Investing in rental properties can be a worthwhile venture, but it also comes with various financial and legal considerations. When looking to purchase a rental property, one is often faced with the decision of whether to own rental properties personally or through a corporation.
This choice can significantly impact your tax liabilities, asset protection, long-term financial goals and often depends on various factors including your own financial situation. In this article, we’ll explore the Canadian tax implications of owning rental properties within a corporation compared to personal ownership.
Personal Ownership of Rental Properties
- Rental Income Taxation: When you own rental properties personally, the rental income is added to your personal income each year and reported on a rental schedule of your personal tax return. This income is taxed at your marginal tax rate, which could potentially result in a higher tax burden when it is added to your other sources of income (employment income, pension income and investment income.)
- Deductions and Expenses: You can deduct eligible expenses related to the rental property, such as mortgage interest, property taxes, maintenance costs, insurance, property management fees, utilities and more, that are paid by you, to reduce your taxable rental income. However, the deductions are limited by specific rules and subject to scrutiny by the Canada Revenue Agency.
- Capital Cost Allowance (CCA): You can claim CCA, also known as depreciation, on the cost of the building and certain eligible capital expenses. This allows you to deduct a portion of the property’s cost each year to account for wear and tear.
- Capital Gains Tax: When you sell the rental property, it is treated as a disposition on your personal tax return and any increase in its value from when it was purchased up to when it was sold (capital gain) is subject to capital gains tax.
Generally, only 50% of the capital gain is taxable. You may need to recapture a portion of the CCA you previously claimed as income. The recaptured CCA is included in your income in the year of sale. The recapture is generally equal to the lesser of the total CCA claimed or the capital gain on the property.
Owning a Rental Property within a Company
- Rental Income and Expenses: When a corporation owns a rental property, it will generate rental income. The corporation can deduct eligible expenses, such as property maintenance, mortgage interest, property taxes, utilities, and property management fees from its rental income to determine its taxable rental income.
- Reduced Tax Rates: There is the potential for tax rate savings if the properties are held within a company. If the Company has 5 or more full-time employees, the income will change from inactive income to active business income and would have a lower corporate tax rate than normal personal rates.
However, most companies who own rental properties are considered to have inactive income which means it is taxed at a higher federal tax rate and not the small business rate. The federal small business tax rate is generally lower than personal income tax rates, which can often provide potential tax savings.
This is not always the case, so it is important to talk with your accountant regarding potential tax savings.
- Opportunities for tax-deferred growth: As noted above, the rental income is taxed at the corporate level, which may allow for more capital to reinvest in the property or other investments.
- Incorporating rental properties can offer asset protection: If you face legal issues or the property generates liabilities, your personal assets are less exposed because the corporation is a separate legal entity.
- Losses: Rental property losses in a corporation may not provide the same immediate personal tax benefits as they would if the property were owned personally. Corporate losses can be carried forward to offset future rental income or carried back for up to three years to offset past rental income and recover income taxes that have been paid, but they cannot generally be used to reduce other forms of income for the shareholders.
- Passive Income Rules: In Canada, certain rules aim to prevent the accumulation of passive investment income within a corporation. These rules can affect the tax advantages of corporate ownership for rental properties. If a corporation earns significant passive income, it may be subject to higher corporate tax rates. Rental income is generally considered passive income, so this could affect your tax liability.
Article Wrap Up
The decision to own rental properties within a corporation or personally is multifaceted and depends on your unique financial situation and objectives. While owning rental properties within a corporation can offer tax advantages, it also comes with added complexity and requires diligent tax planning. Personal ownership, on the other hand, may result in a higher tax burden but is often simpler to manage.
In either case, it’s crucial to consult with tax professionals who can help you navigate the complexities of Canadian tax laws and make informed decisions that align with your financial goals. Balancing the potential tax benefits with administrative responsibilities will be key in determining the best ownership structure for your rental properties.