How to prepare tax returns for real estate investors
Are you a real estate investor that’s looking for advice on how to prepare tax returns for rental properties in Canada? Would you like to know which rental expenses are tax deductible? If yes, then this article is for you.
There are 5 easy steps to preparing a tax return for real estate investments:
1. Complete Form T776, Statement of Real Estate Rentals
Form T776 is used to report the income and expenses related to your rental property for tax purposes. It’s an integral part of your tax return.
The net income from your rental property, calculated on form T776, should be entered on line 126 of your income tax return (T1).
2. Calculate expenses
Now that you know the tax form to complete for your rental property, you must review your expenses to determine what you can deduct from rental income.
The most common expenses that are deductible from rental income are:
- Bank charges
- Car expense (to the extent that you used your car for real estate activities)
- Condo fees
- Insurance
- Maintenance and repairs
- Mortgage interest (not mortgage principal)
- Property taxes
- Utilities
The following criteria must be when determining, “Which expenses are tax-deductible from rental income?”:
- The expense should be incurred for the purpose of earning rental income
- The amount of the expense should be reasonable
3. Determine rental income
The next step in preparing tax returns for rental properties in Canada is to determine the gross rental income.
The gross rental revenue that you earned in the year must be reported on Form T776. Gross rental revenue earned is equal to the amount of rent payments that you received in the year, less prepaid rent received.
Prepaid rent is not rental income, but is a tenant deposit that you are holding onto, usually to be applied against the last month’s rent.
Prepaid rent is only recognized as revenue when it is applied to the month (usually the last month of the rental term), to which the prepaid rent relates. For example, assume that you began renting your property on June 1, 2009 and received 1 cheque for $2,000 (for first and last month’s rent) and 11 cheques for $1,000. The gross rental income that should be reported on your 2009 tax return is $7,000 (i.e. $8,000 rent received, less $1,000 of prepaid rent).
4. Claim Capital cost allowance (tax depreciation)
One of the most important tax decisions that you need to make is whether to claim capital cost allowance (tax depreciation or CCA). CCA is an annual tax-write off, calculated as a % of the cost of the property (excluding land). The following CCA % rates apply:
- 4% for residential properties
- 6% for commercial properties
- 10% for properties used in the manufacturing industry
The advantage of claiming CCA is that it reduces your taxable income from the rental property. The disadvantage is that at the time of sale, all of the previous CCA claimed must be recaptured into taxable income and is therefore subject to tax.
5. Calculate gain or loss on sale
The last step in “How to prepare tax returns for rental properties in Canada” is to calculate the capital gain or loss.
When you sell your rental property, you will either have a capital gain or a capital loss. The capital gain/loss is calculated as follows:
- Capital Gain: ½ x [Sale proceeds (after commissions and legal fees) in excess of the original cost of the property]
- Capital loss: ½ x [Original cost of property in excess of the sale proceeds (after commissions and legal fees)]
Only half of a capital gain is taxable and similarly only half of a capital loss is recognized.
The capital gain or loss is reported on Schedule 3 of the tax return and is also entered on line 127 of your personal tax return (T1).
Note that capital losses can only be applied against capital gains.
For additional information on real estate investing, please see the presentation Taxation for Real Estate Investors
About the Author, Allan Madan - Contact Now
Allan Madan is a Chartered Accountant and Tax Expert who practices tax in the Greater Toronto Area. Allan is also a real estate investor and has spoken on tax issues surrounding real estate at many conferences.
To learn more about Allan Madan, please see http://madanca.com
To contact Allan Madan please call 905-268-0150 or click here
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