Rental Income: Reporting, Deductions, and Important Considerations
- Rylan Kaliel
- Apr 21
- 7 min read
Updated: Apr 27
Owning rental properties can be a profitable investment, but it also brings unique tax obligations. In Canada, rental income must be reported on your tax return, and there are specific rules regarding what expenses you can deduct. This blog post provides an in-depth look at how rental income is taxed, which expenses are deductible, and key considerations every landlord should know.
Reporting Rental Income (Form T776)
All rental income you receive from tenants must be reported to the Canada Revenue Agency (CRA). Rental income may include:
Monthly rent payments
Security deposits utilized for repairs, missed rent, etc.
Income from short-term rentals (e.g., Airbnb)
Amounts received for utilities or services provided to tenants
You report rental income using Form T776 Statement of Real Estate Rentals. This form allows you to clearly identify your rental income, calculate allowable expenses, and determine your net rental income or loss.
Allowable Deductions for Rental Properties
CRA allows landlords to deduct certain expenses from rental income, effectively lowering their taxable income. Common deductible expenses include:
Mortgage Interest: Interest portion (not principal) of mortgage payments.
Property Taxes: Taxes levied by municipalities.
Utilities: Gas, electricity, water, or heating paid for the rental property.
Insurance: Premiums paid to insure the rental property.
Repairs and Maintenance: Costs associated with maintaining or repairing the property.
Property Management Fees: Payments to property managers or rental agents.
Advertising Expenses: Costs to attract tenants, including listings and advertising.
Professional Fees: Accounting, bookkeeping, or legal fees related to rental property.
It's crucial to keep detailed records and receipts for all expenses claimed.
Property Tax and Interest Limitations
With respect to property tax and interest, the amount deductible for these is limited to the amount of net income prior to these deductions with some modifications for corporations. Any non-deductible amounts would be added to the cost base of the land.
With respect to this, see the below simple example as to how this would work.
As we can see, we had property tax of $2,000 and mortgage interest of $6,000, however, net income before these amounts was $3,250, so only $3,250 would be deductible, leaving $4,750 as non-deductible. This $4,750 would be added to the cost of the land as follows:
When the property is sold, this would reduce the capital gain arising on the sale of the land. As a result of this, a careful tracking of the cost of the land should be undertaken if the property ever has any non-deductible property tax and/or mortgage interest to ensure the cost is updated and the capital gain is reduced on any future sales.
Understanding Capital Cost Allowance (CCA)
Capital Cost Allowance (CCA) is a depreciation deduction landlords can claim on their rental properties. It provides tax relief by allowing landlords to deduct the cost of wear and tear over time.
Generally speaking, CCA works by deducting a fixed percentage on assets based on pre-determined asset classes. For example, most buildings are included in Class 1 and are deductible at a rate of 4%. This deduction is done on a declining balance, which means that the 4% rate is applied to the remaining balance, or undepreciated capital cost (UCC), of the assets, such that the deduction is reduced each year. Take the below as an example.
As we can see, as the years go on the maximum CCA deduction we can claim goes down. This is the essence of how the declining balance method works, each year the balance declines and thus so does the deduction. You’ll also note that we indicated that this was the maximum CCA that can be claimed, which is due to the fact that CCA is a discretionary deduction, meaning you do not have to claim the maximum amount and, for rental properties, there is a limitation on the amount of the CCA that can be claimed, which will be discussed further below.
One final note, you’ll see that we indicated the UCC of the building, but not the land. Land is not depreciable and therefore not eligible for a CCA claim, so we would only claim CCA on the building. The logic is that a building with eventual be tore down due to wear and tear but the land will not.
Please note the following key considerations for CCA on rental properties:
CCA Limitations: The amount of CCA you can claim is limited to your net income on the property after all other expenses are claimed.
Recapture: Claiming CCA can lead to recapture (additional taxes) when you sell the property. This generally arises where the UCC of the property is less than the proceeds received on the sale of the property.
