Content
1. Revenues & Expenses
2. GST & Record Keeping
3. Audits and Appeals
4. General Topics on Real Estate
5. International Topics
6. Tax Planning
1. Revenues & Expenses
Accounting & Tax Principles.
Net income is simply gross revenues less expenses and the result may be
a loss. Business losses, including rental losses, are first deducted
against other income in the year and excess losses may be carried back
3 tax years and forward for 7 years. Business statements are based on
either the accrual method which reports income if invoiced in the fiscal
period - use closing dates - and deducts expenses incurred in the period
OR the simpler cash method, available to self-employed commission earners,
which declares revenue only if received by year-end and deducts only
expenses paid. Self-employed agents may receive a T4A slip from their
broker showing self-employed commissions and it may conflict with the
cash basis.
Deductible Expenses.
Employee agents get T4 slips showing commissions earned with CPP,
EI and Tax withheld. Commission employees claim "Employees Allowable
Expenses", including GST , and get a GST Rebate in their annual tax
filing. They do not collect nor remit GST. A T2200
"Declaration of Employment Conditions" , signed by the broker,
must be enclosed with the annual tax filing. Rules for deductibility of
expenses are punitive for commission employees. They are disallowed vehicle
usage to and from their broker's office and may claim a home/office expense
only if they work more hours at home than at the broker's place of business.
Self-employed agents are not subject to Employment Insurance premiums and income tax and CPP are paid on the installment basis rather than deducted from each commission. The good news is that self-employed agents may deduct any expense "reasonably connected to the earning of income". Claim all arguable expenses and don't blink if you are audited.
On starting self-employment, value furniture and equipment used for business and vehicles at FMV or the undepreciated cost and enter the amounts for depreciation. Claim the GST on the FMV, at commencement of self-employment, on furniture, equipment and on any car bought after 1990 in your first GST remittance.
Mortgage interest, often your largest home expense, may be added to the home/office deduction. This expense is pro-rated based on the area used exclusively for business or on a room-by-room basis not counting washrooms. The home/office expense must be carried forward once self-employed income is reduced to NIL. Self-employed agents may treat driving to and from the broker's place of business as deductible business usage.
Dinners and event costs are only 50% deductible since February 22, 1994. Cars purchased after 2001 are capped for depreciation at $30,000 plus GST and PST - - self-employed claim back the GST as an Input Tax Credit in their GST remittance - - with a monthly lease cap of $800 plus taxes. Car loan interest is capped at $10 per day. The full GST may be claimed back on the purchase of a car and on all operating expenses - gas, repairs, lease etc. - if the car is used at least 90% for business. If you drive only 89% for business you will get only 89% of the GST back.
Business Numbers.
Replaced GST numbers in 1996 and are used for GST and payroll remittances
and in personal and corporate tax returns. If annual revenues are under
$30,000, you must still complete the BN application and claim exempt
status from charging and remitting GST on that basis.
Quarterly Tax Installments.
These are paid on March 15, June 15, September 15, and December 15th of
each year and may be based on the LEAST of: 1) prior year; 2) current
year; or, 3) 2 years back for first 2 payments and 1 year back for the
last two. Pick the method that minimizes the payments while avoiding
interest charges. Theoretically, you are paying ¼
of your annual personal taxes and self-employed CPP owed in each payment
and you will pay more taxes or get a refund depending on the figures in
your tax return.
Operating Or Current Expenditures.
For both revenues and expenses govern yourself by the principles of accuracy
and thoroughness.
The first task in any bookkeeping is to distinguish between expenses with GST and those without.
2. Broker Administrative Fees.
This is a `basket' heading. It includes all monthly fees, desk fees or
any other charges. Segregate Errors & Omissions Insurance and Provincial
License Fees to heading 19 below if they are paid by your broker, as
they include no GST.
3. Accounting & Legal Fees.
All professional fees including tax preparation fees.
4. Advertising, Promotion, Gifts.
Includes all promotional expenses such as advertising, circulars, gifts
including cash gifts, giveaway items and distribution costs paid by you
to third parties other than the broker.
