1. Revenues & Expenses
2. GST & Record Keeping
3. Audits and Appeals
4. General Topics on Real Estate
5. International Topics
6. Tax Planning
1. Revenues &
Accounting & Tax Principles.
Net income is simply gross revenues less expenses and the result
may be a loss. Business losses, including rental losses, are first
deducted against other income in the year and excess losses may
be carried back 3 tax years and forward for 7 years. Business statements
are based on either the accrual method which reports income if invoiced
in the fiscal period - use closing dates - and deducts expenses
incurred in the period OR the simpler cash method, available to
self-employed commission earners, which declares revenue only if
received by year-end and deducts only expenses paid. Self-employed
agents may receive a T4A slip from their broker showing self-employed
commissions and it may conflict with the cash basis.
Employee agents get T4 slips showing commissions earned
with CPP, EI and Tax withheld. Commission employees claim "Employees
Allowable Expenses", including GST , and get a GST Rebate in
their annual tax filing. They do not collect nor remit GST. A T2200
"Declaration of Employment Conditions" , signed by the
broker, must be enclosed with the annual tax filing. Rules for deductibility
of expenses are punitive for commission employees. They are disallowed
vehicle usage to and from their broker's office and may claim a
home/office expense only if they work more hours at home than at
the broker's place of business.
Self-employed agents are not subject to Employment
Insurance premiums and income tax and CPP are paid on the installment
basis rather than deducted from each commission. The good news is
that self-employed agents may deduct any expense "reasonably
connected to the earning of income". Claim all arguable expenses
and don't blink if you are audited.
On starting self-employment, value furniture and
equipment used for business and vehicles at FMV or the undepreciated
cost and enter the amounts for depreciation. Claim the GST on the
FMV, at commencement of self-employment, on furniture, equipment
and on any car bought after 1990 in your first GST remittance.
Mortgage interest, often your largest home expense,
may be added to the home/office deduction. This expense is pro-rated
based on the area used exclusively for business or on a room-by-room
basis not counting washrooms. The home/office expense must be carried
forward once self-employed income is reduced to NIL. Self-employed
agents may treat driving to and from the broker's place of business
as deductible business usage.
Dinners and event costs are only 50% deductible
since February 22, 1994. Cars purchased after 2001 are capped for
depreciation at $30,000 plus GST and PST - - self-employed claim
back the GST as an Input Tax Credit in their GST remittance - -
with a monthly lease cap of $800 plus taxes. Car loan interest is
capped at $10 per day. The full GST may be claimed back on the purchase
of a car and on all operating expenses - gas, repairs, lease etc.
- if the car is used at least 90% for business. If you drive only
89% for business you will get only 89% of the GST back.
Replaced GST numbers in 1996 and are used for GST and payroll remittances
and in personal and corporate tax returns. If annual revenues are
under $30,000, you must still complete the BN application and claim
exempt status from charging and remitting GST on that basis.
Quarterly Tax Installments.
These are paid on March 15, June 15, September 15, and December
15th of each year and may be based on the LEAST of: 1) prior year;
2) current year; or, 3) 2 years back for first 2 payments and 1
year back for the last two. Pick the method that minimizes the payments
while avoiding interest charges. Theoretically, you are paying ¼
of your annual personal taxes and self-employed CPP owed in each
payment and you will pay more taxes or get a refund depending on
the figures in your tax return.
Operating Or Current Expenditures.
For both revenues and expenses govern yourself by the principles
of accuracy and thoroughness.
The first task in any bookkeeping is to distinguish
between expenses with GST and those without.
2. Broker Administrative Fees.
This is a `basket' heading. It includes all monthly fees, desk fees
or any other charges. Segregate Errors & Omissions Insurance
and Provincial License Fees to heading 19 below if they are paid
by your broker, as they include no GST.
3. Accounting & Legal Fees.
All professional fees including tax preparation fees.
4. Advertising, Promotion, Gifts.
Includes all promotional expenses such as advertising, circulars,
gifts including cash gifts, giveaway items and distribution costs
paid by you to third parties other than the broker.
