Tax strategies for cottage ownership and rentals.
Our May webinar featured Wayne Root CPA,CGA and Partner at rib lip and Eric Tuffnail, CPA, Manager at rlb llp accounting firm. We recorded this discussion and the video will be up on our YouTube channel - “Serenity Vacation Rentals” . This weeks blog will attempt to provide a high level answer to some of the commonly asked questions. There was a lot of information to unpack in this conversation so we would advise you to reach out to your accountant or to Wayne and Eric if you need an accountant to ensure that the tax advice given is specific to your needs.
- What is the difference from a tax perspective of owning a cottage personally or corporately? From a personal perspective any rental income is considered passive income and is taxed at a higher rate than corporate income. If the property is owned personally there is flexibility to use the principal residence deduction on the cottage versus the home. If you own it corporately and use it personally you should be paying rent to the corporation for the use of the cottage. Savings in the long term with corporate ownership is that any capital gains at the sale of the cottage is left in the company and can be taken out as income /dividends at a future date when your marginal tax rate is lower (ie) retirement. The downside is that there are legal costs to set up a corporation and ongoing yearly fees to have the corporation operating. Both personal and corporate ownership have their pros and cons. The decision comes down to what works better for your overall tax strategy.
- Estate planning with children and how do you minimize any future tax implications? Taxes are paid on the death of the second spouse and are assessed based on the Fair Market Value (FMV) of the property on the date of death. There are a few common strategies to offset any estate taxes and they are (1) purchase life insurance in the amount of the potential estate taxes to cover the tax off at death so the full estate is passed to your heirs. (2) Sell the cottage to your heirs during your lifetime. A ownership change is deemed to be the same as a sale and would be at FMV. The downside to this is that once the children own the cottage you have no control over that cottage. (3) You could consider Joint Tenants and Tenants in common as an other option. If you want to “gift” the cottage - CRA deems that a sale at FMV and you would potentially have capital gains taxes on the increased value of the cottage .
- Taxes on the sale of the cottage? Example given: Buy for $500K and sell for $1 mill. There is a capital gain of $500K of which you pay income tax on 50%. If owned corporately you can leave the capital gains in the company and take it out as a dividend at a later date when your marginal tax rate is lower as your income is lower. If it is personally owned then the 50% that you pay income tax on is added to your income for that year and you would pay anywhere from 20% -53.53% depending on the tax bracket you are in. You can reduce the taxable portion with expenses such as legal fees, commissions, renovations done to sell etc.
- Do I need to collect HST on short term rentals ? If you do not have any other business that you collect HST on (ie) you are not self employed and charging HST then the threshold for collecting HST is $30 000 a year gross income on your rentals. If you are collecting HST as a self employed person then you likely need to collect HST on the first rental dollar as all of the income for HST is added up to meet the $30K threshold. There is also HST on the sale of a property if it is corporately owned. This can limit the resale as more buyers using for personal or missed use do not want to pay HST on top of the sale price. If you decide to change ownership prior to selling the cottage the change from Corporate to Personal is deemed a sale at FMV and capital gains could be involved if the value has gone up.
- Can I claim expenses on my short term rental to reduce the income? Yes you can claim expenses and there is a list of eligible expenses on the CRA website. The following is most of the expenses that can be claimed: advertising, management fees, mortgage interest, taxes, utilities, insurance, condo fees, legal and accounting fees, repairs and maintenance and travel expenses to your cottage to check on it and do repairs. What is the difference between a capital expense versus a repair? A capital expense is making the property better and a repair is fixing something and not adding value. Example is a roof . If you repair the roof with the same shingles that you currently have it is a repair. If you replace the roof with a Steele roof that is deemed an improvement and a capital expense. A capital expense is written off over the lifetime of the asset ( added to the cost of the property or the ACB). A repair is written off (reduce net income by that cost) the year it has occurred.
- Additional Tax advice from our Accountants: (1) when asked about selling shares to a child we were told that you can “freeze” your estate/asset and means that the assets are valued at that time. You pay taxes on the asset up to that point but any future growth is given to the kids (as per a trust agreement). The child would then get insurance to cover that tax liability at their death. (2) always advised to track all of the improvements that you do at a cottage, the date and the cost and keep proof/receipts.These can be helpful to try and minimize your taxes at sale. (3) Capital Cost Allowance (CCA) is an optional deduction to reduce income. The only concern using CCA is that if you sell at a gain then all of the CCA deductions you used come back in as income. (4) RRSP: If the cottage is personal use ownership then you could put money into an RRSP the same year as the sale and this would reduce the capital gains and taxes.
There are so many variables when looking at the accounting perspective. Is the cottage personally or corporately owned? Is it rented all of the time or mixed use? What are your short and long term planning strategies? There is no a one size fits all solution. We highly encourage you to reach out your accountant to ensure that you have a holist approach to your estate planning and tax strategy.
As always, we look forward to hearing from you!