5. Conventions, Seminars, Training.
The general restriction is 2 conventions per fiscal year.
6. Delivery, Courier, Taxis.
Including packages sent by courier rather than regular mail.
7. Dues ( TREB, OREA etc.)
And any other professional organization fees. Recreational club membership
fees including golf fees are strictly disallowed.
8. Entertainment & Meals: at 50%.
Deductibility and the GST Input-Tax-Credit have been restricted to 50%
since Feb. 22, 1994. Includes tickets to all events. ( Add back in to
the expense the GST not claimed for refund purposes in your GST remittance.)
9. Equipment Rental/Lease.
Computers, faxes, phone systems, furniture and other equipment used directly
in the course of your business. Short-term car rentals may be included.
10. Office Supplies, Postage etc.
This is another `basket' category which includes all the obvious expenses
and anything which might not fit elsewhere.
11. Parking - Business.
100% deductible. Approximate for meters but enter in auto log book.
This includes business parking paid on a monthly basis. Residential tenants
who pay a segregated parking cost should pull that amount from the "Home/Office" amount
and enter it in the identified area for auto expenses for the higher deduction
rate. Parking tickets are now deductible.
12. Subcontract & Consulting Fees.
Includes invoiced services including your children at Fair Market Value
and the `computer guy' or promotion/advertising consultant.
13. Tel., Cellular, I internet, Pager, Home L.D.
Segregate the long distance charges on your home phone and claim the full
cost of fax/internet and dedicated business lines. The basic cost of
the first line is treated as personal and non-deductible.
14. Travel: 50% of Meals.
You must be 12 hours from your "regular place of business"
such as the GTA. This expense is your own cost of dining. You need not
be with a client.
15. Travel: 100% Hotel/Fares/Cleaning.
You must be 12 hours away from the GTA but these expenses are fully deductible.
Attend a conference in Vancouver but justify it.
16. Other GST-Included Expenses.
17. Expenses Paid Outside Canada.
Includes U.S. products/services. [ No GST ]
18. Interest & Bank Charges.
Includes bank service charges and interest on lines of credit and business
loans. [ No GST ]
19. Insurance (E&O, Liability), Licenses.
Professional liability insurance, errors and omissions, provincial or other
licenses. Do not include disability or life insurance. [ No GST]
20. Referral Fees.
You must both document and receipt these expenses and then claim them in
the tax return under "Consulting Fees" or "Promotion"
to avoid an audit because of the strict rules.
21. Salaries, Payroll/Casual Labor.
Spouses must and children should be put on payroll with deductions for
CPP, EI - none for a spouse - and taxes. You make payroll remittances
by the 15th of the each month for the prior month using your Business
Number. You match the CPP and add 1.4 times EI premiums withheld. No
GST is charged on salaries and payroll costs. The test of "employment"
is regular hours, at a fixed location with any degree of supervision.
23. GST on Vehicle Expenses - - carry this over
from the "Vehicle Expenses" summary.
Includes only gas & oil, repairs, insurance, license, washes,
auto club dues and lease costs. Claim the full amount of vehicle GST as
an Input Tax Credit if you drive 90% or more business and the actual proportion
of GST if less than 90%.
24. GST on Equipment Purchases.
Subject to the 90% threshold rule, claim the GST on up to $30,000 in the
period acquired. If starting self-employment, claim the GST on the FMV
at commencement the vehicle's Undepreciated Capital Cost if the car was
depreciated for other than self-employed activity. Also includes purchases
of computers and hardware, software, office equipment such as faxes and
telephones, furniture and fixtures. Use actual invoices to extract the
GST and enter on the summary. The remainder including PST is entered
for depreciation.
25. GST on Office-in-Home.
Only the GST paid on the business portion of home utilities and maintenance
expenses.
2. GST & Record Keeping
When applying for a Business Number, showing annual GROSS commissions under $500,000 will get you an annual filing frequency on the calendar year. Quarterly filers must finish the year then elect onto an annual filing for the beginning of the next year. Note: If you are an annual filer and your total remittance to GST was greater than $1,500 in the previous year, you must submit quarterly GST installments equal to 1/4 of the total GST remitted in the prior year.
