Are you a rental property accountant? There are several accounting and tax considerations that are tied to rental income earnings. If your clients own rental property and collect money for its use, you should be aware of rental income rules and requirements imposed by the Canada Revenue Agency (CRA).
Rental Income Accounting Methods – Cash or Accrual?
The accounting method you decide to use (cash or accrual) when reporting your clients’ rental income may have a material impact on their bottom line. If your clients’ income is truly rental income, they can choose to use the cash or accrual method of accounting. If, on the other hand, the income falls under the categorization of business income, you must record your clients’ income under the accrual method. The cash method means that revenue and expenses are reported only when the funds are actually collected or disbursed. Under the accrual method, you record revenue in the period in which your client earned it, regardless of whether the lessee has actually paid.
Is Rental Income Considered Business Income?
There are rules that dictate which accounting method you can use. If your client, in addition to renting out space, provides additional services such as cleaning, concierge, or other services, then it’s more likely the CRA will consider the income to be from business rather than rental, because there is a service being provided. Also, it doesn’t matter how many rental properties the client owns – the ‘business or rental’ rule still applies.
Say your client owns an apartment complex with 50 units, 25 first floor and 25 top floor, as well as four townhouses on the corners of the property. In total, there are 54 units. The 50 units in the main building have access to a laundromat, Wi-Fi, and other amenities. For the renters in the townhouses, your client also offers optional maid services. Even though these optional services are only available to four of the client’s units, because it is all one property and services are provided with rentals, your client must use accrual accounting. For all 54 units, the CRA will consider the income to be business income and not rental income.
Tax on Rental Income in Canada – Deductible Expenses
As long as expenses are reasonably required to incur your client’s rental revenue, you are able to deduct the costs when preparing your client’s tax return. You must consider though whether to report these expenses as current expenditures or capitalized costs. The CRA classifies a current expense as a cost that reoccurs after a short period time. Ongoing maintenance and utilities are examples of current expenses. There are other costs, though, that the CRA considers capital expenditures. These costs give a lasting benefit or advantage such as extending the property’s useful life. Adding vinyl siding to a building’s exterior walls is an example of a capital expenditure.
When completing your client’s tax return, you are allowed to deduct all current expenditures including:
- Costs for advertising the rental property when available
- Premiums for insurance coverage on the rental property for the current year
- Legal services to prepare leases or collect overdue rent
- Fees paid to manage the property
- Office expenses
- Property taxes
- Travel costs if the expenses are related to the collection of rent
- Supervision of repairs
- Management of property
Legal fees to buy rental property cannot be deducted against rental income. You also can’t deduct maintenance and repair costs if those expenses incorporate your client’s own labour. Other deductible costs include amounts paid to personnel related to the care and maintenance of your client’s rental property. If your client is an employer, you can deduct its Canada Pension Plan (CPP), Quebec Pension Plan (QPP), Employment Insurance (EI) premiums, and Workers’ Compensation contributions.
Rental Property Tax Rules – Non-Deductible Expenses
You are not allowed to deduct any personal spending as a rental property expense. Suppose your client has a single property with eight rentable units. If five units are rented and three are retained for your client’s personal use, the client can only deduct the expenses specifically traceable to the five rented units. This means that 62.5% (5/8) of the building’s expenses, such as taxes or insurance, are deductible.
Keep in mind that some business expenditures are always non-deductible. You can’t deduct repayments on the principal portion of a loan or mortgage, nor can you deduct personal labour, tax penalties, or transfer taxes on the purchase of a new rental property. The latter, however, most likely counts as a capital expenditure.
Tax Accounting for Rental Properties – Non-Capital Losses
Non-capital losses are unused losses from business operations. Canadian tax rules stipulate you can carry back a non-capital loss for three years. Additionally, you can carry forward the loss seven, 10, or 20 years, depending on the year in which the loss occurred. You can carry any non-capital loss occurring in a tax year after 2005 forward 20 years. If losses are unused after 20 years, any remaining losses expire and cannot be incorporated into your client’s tax returns.
Rental Property Accounting – Capital Cost Allowance
You can use capital cost allowance (CCA) to claim a current depreciation expense on capital expenditures. Should you claim a CCA for your client? The amount of capital cost allowance your client can claim depends on the type of property and the date they acquire it. You can group your client’s depreciable property into groups such as buildings or condominiums. Land is typically not depreciable property, so it does not have an assigned CCA rate.
A rental building can belong to one of several classes, and each class has a different CCA rate. A condominium that is part of a building has the same CCA rate as the building. If your client owns a condominium in a Class 31 building, the condominium is a Class 31 rental property.
Reporting Foreign Rental Income to the CRA
If your client owns foreign property with a cost basis in excess of $100,000, they may have to declare this property on their tax return and make an annual disclosure using CRA’s Form T1135 (Foreign Income Verification Statement). The penalty for nondisclosure is $25 per day up to $2,500 per taxpayer. You do not need to disclose any of your client’s personal property, such as a cottage or an automobile, nor do you need to disclose property such as a warehouse, inventory, or equipment that is used for running a business.
There are strict rules regarding how your clients have to report their rental income and properties. For their income taxes, understand which of your client’s expenses are deductible. Properly assess the property’s CCA class and make note of any foreign properties your client may be holding as rental property.
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