5. Conventions, Seminars, Training.
The general restriction is 2 conventions per fiscal year.
6. Delivery, Courier, Taxis.
Including packages sent by courier rather than regular mail.
7. Dues ( TREB, OREA etc.)
And any other professional organization fees. Recreational club
membership fees including golf fees are strictly disallowed.
8. Entertainment & Meals: at 50%.
Deductibility and the GST Input-Tax-Credit have been restricted
to 50% since Feb. 22, 1994. Includes tickets to all events. ( Add
back in to the expense the GST not claimed for refund purposes in
your GST remittance.)
9. Equipment Rental/Lease.
Computers, faxes, phone systems, furniture and other equipment used
directly in the course of your business. Short-term car rentals
may be included.
10. Office Supplies, Postage etc.
This is another `basket' category which includes all the obvious
expenses and anything which might not fit elsewhere.
11. Parking - Business.
100% deductible. Approximate for meters but enter in auto log book.
This includes business parking paid on a monthly basis. Residential
tenants who pay a segregated parking cost should pull that amount
from the "Home/Office" amount and enter it in the identified
area for auto expenses for the higher deduction rate. Parking tickets
are now deductible.
12. Subcontract & Consulting Fees.
Includes invoiced services including your children at Fair Market
Value and the `computer guy' or promotion/advertising consultant.
13. Tel., Cellular, I internet, Pager,
Segregate the long distance charges on your home phone and claim
the full cost of fax/internet and dedicated business lines. The
basic cost of the first line is treated as personal and non-deductible.
14. Travel: 50% of Meals.
You must be 12 hours from your "regular place of business"
such as the GTA. This expense is your own cost of dining. You need
not be with a client.
15. Travel: 100% Hotel/Fares/Cleaning.
You must be 12 hours away from the GTA but these expenses are fully
deductible. Attend a conference in Vancouver but justify it.
16. Other GST-Included Expenses.
17. Expenses Paid Outside Canada.
Includes U.S. products/services. [ No GST ]
18. Interest & Bank Charges.
Includes bank service charges and interest on lines of credit and
business loans. [ No GST ]
19. Insurance (E&O, Liability), Licenses.
Professional liability insurance, errors and omissions, provincial
or other licenses. Do not include disability or life insurance.
[ No GST]
20. Referral Fees.
You must both document and receipt these expenses and then claim
them in the tax return under "Consulting Fees" or "Promotion"
to avoid an audit because of the strict rules.
21. Salaries, Payroll/Casual Labor.
Spouses must and children should be put on payroll with deductions
for CPP, EI - none for a spouse - and taxes. You make payroll remittances
by the 15th of the each month for the prior month using your Business
Number. You match the CPP and add 1.4 times EI premiums withheld.
No GST is charged on salaries and payroll costs. The test of "employment"
is regular hours, at a fixed location with any degree of supervision.
23. GST on Vehicle Expenses - - carry this
over from the "Vehicle Expenses" summary.
Includes only gas & oil, repairs, insurance, license,
washes, auto club dues and lease costs. Claim the full amount of
vehicle GST as an Input Tax Credit if you drive 90% or more business
and the actual proportion of GST if less than 90%.
24. GST on Equipment Purchases.
Subject to the 90% threshold rule, claim the GST on up to $30,000
in the period acquired. If starting self-employment, claim the GST
on the FMV at commencement the vehicle's Undepreciated Capital Cost
if the car was depreciated for other than self-employed activity.
Also includes purchases of computers and hardware, software, office
equipment such as faxes and telephones, furniture and fixtures.
Use actual invoices to extract the GST and enter on the summary.
The remainder including PST is entered for depreciation.