GST is factored out of both revenues and expenses in statements in T1 personal tax returns. You are a tax collector for Revenue Canada (Customs & Excise) and your GST remittances reconcile the GST depending on the GST method selected for accounting and remittance. GST is simply an extra 7% pool of cash you receive in addition to your commissions.
1. Detailed GST Method.
Those with commissions $500,000 or more must use this method which requires
that every revenue and expense be entered with the principal amount and
the GST amount entered separately.
3. Audits and Appeals
If you keep clean records, you are ready for an audit. The onus is on you to relate expenses to the earning of income. You should provide to Canada Customs and Revenue Agency (C.C.R.A.) auditors only documents specifically requested although you cannot be seen to obstruct them. A fine line. Never let them interfere with your business operations. You must keep business records for 6 years. Designate a professional agent to act on your behalf with requests for information from C.C.R.A. . C.C.R.A. can audit a return only up to 3 years from the date of an assessment unless you sign a waiver. Never sign. Lacking a waiver, they can go beyond the 3 years only in cases of non-declaration of income, falsified expenses or of "misrepresentation" which may include carelessness. Statements about driving habits, hobbies, business practices, etc. will commonly be interpreted prejudicially to you.
You might be asked to produce an automobile log book but you can make representations to support the proportion of business usage claimed despite not having a logbook. You will be asked to produce receipts/vouchers - - categorized and totaled - - for all items on the T2124 business statement on your tax return. Self-employed agents who have a room OR area used exclusively for business get a home/office expense as of right. You only need to meet clients at home on a regular and consistent basis if you pay commercial rent and want to take an additional home/office expense.
An assessment or reassessment of a personal tax return or of a G.S.T. remittance may be appealed using a standard T400A "Objection" Form. An assessment of a current personal tax return must filed within 1 year of the regular filing deadline of April 30th. An appeal of a reassessment of a return preceding the current tax year must be filed within 90 days. Audits as well as appeals from assessments and reassessments are dealt with locally at your District Tax Services Office. You have an automatic right of appeal which will be handled in a relatively summary and inexpensive manner. Your problem gets very expensive with potential lawyer's fees only once you lose an appeal of an assessment or reassessment. You are then in Federal Tax Court.
4. General Topics on Real Estate
1. Principal Residence Exemption (PRE).
This differs from the basic $100,000 Capital Gains Exemption which ran
from 1985 to 1994. The PRE has NO DOLLAR LIMIT. Each married couple,
including common-law spouses since 1993 , and their children have only
one PRE. The PRE covers the building and up to 1/2 hectare of land unless
it can be shown that a larger area of land was required for the "enjoyment
and use" of the property. Parents are buying their adult children
homes to give them a start in their careers and to give them an asset
providing tax-free dollars on sale.
With low returns from cash investments, a `wobbly' stock market and with
realty values moving up, recommend selling and a `BUMP UP' to a larger
home. Low mortgage interest rates suggest that this is a very, very good
time to be buying real estate for any reason. A $450,000 `dream' home doubling
in value gives more tax-free dollars than a smaller home. Agents can get
both a commission on the sale and on the purchase of the new home. Mortgage-free
owners will be most interested in this approach especially if they have
cash investments giving low interest returns or cottages, stocks and mutual
funds with a high ACB through use of the Capital Gains Election form in
their 1994 tax return.
Conversely, many home-owners are cash-starved. They have low incomes and over-sized homes. This might include seniors, widow(er)s and those suffering career dislocations. These are all candidates for a 'BUMP DOWN'. This involves selling the current home for TAX-FREE dollars, buying a less expensive home and investing the excess cash for added income. Again, two commissions. Look for reverse mortgages and urge a sale to pay off the mortgage and consolidate the owner's finances.
Owners fear losing the principal residence exemption especially when values appear to be on the rise. You MAY rent out part of your home to tenants - ancillary usage - and even operate a home/office in your house so long as the MAJORITY of floorspace - read 51% - is for personal usage. The exemption is lost on any part of the home on which depreciation is claimed. Never claim depreciation on your own home. Against rent collected, you may claim a PROPORTIONATE share of expenses and often get the rent `tax-free'. Revenue Canada will not allow losses in this situation. Be content with the tax-free rent which pays down the mortgage.
