have to split I could claim 4% on a higher number...

The benefit is when you sell, or have a deemed disposition, of the rental property. At this point you, as the seller, and the purchaser need to agree on the split between land and building. As the seller you should want more of this going towards your land, and this will reduce the amount of recapture. In an over the top example, let's say you buy your condo for $100,000. You allocate 80% to building and 20% to land. After a number of years the UCC of your building has gone from $80,000 to $60,000. Now let's suppose you sell this condo for $120,000. If you can allocate 50% of the value to the land, and 50% to the building, your proceeds from disposition are equal to the UCC of your building, and then there is no recapture.

Some people want to be able to take more CCA, so they want to allocate more of the value to the building. It's all preferences and priorities.

[rohara66]

Stupid question regarding income tax on a rental property.

When I do my taxes every year I add the rental income to my personal income and then I write off mortgage interest, property tax, insurance cost and condo fees. These number are severally hurting me come tax return season as I’m basically paying income tax on the mortgage principal (and the small monthly profit). It is a townhouse (condo) so am I eligible to write off the property depreciating (or whatever you guys are talking about above)?

Sorry for the hijack but now I’m intrigued and I usually end up owing bigtime.

[CorsiHockeyLeague]

Why do you think you're paying tax on the mortgage principal? The principal is just a part of your ACB in the asset.

And yes, you can probably take the depreciation along the lines discussed here, but just know that any amount you deduct over the years is coming back into your income all at once when you dispose of the property, either by selling it or changing its use from a rental property.

Originally Posted by squiggs96

Some people want to be able to take more CCA, so they want to allocate more of the value to the building. It's all preferences and priorities.

Right, but this is in a sale context, and there's going to be tension between buyer and seller that'll be reflected in the negotiated price. As the purchaser, you don't want to allocate to land just so that you can save recapture later unless you're not planning to take CCA at all (in which case you can use this to your advantage and get the seller to lower the price in exchange for a favourable allocation for him). If you ARE planning to take CCA, all you'd be doing by allocating more to land would be giving away a deferral advantage.

[squiggs96]

I can't quote rohara66 right now, for some odd reason, but you are confusing cash paid and income/profit. Read my entry at post #4 for an example. There are specific orders in how to calculate your taxable income. You're not basically paying tax on the mortgage principal. You are paying taxes on the net income. As stated, that's your rent less your expenses. I highly recommend you find an accountant, such as Locke, and pay him for his services. It'll cost you money, but especially if you have rental properties, you can write this off. Yes, it'll cost you some cash, but it also has the potential to save you some cash.

I know nothing about plumbing or cars. I take the money I made as an accountant, and give it to plumbers and mechanics that will do a far better job than I could do, in a much faster time frame when I have problems with my pipes or my car. This is how you should feel about your taxes if you have any complexity.