25. GST on Office-in-Home.
Only the GST paid on the business portion of home utilities and
2. GST & Record
applying for a Business Number, showing annual GROSS commissions
under $500,000 will get you an annual filing frequency on the calendar
year. Quarterly filers must finish the year then elect onto an annual
filing for the beginning of the next year. Note: If you are an annual
filer and your total remittance to GST was greater than $1,500 in
the previous year, you must submit quarterly GST installments equal
to 1/4 of the total GST remitted in the prior year.
GST is factored out of both revenues and expenses
in statements in T1 personal tax returns. You are a tax collector
for Revenue Canada (Customs & Excise) and your GST remittances
reconcile the GST depending on the GST method selected for accounting
and remittance. GST is simply an extra 6% pool of cash you receive
in addition to your commissions.
1. Detailed GST Method.
Those with commissions $500,000 or more must use this method which
requires that every revenue and expense be entered with the principal
amount and the GST amount entered separately.
3. Audits and Appeals
you keep clean records, you are ready for an audit. The onus is
on you to relate expenses to the earning of income. You should provide
to Canada Customs and Revenue Agency (C.C.R.A.) auditors only documents
specifically requested although you cannot be seen to obstruct them.
A fine line. Never let them interfere with your business operations.
You must keep business records for 6 years. Designate a professional
agent to act on your behalf with requests for information from C.C.R.A.
. C.C.R.A. can audit a return only up to 3 years from the date of
an assessment unless you sign a waiver. Never sign. Lacking a waiver,
they can go beyond the 3 years only in cases of non-declaration
of income, falsified expenses or of "misrepresentation"
which may include carelessness. Statements about driving habits,
hobbies, business practices, etc. will commonly be interpreted prejudicially
You might be asked to produce an automobile log
book but you can make representations to support the proportion
of business usage claimed despite not having a logbook. You will
be asked to produce receipts/vouchers - - categorized and totaled
- - for all items on the T2124 business statement on your tax return.
Self-employed agents who have a room OR area used exclusively for
business get a home/office expense as of right. You only need to
meet clients at home on a regular and consistent basis if you pay
commercial rent and want to take an additional home/office expense.
An assessment or reassessment of a personal tax
return or of a G.S.T. remittance may be appealed using a standard
T400A "Objection" Form. An assessment of a current personal
tax return must filed within 1 year of the regular filing deadline
of April 30th. An appeal of a reassessment of a return preceding
the current tax year must be filed within 90 days. Audits as well
as appeals from assessments and reassessments are dealt with locally
at your District Tax Services Office. You have an automatic right
of appeal which will be handled in a relatively summary and inexpensive
manner. Your problem gets very expensive with potential lawyer's
fees only once you lose an appeal of an assessment or reassessment.
You are then in Federal Tax Court.
Topics on Real Estate
1. Principal Residence Exemption (PRE).
This differs from the basic $100,000 Capital Gains Exemption which
ran from 1985 to 1994. The PRE has NO DOLLAR LIMIT. Each married
couple, including common-law spouses since 1993 , and their children
have only one PRE. The PRE covers the building and up to 1/2 hectare
of land unless it can be shown that a larger area of land was required
for the "enjoyment and use" of the property. Parents are
buying their adult children homes to give them a start in their
careers and to give them an asset providing tax-free dollars on
With low returns from cash investments, a `wobbly' stock market
and with realty values moving up, recommend selling and a `BUMP
UP' to a larger home. Low mortgage interest rates suggest that this
is a very, very good time to be buying real estate for any reason.
A $450,000 `dream' home doubling in value gives more tax-free dollars
than a smaller home. Agents can get both a commission on the sale
and on the purchase of the new home. Mortgage-free owners will be
most interested in this approach especially if they have cash investments
giving low interest returns or cottages, stocks and mutual funds
with a high ACB through use of the Capital Gains Election form in
their 1994 tax return.
Conversely, many home-owners are cash-starved.
They have low incomes and over-sized homes. This might include seniors,
widow(er)s and those suffering career dislocations. These are all
candidates for a 'BUMP DOWN'. This involves selling the current
home for TAX-FREE dollars, buying a less expensive home and investing
the excess cash for added income. Again, two commissions. Look for
reverse mortgages and urge a sale to pay off the mortgage and consolidate
the owner's finances.