2. First-time Buyers.
The Ontario government still offers the LAND TRANSFER TAX REFUND
to first-time buyers of newly built homes. The maximum rebate of $2,000
covers a home costing up to $200,000 for Agreements of Purchase and Sale
signed by March 31, 1998 Neither spouse can have owned a home.
The federal government provides the greatest incentive to first-time buyers through the HOME BUYERS PLAN which was converted to a first-time buyers program on March 1, 1994. Up to $20,000 may be withdrawn by each taxpayer from their RRSP towards a home purchase upon production to the RRSP trustee of a signed offer of purchase and sale. This amounts to an interest-free loan to yourself from your own RRSP. No taxes are withheld on the withdrawal. You cannot have owned a home during the 4 years preceding the year of withdrawal - since January 1, 1998 for a 2001 withdrawal. RRSP contributions must be left in for 90 days to qualify under the plan. RRSP contributions for year 2000 tax savings may be bought from now until up to 60 days into 2001 and qualify if left in for 90 days before withdrawal under the HBP. Get your timing right. The withdrawal is repaid in up to 15 equal installments starting 2 years after the year of withdrawal - - in the year 2003 for 2001 withdrawals. Failure to make the prescribed minimum repayment in a year results in the `shortfall' amount being included in income and an excess repayment will `average down' subsequent payments.
The Home Buyers Plan is often combined with a high-ratio mortgage to get first-time buyers into affordable homes. Those with high residential rents will be most interested in this approach. Many `top-up' their RRSPs when using the HBP and unused RRSP contribution limits have accumulated since 1991 - - no more "use it or lose it". Each spouse including `common-law' spouses qualify. The higher earner can make a spousal contribution to increase the spouse's RRSPs to $20,000 and the rule attributing the income to the contributor - - normally leave it in for the year of contribution and 2 subsequent years - - is not applied for withdrawals under the HBP. But, if you cohabit with a spouse who owned a home in the 4 prior years and up to 31 days before the withdrawal, NEITHER OF YOU qualify. For a 2001 withdrawal, you must close by Oct. 1. of 2002.
Some technical points:
You must purchase a Canadian home - - liberally defined including
mobile homes and houseboats - - or a contract to build a home.
Complete the FORM 1036 for the qualifying withdrawal. No taxes are withheld.
Certify that it will be used as your principal residence within 1 year
after the close.
Leave RRSP contributions you want to qualify inside the RRSP for at least
90 days. To meet this requirement, you can make the withdrawal up to 30
days after the close of ownership.
With $20,000 for each joint purchaser, you will likely qualify for a conventional
first mortgage and avoid the insurance costs of a high-ratio mortgage.
Make your required HBP repayment into an RRSP within 60 days of the year-end.
Any shortfall less than the required amount is taxed as income.
DO NOT sign a realty offer for a close within 60 days of an RRSP contribution
which you wish to qualify for withdrawal.
DO NOT die. Any balance is taxed unless a surviving spouse assumes the
repayments.
DO NOT emigrate without repaying any balance within 60 days of leaving
Canada or it falls into income. (Withdraw RRSPs as a non-resident after
repaying.)
DO NOT reach an age where you are not entitled to maintain an RRSP account.
You must repay any balance or let the annual minimum repayment fall into
income.
3. Second Homes/Cottages.
Each individual or married couple and their children under 18
are entitled to one principal residence exemption. This explains the transfer
of cottages to 18-year old children until they buy their own home. The
1994 tax return allowed taxpayers to use a Capital Gains Election of up
to $100,000 each to raise the 'book value' on second homes and rental properties.
The election benefited any cottages and rental properties owned before
about 1988.
The new higher "elected cost base" - - potentially $200,000 higher
if joint owners - - is then used to calculate taxable gains on sale. As
stated above, second homes and rental properties, along with stocks and
mutual funds, can provide tax-free dollars to buy new properties or a larger
principal residence. Ask your clients about cottages and rental properties.
