You may be thinking about buying investment properties and renting them out for extra income, or perhaps renting out your farmland.
However, before becoming a rental property owner, there are some things you should know about how it will affect your taxes.
When getting into property rental, most people will run their new business as a proprietorship. That is, they will report all their income and expenses from rentals on their personal tax return. Many expenses can be deducted against rental income: mortgage interest, property taxes, utilities, insurance, repairs and maintenance, property management fee, and advertising. Principal that is paid on the property’s mortgage is not a deductible expense.
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This is based on the principal cost of the rental property, written off over time, a portion each year. This reduces rental income, which lowers taxes.
CCA is based on the value of the home, as well as furniture, fixtures, renovations and improvements. For rented farmland, CCA can be claimed on irrigation equipment and other permanent fixtures.
No CCA can be written off on the land because it is expected that the value of the land will never go down. As well, CCA cannot be used to increase a rental loss.
Deducting CCA is an option, but owners often choose not to claim CCA on rental properties. There are two main reasons:
- Renting a portion of your home and claiming the rental portion of the CCA could result in the loss of the principal residence exemption when the home is sold, which would result in greater tax costs.
- The selling price of the property is often greater than what was originally paid for the property. When you sell a property for more then you paid, and CCA was claimed on the asset, all prior CCA expense claims will have to be included as income in the year the property is sold. This is called recapture, and depending on the value, it could create a significant tax consequence in the year of sale.
A rental loss results when rental income is lower than the rental property expenses. Rental losses can be used to reduce total taxable income, as long as the rent you are charging is fair market value. You cannot use a rental loss if it is the result of charging discounted rent to a family member.
Most rental income in a company is considered “non-active income,” as opposed to “business income.” This type of income is taxed at a much higher rate than business income, so there is usually no direct tax benefit to owning rental properties in a company rather than personally. There are some exceptions to these rules.
When leasing farmland, the landowner could consider a crop share lease, a cash lease or a flexible cash lease. However, there are some tax considerations to keep in mind:
- If you are renting farmland to a non-family member as a cash lease, it may affect your ability to use the capital gain exemption or tax free rollover when land is transferred to your child or sold, resulting in greater future tax costs. This can be mitigated, but it may re-quire some tax planning.
With a crop share lease, you may be considered to be farming your own land if you are still involved in farm management, such as deciding what crops to plant. This means that your income from the rental property may be considered farm income.
Farm expenses can be claimed to lower current tax costs, and the capital gain rollover is less likely to be affected. However, unlike a standard lease, the risks of the farm business will be still be yours.
There are many ways to approach investing in rental properties. Talk to a professional adviser to determine what is right for you and your family.