Owners fear losing the principal residence exemption
especially when values appear to be on the rise. You MAY rent out
part of your home to tenants - ancillary usage - and even operate
a home/office in your house so long as the MAJORITY of floorspace
- read 51% - is for personal usage. The exemption is lost on any
part of the home on which depreciation is claimed. Never claim depreciation
on your own home. Against rent collected, you may claim a PROPORTIONATE
share of expenses and often get the rent `tax-free'. Revenue Canada
will not allow losses in this situation. Be content with the tax-free
rent which pays down the mortgage.
2. First-time Buyers.
The Ontario government still offers the LAND TRANSFER TAX
REFUND to first-time buyers of newly built homes. The maximum rebate
of $2,000 covers a home costing up to $200,000 for Agreements of
Purchase and Sale signed by March 31, 1998 Neither spouse can have
owned a home.
The federal government provides the greatest incentive
to first-time buyers through the HOME BUYERS PLAN which was converted
to a first-time buyers program on March 1, 1994. Up to $20,000 may
be withdrawn by each taxpayer from their RRSP towards a home purchase
upon production to the RRSP trustee of a signed offer of purchase
and sale. This amounts to an interest-free loan to yourself from
your own RRSP. No taxes are withheld on the withdrawal. You cannot
have owned a home during the 4 years preceding the year of withdrawal
- since January 1, 1998 for a 2001 withdrawal. RRSP contributions
must be left in for 90 days to qualify under the plan. RRSP contributions
for year 2000 tax savings may be bought from now until up to 60
days into 2001 and qualify if left in for 90 days before withdrawal
under the HBP. Get your timing right. The withdrawal is repaid in
up to 15 equal installments starting 2 years after the year of withdrawal
- - in the year 2003 for 2001 withdrawals. Failure to make the prescribed
minimum repayment in a year results in the `shortfall' amount being
included in income and an excess repayment will `average down' subsequent
The Home Buyers Plan is often combined with a high-ratio
mortgage to get first-time buyers into affordable homes. Those with
high residential rents will be most interested in this approach.
Many `top-up' their RRSPs when using the HBP and unused RRSP contribution
limits have accumulated since 1991 - - no more "use it or lose
it". Each spouse including `common-law' spouses qualify. The
higher earner can make a spousal contribution to increase the spouse's
RRSPs to $20,000 and the rule attributing the income to the contributor
- - normally leave it in for the year of contribution and 2 subsequent
years - - is not applied for withdrawals under the HBP. But, if
you cohabit with a spouse who owned a home in the 4 prior years
and up to 31 days before the withdrawal, NEITHER OF YOU qualify.
For a 2001 withdrawal, you must close by Oct. 1. of 2002.
Some technical points:
You must purchase a Canadian home - - liberally defined
including mobile homes and houseboats - - or a contract to build
Complete the FORM 1036 for the qualifying withdrawal. No taxes are
withheld. Certify that it will be used as your principal residence
within 1 year after the close.
Leave RRSP contributions you want to qualify inside the RRSP for
at least 90 days. To meet this requirement, you can make the withdrawal
up to 30 days after the close of ownership.
With $20,000 for each joint purchaser, you will likely qualify for
a conventional first mortgage and avoid the insurance costs of a
Make your required HBP repayment into an RRSP within 60 days of
the year-end. Any shortfall less than the required amount is taxed
DO NOT sign a realty offer for a close within 60 days of an RRSP
contribution which you wish to qualify for withdrawal.
DO NOT die. Any balance is taxed unless a surviving spouse assumes
DO NOT emigrate without repaying any balance within 60 days of leaving
Canada or it falls into income. (Withdraw RRSPs as a non-resident
DO NOT reach an age where you are not entitled to maintain an RRSP
account. You must repay any balance or let the annual minimum repayment
fall into income.