Principal residence exemption: Claiming CCA on a rental property can cause difficulties claiming the principal residence exemption in the future if you have ever previously or intend to use the property as a principal residence in the future. More on this in a future blog.
Deciding whether to claim CCA involves careful tax planning to avoid potential future tax liabilities.
Change in Use (Ss. 45(2) & 45(3))
A change in use arises when you change your property from some other purpose (i.e., principal residence) to be used for the purposes of gaining or producing income (i.e., rental property) or vice-versa. When a change in use arises, even if it is not for the entire property (i.e., converting a basement into a rental suite), there is a deemed disposition of the property, or portion of the property, at the fair market value at the time the property had its change in use.
Generally speaking, what will happen is that you will have a gain or a loss based on the fair market value at this time less the cost of the property. This can be illustrated as follows:
In the above example, we see that there is a fair market value of $690,000 at the time of the change in use and a cost of $585,000, which results in a gain of $105,000. This gain would be required to be reported on your tax return. Generally, most gains arising on change in use would be a capital gain, of which only 50% of the actual gain would be taxed (more on this in our upcoming blog on capital gains). Further, if the property was your principal residence prior to the change in use you may be able to claim the principal residence exemption to reduce or eliminate any capital gain that arose (more on this in an upcoming blog on the principal residence exemption rules).
As a small note, there can be some exemptions to this gain being treated as a capital gain, such as if the property was held for less than 365 days or if it is not factual capital property, which will be discussed in future blogs. Further, this deemed disposition can be taxed even if you did not receive any cash, so it can cause issues in that you have to pay tax even if you have not received any cash as a result. If you ever find yourself in this type of a situation, it is recommended that you reach out to a tax professional for assistance to evaluate your options.
Despite these situations, the Income Tax Act (Canada) has specific provisions that can be utilized if you convert your principal residence into a rental property, or vice versa:
Section 45(2): This provision allows you to defer the change in use rules from applying, including a deferral of recognizing a deemed disposition (sale) if you convert your primary residence into a rental property.
Section 45(3): This is a similar deferral if a rental property becomes your principal residence.
It is important that note that CCA being claimed on the property can cause issues with these elections, especially in the case of section 45(3). As such, it is advisable that if you may ever use a rental property as a principal residence you carefully consider whether or not CCA should be claimed on this property.
Please also note that this is an election that must be made and included with the return in the year that the change in use arose. These elections can be late-filed, but they may be subject to a penalty.
Despite the complications noted above, these provisions can help you avoid immediate capital gains taxes but require proper elections and documentation. As such, it is recommended that they be discussed with a tax professional to avoid any issues.
Please note that the above is not an exhaustive description of CCA and its various mechanics, but more a quick background. For more information on this topic, please review the CRA’s Claiming capital cost allowance (CCA) article or contact a tax professional.
Common Pitfalls to Avoid
Some common errors landlords make include:
Claiming personal expenses as rental expenses (e.g., full mortgage payments, personal renovations).
Incorrectly claiming capital improvements as repairs and maintenance.
Failing to report short-term rental income (e.g., Airbnb).
Incorrectly calculating or misusing CCA deductions.
To avoid these pitfalls:
Clearly separate personal and rental expenses.
Maintain organized records and receipts.
Seek advice from a tax professional if unsure.
Strategic Tax Planning Considerations
Effective management of rental income and deductions involves strategic tax planning:
Timing repairs and maintenance expenses strategically to optimize tax benefits.
Carefully evaluating whether claiming CCA is beneficial.
Understanding the implications of converting properties between personal and rental use.
Summary
Accurately reporting rental income and understanding allowable deductions are crucial to maximizing your investment returns while remaining compliant with CRA rules. Strategic tax planning and informed decision-making will help you manage your rental properties effectively and minimize your overall tax burden.
Stay tuned for our next blog, where we'll explore capital gains and their tax implications. KLV Accounting is here to help. Contact us today to enhance your financial strategy and drive business success!
For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.
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