The PRE allowed each spouse to own a home until 1982. If a home and cottage are owned jointly from 1972 to the present, and a couple is selling their city home to move to the cottage, or vice-versa, the use of the PRE designation by joint owners on a property for the period 1972 to the year of sale will preclude the use of the PRE on the other home when it is sold. [ Being able to use the PRE for the 1972-1982 period will exempt from taxation the appreciation from December 31, 1971 to December 31, 1981 - - 10 years - - pegged to the FMV at those two dates. It could be a substantial sum. ] The answer is to transfer the joint half interest between spouses so that each owns a home outright. The transferee assumes the exempt status of the transferor. This reorganization exempts from tax the appreciation from 1971 to 1982 on two properties. The PRE can be used on the eventual sale of the cottage but subject to the attribution of 1/2 the gain on sale to the original joint owner. The Ontario government will not charge LTT for spousal transfers if each appears on the original deed. No downside.
4. Rental Properties.
Rental income is treated as income from property and thus not
equivalent to business income unless you provide extra services such as
the rental of furniture, office cleaning and protective services. An example
of business activity is the ownership and management of a hotel/motel operation.
This is of relevance to investors who might avoid pure rental properties
and acquire a motel operation to qualify a CCPC as an active business for
the purposes of the $500,000 Lifetime Capital Gains Exemption per shareholder.
The important thing to acknowledge about rental properties is, that in the current market, their acquisition now makes economic sense. They can now carry themselves since there is some proportion between cost and revenues. Look for bargains and set up investors for positive cashflows and long-term ownership. On sale, gains are taxed preferentially with only 50% of a capital gain included in income. A mortgage reserve may be claimed in a T2017 Schedule where all of the proceeds of the gain are not received in the year of sale. This is accomplished with a vendor take-back mortgage - - remember the good old days of the 1980s - - which can spread gains over as much as a 5-year period and spread gains into the lower tax brackets.
A rental property bought by multiple owners is: easier to borrow against; should carry itself; provides more persons to manage; and, legally spreads taxable gains around to those who pay lower taxes on sale. Get back to basics.
The crash in real estate values in 1989-1990 created a tax-driven market. Investors might now sell rental properties to `crystallize' tax losses. The "terminal loss" treatment on the sale of rental properties is a potential goldmine for agents. The general rule is that depreciation may only be claimed to the extent it reduces net rental income for all properties owned to zero. [ As an aside, most current properties have likely not claimed any depreciation deduction as they have been running at operating losses. ] MURBS were an exception to the general rule and sold very well since owners could claim the full depreciation amount annually in addition to any operating losses -- tax-driven acquisitions. The second exception is a terminal loss which is a final deduction where a property has depreciated more quickly than foreseen in the prescribed rate of depreciation. Section 20 (16) of The Income Tax Act ( ITA ) of Canada provides for the deduction of a terminal loss upon the disposition of all of a taxpayer's depreciable property of any prescribed class.
A rental building acquired at a cost of $50,000 or more
must be entered in its own class for depreciation purposes [ Regulation
1101 (1 ac)]. Class 3 with a rate of 5% was replaced with Class 1 and a
rate of 4% in 1988. This prevents `pooling' of rental buildings to both
delay recapture of depreciation and avoid taxation on rental cashflows
by maximizing depreciation. The government wanted to accelerate taxation
and did not foresee the dramatic reduction in real estate values.
Condominiums are treated entirely as building and a final DEPRECIATION
deduction may be claimed in the rental statement in the year of sale. [Properties
composed of both land and building allocate the acquisition cost and proceeds
from sale between them. E.g., a 60% allocation to building and 40% to land.
Since land cannot be depreciated, any loss would be allocated as a 40%
capital loss. For unimproved land, interest and taxes can only be applied
against rental income on each separate piece of land and then is capitalized
to apply against any gain on sale. The gain is taxed as ordinary income
and not as a taxable gain. ] Any rental loss resulting from the terminal
loss treatment is fully deductible against all other income in the year
of sale and any excess may be carried back 3 years and forward 7 years.
