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Business Advisory, Personal and Corporate Taxes, Business Start-Up, Bookkeeping

Money For Nothing And Your Rent For Free: Will Incorporating Reduce My Rental Income Taxes?

You’re thinking seriously about buying a rental property–now what? The first, obvious thing seems to be to incorporate, because renting properties is a business, but that might not be the best step for you tax-wise. There are definitely pros and cons, as noted by Evelyn Jacks at MoneySense.com

Taxation laws in Canada are not set up to be particularly beneficial for people who own rental properties to see significant tax savings if they incorporate. 

There are also other considerations–incorporating has an expense associated with it up front, and it creates multiple levels of complexity with corporate reporting, more complicated income tax filing, and dividend structures. Unless you have five or more employees working in your rental business, incorporating may not be your best choice.

Smythe LLP in British Columbia has come up with some excellent examples to demonstrate the comparison between a rental property owned personally, or owned by a corporation.

In their first chart, the tax rate paid by the owner of a personally owned rental property is 25%. In the second chart, the tax rate paid by the owner of a corporation-owned property is 28%. The tax rates are comparable (but still a little higher for the corporation), but you have also introduced a corporation and dividends into the mix. This adds another layer of complexity to the problem, rather than you simply reporting your income from your rentals on your personal income tax return, which simply involves one form, and keeping track of and reporting the expenses you incurred to generate the rental income.

You also need to be aware that rolling over personally held property to a corporation may involve a land transfer tax–Alberta does not have one, but most other provinces and territories do, so if your property is out of province, this is probably something you’ll need to deal with.

But wait, you say, don’t I need to incorporate to protect myself and my bank accounts and properties from any potential insurance or legal exposure? That would likely be your most compelling reason to incorporate for rental properties, but these issues can also be addressed with a comprehensive insurance policy–that’s a discussion to have with your insurance representative. If you hold a mortgage on the rental property, the bank will most likely require a personal guarantee against default as well.

Now, let’s talk about what happens if you turn a primary residence into a revenue-generating property, or when you sell your rental property. You will most likely be looking at a capital gains tax at this point. Even if you don’t sell your primary residence, but change part of it to a rental property, you still may be looking at a capital gains tax–the government is interested in any change in the use of your property. 

 Canadians don’t incur a capital gains tax when they sell their primary residences, but changing a primary residence into a rental property would negate that exception.

As you can see, buying a rental property, operating a rental property for income, and selling a rental property can be a complicated undertaking. Our best advice–come talk to us at Shaw & Associates Chartered Accountants, and also talk to your lawyer and your insurance agent before you buy a rental property or start renting out part of your existing property. Pre-planning can save you a lot of headaches in the short and long term.