April 30th, My Favorite Day

I like April 30th, because usually, around 11 pm, I file my final income tax return. It's nice to watch your children grow up and become productive members of society; well, until tax time hits. I now do five personal income tax returns every year, plus two corporate ones. Thank the Lord for Ufile Tax software, man that program has made my life easier. The good side of taxation is that is bestows a few favourable scenarios upon owners of real estate in Canada.

Real Estate Taxation Benefits

Now, as always, full disclosure is in order. I am not a tax accountant and your tax accountant has probably forgotten more about taxation than I know. What I am about to share with you is general information and you have to check with your tax professional for your personal situation.

Canadian law confers a few tax benefits to owners of real estate. Probably the best one is the Capital Gains Exemption. Firstly, the average homeowner never has to pay any taxes on the increase in value of their home. Nice.  Well, to be honest, not so nice because there are a lot better investment returns out there than the rate of return your house will provide, but you do have to live somewhere. You can pay rent or you can own. May as well own, and (among other benefits) reap the tax break.

But investors also get a tax break on the increase in value of their real estate investment. The rise in value of an asset is called a Capital Gain. Capital Gains are currently taxed at 50% in Canada. This means that half of the rise in value of your asset is tax free. Nice.

The next tax break on owners of investment real estate is not really unique to real estate but it is a tax break nonetheless, and that is, surprise the GST! Yes that is right. Now if you are an owner of a multi-family revenue property, it is most likely the case that you cannot register for the GST, but if you are an owner of some other types of revenue-producing property, you may be able to register for the GST. So, when you collect GST from clients, you must remit it to the government; no big deal and no loss. You wouldn't have had that money if you weren't registered. But, when you purchase goods or services for the business, the government will rebate you the GST you paid. What's that word? Oh yes, nice. GST is very, very complicated so be sure to check with a tax professional.

The next tax break is CCA or Capital Cost Allowance (depreciation, but what good beaurocrat would use one word when three will do?). When you buy a piece of real estate, theoretically the improvements (the buildings) depreciate as they age, but the land of course doesn't. So the government allows you to depreciate the asset at 4% per year. So, if you paid $1,000,000 for a revenue property and half ($500,000) was attributable to the building, you could write off 4% of that every year (subject to a couple of silly rules called the half-year rule, declining balance, and year of disposition) as an expense. You got it, nice.

What's The Catch?

Well, there is one catch. And it sounds like a big one but it isn't really. It's called recapture. You see,  in reality improvements don't tend to depreciate, they tend to appreciate. So if you claim CCA for 20 years and sell your building for more than you paid for it (I darn well hope so), your building actually went up in value and the government wants all that tax money back. To which I say, gladly. So what if I have to give it back, it was never mine to begin with, but thank you Government of Canada for an interest free loan for all those years. Just make sure to put the money to good use and re-invest it.

There's another catch. Let's say a real good opportunity to buy a larger property comes along but you have to sell the current one to buy it. When you sell the first property, all the income taxes become due and payable in that year. This of course takes money away that you could have invested in the new property. No big deal I guess. Quite frankly, I wish I had a tax problem. You have to make a lot of money in income to owe a lot in taxes. In the U.S. they have what is called a 1031 exchange that allows you to roll the old property over into the new one and not pay taxes (yet) but we don't have that unless the real estate actually is the business (i.e. hotels). Now this is where I get way over my head so don't listen to me, listen to your tax advisor.

There are many benefits to owning real estate as an investment, and these tax benefits are only a few. Check with your real estate professional and your tax professional to better understand your personal situation. Oh, got to go now, gotta finish those darn taxes.