If you own MORE than one rental unit in a condominium the final depreciation
deduction may be claimed ONLY when the LAST unit is sold. Tax refunds may
be used to buy a better property.
A caution. Revenue Canada had used the MOLDOWAN case to argue that some properties had no "reasonable expectation of profit". Fortunately, the more recent TONN case decided in December of 1995 favors rental investors. The courts will still look at key factors such as the size of the original down payment to see if rental profits were likely.
The above points will allow you to look for tax-driven markets.
Rental properties sold at profit - - other than any recapture of previously claimed depreciation which is fully taxable - - are treated as capital gains with a 75% inclusion rate. Realty agents and brokers must beware of having their own gains from the sale of rental properties taxed fully and not as capital gains. The test of whether a sale qualifies as a capital disposition and thus eligible for capital gains treatment is: 1) similarity to your ordinary course of business; 2) nature of the property; 3) whether their have been acts of sale such as improvements versus acts or expenditures to increase rents: 4) the number and frequency of transactions; and, 5) the period of ownership. The primary intent on purchase to qualify the eventual sale for capital gains must be the earning of rental income. We recommend that if an agent or broker buys a bargain property that they hold for at least 2 years so that they will not be seen as speculating in real estate - - flipping - - and fully taxed on the gain. Investors in real estate must be careful to avoid this same negative treatment.
5. Conversions of Usage.
Properties can be converted from personal to rental usage and vice-versa.
For tax purposes, such conversions are treated as deemed dispositions
and subject to taxation. If you move out of a Principal Residence you
can file an Election under s. 45 of the ITA to postpone tax consequences
for up to 4 years and to decide whether to use the PRE designation on
that property - - the elector is tracking the market to see which property
enjoys the greatest appreciation. No depreciation can be claimed on the
converted property during this 4-year period. If you move more than 40
kilometers for (self-)employment purposes, the s. 45 Election is good
indefinitely so long as you claim no depreciation against rental income.
If you move into a property previously used for rental purposes, you
can designate the home you move from for the purposes of the PRE and
file a s. 45 election on the property you move into so long as you have
not claimed depreciation on the rental property since 1984. This latter
Election is indefinite. A final point on conversions. Terminal losses
may be claimed in the case of a conversion of usage. A move into a rental
property which has lost substantial value results in a
"deemed disposition" and will crystallize deductible losses.
You can sell an investor's home to put them into a rental condominium to
`crystallize' tax deductions on the rental property.
5. International Topics
1.Non-Resident Owners of Canadian Real Estate
Non-resident Owners of Rental Property.
Rental payments to non-residents are subject to withholding tax.
Tenants or agents for non-residents owners of rental property in Canada
are required to withhold 25% of the gross rent paid and remit it to Revenue
Canada by the 15th of the month following receipt. The non-resident is
not required to file a tax return, but may elect to do so to obtain a tax
refund based on the net income. Alternatively, the non-resident owner may
file annually prior to January 1st of each year or prior to receipt of
the first rent payment a Form NR6 election with Revenue Canada. There is
an election in the Form NR6 to file a Canadian T1159 tax return within
6 months after the tax year-end. Non-residents can claim personal tax credits
only if 90% of their world income is in Canada and they are subject to
tax at the regular tax rates for Canadians. A designated agent is required
to sign the NR6 and thereafter will withhold 25% of the net rent proceeds
- - the remittance might be NIL - - and remit to Revenue Canada. If the
non-resident fails to file the tax return within the 6 months, the agent
is liable for any taxes less amounts actually remitted.
Sale of Real Estate by Non-residents.
Generally, the Income Tax Act (ITA) requires prepayment of income tax attributable
to sales of Taxable Canadian Property (TCP) by non-residents. The purchaser
of the property from the non-resident must withhold 33 1/3% of the purchase
price and remit it within 30 days from the end of the month of the purchase.
