December 8, 2014

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With rising home prices many homeowners nowadays are looking at offering rental suites to tenants in order to assist with monthly mortgage payments. The income generated from rentals can be a great “mortgage-helper” to any household. In turn, interest rates have been at all time lows and purchasing that condo, cottage, or house as a second rental property can be a great investment.

An outlook many landlords have on reporting income generated from a rental is to keep this amount undisclosed in order to keep more cash away from the taxman. This article will go over why it is necessary to disclose this income to Canada Revenue Agency (CRA) not only to satisfy tax law, but for your benefit as well.

Definition of Rental Income

Rental income is simply defined as any earned income as a result of rental property you own or have use of. Rental income includes houses, apartments, rooms, office space, and other real or moveable property.

Whether your rental is an apartment or an illegal (secondary) suite, CRA still requires you to disclose any income. A large concern of many owners of illegal suites is being exposed to municipal authorities. Generally, all information provided to CRA from taxpayers is protected under strict privacy law. In the eyes of CRA, income not earned legally is still simply considered income; the same as any other legal income earned. It is not in the interest of the CRA to report illegal suites to different municipalities, but to ensure all income included for tax purposes.

Deductible Expenses

The largest benefit to disclosing rental income on your tax return is the ability to reduce income by claiming deductible expenses. Most landlords spend a large amount of money on expenses directly related to earning rental income; these expenses are not deductible if a landlord does not disclose this income to CRA. The following are a list of common current expenses that can be deducted against rental income:

  • Advertising:  Any amounts paid to newspapers, online ads, signs, posters, or other advertising materials related to your rental property.
  • Insurance:  Insurance costs incurred to cover your rental property; or, if your rental is a part of your home, a portion of your total insurance may be deductible.
  • Interest:  If a landlord has borrowed funds in order to purchase a rental property, typically a mortgage, interest payments are deductible against rental income. This only applies to interest and not to payments applied to principle.
  • Repairs and Maintenance:  The topic of repairs and maintenance has many “grey areas”. Any costs incurred in doing regular repairs and maintenance are deductible; however, determining what is actually “regular” repairs and maintenance is where this gets tricky.

ie. Cost incurred relating to cutting the lawn at the home would be considered regular; however, replacing the lawnmower itself may not.

  • Professional /Management:  While the rental property is operating, any costs related to management companies, legal, and accounting can all be deducted.
  • Utilities:  In operating a home, any costs incurred to heat, provide electricity, telephone, internet, cable, or gas can all be deducted. If the rental is a suite in your home, a portion of your total utility bill can be deducted against rental income.

Other expenses not listed above may still be deductible if considered “reasonable” in earning rental revenue. With all the deductions available to owners of a rental property, the result of properly reporting income can result in a tax saving. Owners with high income from other areas, if planned properly, can end up reporting a loss and reduce their overall tax payable.

Consequences of Not Disclosing Income

Dealing with a CRA audit can be a very stressful situation. Not disclosing any type of income can result in numerous consequences.

  • Interest Accrual:  Any tax owing from income that had been unreported can be subject to interest. This interest is calculated from when the income should have been reported and can easily total up to a large sum.
  • Penalties and Fines:  CRA has the ability to charge penalties for late filing. This amount is also backdated to the time when the income should have been reported. Interest is calculated on the penalty itself as well. Not reporting income to CRA is a form of tax evasion; this can result in extremely large fines making re-payment difficult. Failure to report income can result in a number of different penalty categories with CRA:

The first being the “Failure to Report Income Penalty”. This penalty simply charges 10% of the total amount you failed to report on your tax return. Interest is compounded daily on this amount backdated to the date owed.

The second category this may fall under is “False Statements or Omissions Penalty”. This penalty is commonly known as gross negligence. If CRA deems you to have falsified your tax return they have calculated the following gross negligence penalty:

The greater of:

$100; and

50% of the understatement of tax and/or the overstatement of credits related to the false statement or omission.

If any non-disclosed amount is voluntarily reported to CRA you may qualify for the “Voluntary Disclosure Program” which could waive you of any penalties. If you find yourself in a situation like this, consult with your professional accountant to determine the best course of action.

  • Loss of Personal Property:  In the event of a large amount owing to CRA, they have the ability to place liens on homes and property, garnish wages and/or bank accounts. These liens take priority over any other liens and mortgages already registered on the property.
  • Prison:  Tax evasion is a crime. CRA can pursue charges against a taxpayer which can result in imprisonment.

If your rental property is a portion of your home (principle residence) you need to ensure no capital cost allowance (CCA) is taken. A principle residence is exempt from capital gains, a great advantage when holding a property and selling for a profit. By claiming any amount of CCA on your property, you may not be able to claim it as a principle residence and therefore not be exempt from capital gains when selling.

In the case of a second property, you can claim CCA, which in turn reduces your taxable income related to your rental property. When a rental property, that is not your primary residence is sold, you must report capital gains earned on the sale. Failure to report capital gains will result in severe taxes and penalties from CRA.

Withholding income from CRA can not only cause you trouble, but can also leave you missing valuable deductions. Before you get a knock on the door from the taxman, speak with your accountant to help with important tax planning.

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