The non-resident vendor may make application to the District Taxing Office
(DTO) where the property is located on Form T2062 and pay or provide
acceptable security in a sum equal to 33 1/3% of the estimated capital
gain on the sale. The DTO will issue a Clearance Certificate (T2064)
which will have a 'certificate limit' on it and provided the property
is not sold for a price in excess of the 'certificate limit' the purchaser
is not required to withhold any sum. If the purchase price exceeds the
'certificate limit', the purchaser is required to withhold 33 1/3% of
the amount by which the purchase price exceeds the certificate limit.
If the T2062 is not filed prior to the purchase date, the vendor must file it within 10 days after the purchase date. The non-resident vendor may pay the tax on the capital gain realized or deposit acceptable security and the DTO will issue a clearance certificate on T2068. Upon receipt of the T2068, the requirement of the purchaser to withhold ceases.
Sale of Canadian Residence.
Canadian residents emigrating have to consider the tax impact of retaining
a Canadian residential property. The Principal Residence Election is
an annual election and upon emigration, by definition is not available
to non-residents. Therefore, for each year the emigrant owns the Canadian
residence, a larger percentage of the gain on the sale will be a taxable
capital gain because of the averaging effect of the Principal Residence
Designation Form T2061.
2. Investors in U.S. Real Estate
Recent Canadian legislation, effective as of 1996, requires Canadians to disclose specified foreign assets held outside Canada, if the total fair market value exceeds $100,000. The purpose of the declaration is to track assets outside Canada to ensure that worldwide income on property is being reported and for capturing all assets for departure tax upon emigration or tax on deemed dispositions upon death. This legislation is currently being reconsidered because of the negative reaction from recent emigrants who have large offshore assets and are moving out of Canada rather than make these disclosures. Foreign rental properties worth more than $100,000 alone or combined must be reported. Assets not included are those used in active business of the reporting person and personal use assets of the reporting person including personal homes.
Many Canadians have rental properties in the U.S. as well as personal homes. All rental income and gains on the sale of realty in the U.S. must be reported in Canadian tax returns. This income is reportable in a U.S. federal tax return - - some states require state filings where tax will be levied - - and is taxed first in the U.S. since the U.S. is the `source' country. You are required to file a 1040NR U.S. federal income tax return and, since the 1996 filing, obtain a Taxpayer Identification Number (TIN) from the IRS even if you have used a U.S. Social Security Number for previous filings. You must discontinue using the SSN.
The rules for depreciation of rental buildings differ. In Canada you cannot use depreciation to create or increase a loss. In the U.S. you must take the prescribed depreciation in the annual filing and carry forward any losses to apply against gains on sale. The U.S. has draconian non-compliance provisions for non-residents and U.S. citizens who do not file. Failure to file can result in being taxed on the gross rents during ownership on an annual basis with no right to reduce tax based on operating expenses or depreciation. On sale, you will be imputed to have claimed the prescribed depreciation annually, then taxed on the recapture as ordinary income to the extent this imputed depreciation reduces your cost base of the property below original cost. You will also pay capital gains tax to the extent the proceeds of sale exceed your original cost.
Any federal and state taxes paid in the U.S. can be used
to offset Canadian taxes through the Foreign Tax Credit Schedule in the
Canadian return. The US requires purchasers to withhold a portion of the
purchase price which is remitted to the I.R.S. when buying real estate
from non-residents of the U.S. Note that in the event of death, you are
subject to estate taxes in the U.S. but under the U.S.- Canada Tax Treaty
the exempt amount is rising to $600,000 (U.S.) pro-rated based on the proportion
that your U.S. holdings represent of your world assets.
3. Emigrants
Need to consider the consequences of selling the Canadian
residence versus changing its use to rental property. You can file a s.
45 election under the ITA to postpone taxes for Canadian purposes on the
deemed disposition. But as per U.S. taxes, if the immigrant to the U.S.
rents out the Canadian property, the property is classed as an investment
property and will not qualify for the U.S. residential tax exemption. The
cost basis for calculating gain on sale is the original cost not FMV at
the date of the conversion of use to rental usage. Upon sale, all of the
gain will be taxable on the U.S. Tax return. This also true for rental
properties as their cost base for U.S. tax purposes is their original cost.
The deemed disposition under Canadian law by virtue of emigration triggers
capital gains tax on the rental property. You can provide for this with
6 equal annual tax payments to Revenue Canada based on the calculated tax
and subject to interest and the posting of security. In U.S. terms you
will pay taxes on the full gain based on your original cost and you must
sell the property within 5 years for any credit in a U.S. tax filing for
the calculated Canadian tax resulting from the deemed disposition. In U.S.
terms, all or nothing. The lesson is to sell your home and rental properties
before moving to the U.S.
Canadian tax rules are based on residency which requires living in Canada
for at least 183 days a year with a "settled intention"
to remain here. U.S. tax rules, in contrast, are based on citizenship although
both jurisdictions tax based on worldwide income with the source country
taxing first and foreign tax credits provisions to offset or reduce double
taxation.
4. Immigrants
Immigrants to Canada are deemed to have acquired capital
assets owned at the date of immigration at FMV at that date. This will
be the basis against which gains will be subsequently calculated for Canada
tax. Excepted from this rule is Taxable Canadian Property owned by the
immigrant on the date of immigration which includes:
1) real property situate in Canada;
2) capital property used to carry on a business in Canada;
3) certain shares in public corporations; and
4) Canadian resource property.
The Canadian and U.S. governments are freely exchanging information to as part of reciprocal assistance to enforce the tax laws of the countries. The U.S. has built up a huge computer database of real property transactions in the U.S. Revenue Canada has access to this information. Conversely, there are an estimated 250,000 residents of Ontario who have U.S. citizenship and the I.R.S. now has access to Canadian data. The I.R.S. has been recently mandating that these U.S. citizens - - Overseas Filers of U.S. taxes - - satisfy U.S. tax compliance rules and file the current U.S. return along with the prior 6 years worth of filings.
6. Tax Planning
1. RRSPs.
Defer income and accumulate tax-free. The `lag' formula is 18% of the prior
year's EARNED INCOME to a maximum of $13,500 based on $75,000 of income.
The cap of $13,500 is in place until 2003 but unused RRSP eligibility
may be carried forward indefinitely. Hope for an inheritance. [Those
under 69 in 1996 will have to convert RRSPs to RRIFs or annuities in
the year that they turn 69 -- formally age 71.] If cash-starved, transfer
stocks or mutual funds to your RRSP.
2. Losses.
Since May of 1985, capital losses are only deductible against capital gains.
Business losses and rental losses are deducted against all other income
in the year incurred then carried back 3 years and forward 7 years.
3. Limited Partnerships.
These deductions have the same effect as RRSP deductions. These investments
provide interest deductions along with partnership deductions. Emphasis
should remain on investment value and real estate limited partnerships
could do well in the current market.
4. Labor-Sponsored Venture Capital Corporations
(LSVCCs).
A $5,000 purchase of a labor-sponsored venture capital corporation (LSVCC)
gives 30% tax credits with a federal tax credit of $725 and an equal provincial
tax credit. You may roll the LSIF into an RRSP for a contribution deduction
or even buy the funds from within an RRSP before March 1, 2001 to get the
tax credits for 2000 taxes. You must leave the LSIF intact for 8 years.
Medical funds are popular.
5. Odds & Ends.
Legal/accounting costs relating to (re-)assessments and tax appeals are
deductible. Every transaction may be challenged by C.C.R.a. as done PRIMARILY
for tax reasons and not for business purposes and disallowed under the
general anti-avoidance rule (GAAR). Get advice before getting too clever.
Put spouses and children on payroll according to the rules for income-splitting.
RRSP loans are not deductible. Emphasize repayments of non-deductible
loans first while leaving deductible loans intact. Sell stocks/mutual
funds to buy a larger home or invest in real estate then borrow to buy
stocks/mutual funds at a later date with an interest-deductible loan.
INFORMATION ON THIS WEBSITE IS
FOR GENERAL INTEREST ONLY, YOU SHOULD SEEK PROFESSIONAL ADVICE.
BDC ASSUMES NO RESPONSIBILITY FOR THE ACCURACY OF THE CONTENTS.
APPLICABLE LAW AND REGULATIONS ARE CHANGED CONSTANTLY.