3. Second Homes/Cottages.
Each individual or married couple and their children under
18 are entitled to one principal residence exemption. This explains
the transfer of cottages to 18-year old children until they buy
their own home. The 1994 tax return allowed taxpayers to use a Capital
Gains Election of up to $100,000 each to raise the 'book value'
on second homes and rental properties. The election benefited any
cottages and rental properties owned before about 1988.
The new higher "elected cost base" - - potentially $200,000
higher if joint owners - - is then used to calculate taxable gains
on sale. As stated above, second homes and rental properties, along
with stocks and mutual funds, can provide tax-free dollars to buy
new properties or a larger principal residence. Ask your clients
about cottages and rental properties.
The PRE allowed each spouse to own a home until
1982. If a home and cottage are owned jointly from 1972 to the present,
and a couple is selling their city home to move to the cottage,
or vice-versa, the use of the PRE designation by joint owners on
a property for the period 1972 to the year of sale will preclude
the use of the PRE on the other home when it is sold. [ Being able
to use the PRE for the 1972-1982 period will exempt from taxation
the appreciation from December 31, 1971 to December 31, 1981 - -
10 years - - pegged to the FMV at those two dates. It could be a
substantial sum. ] The answer is to transfer the joint half interest
between spouses so that each owns a home outright. The transferee
assumes the exempt status of the transferor. This reorganization
exempts from tax the appreciation from 1971 to 1982 on two properties.
The PRE can be used on the eventual sale of the cottage but subject
to the attribution of 1/2 the gain on sale to the original joint
owner. The Ontario government will not charge LTT for spousal transfers
if each appears on the original deed. No downside.
4. Rental Properties.
Rental income is treated as income from property and thus
not equivalent to business income unless you provide extra services
such as the rental of furniture, office cleaning and protective
services. An example of business activity is the ownership and management
of a hotel/motel operation. This is of relevance to investors who
might avoid pure rental properties and acquire a motel operation
to qualify a CCPC as an active business for the purposes of the
$500,000 Lifetime Capital Gains Exemption per shareholder.
The important thing to acknowledge about rental
properties is, that in the current market, their acquisition now
makes economic sense. They can now carry themselves since there
is some proportion between cost and revenues. Look for bargains
and set up investors for positive cashflows and long-term ownership.
On sale, gains are taxed preferentially with only 50% of a capital
gain included in income. A mortgage reserve may be claimed in a
T2017 Schedule where all of the proceeds of the gain are not received
in the year of sale. This is accomplished with a vendor take-back
mortgage - - remember the good old days of the 1980s - - which can
spread gains over as much as a 5-year period and spread gains into
the lower tax brackets.
A rental property bought by multiple owners is:
easier to borrow against; should carry itself; provides more persons
to manage; and, legally spreads taxable gains around to those who
pay lower taxes on sale. Get back to basics.
The crash in real estate values in 1989-1990 created
a tax-driven market. Investors might now sell rental properties
to `crystallize' tax losses. The "terminal loss" treatment
on the sale of rental properties is a potential goldmine for agents.
The general rule is that depreciation may only be claimed to the
extent it reduces net rental income for all properties owned to
zero. [ As an aside, most current properties have likely not claimed
any depreciation deduction as they have been running at operating
losses. ] MURBS were an exception to the general rule and sold very
well since owners could claim the full depreciation amount annually
in addition to any operating losses -- tax-driven acquisitions.
The second exception is a terminal loss which is a final deduction
where a property has depreciated more quickly than foreseen in the
prescribed rate of depreciation. Section 20 (16) of The Income Tax
Act ( ITA ) of Canada provides for the deduction of a terminal loss
upon the disposition of all of a taxpayer's depreciable property
of any prescribed class.
A rental building acquired at a cost of $50,000
or more must be entered in its own class for depreciation purposes
[ Regulation 1101 (1 ac)]. Class 3 with a rate of 5% was replaced
with Class 1 and a rate of 4% in 1988. This prevents `pooling' of
rental buildings to both delay recapture of depreciation and avoid
taxation on rental cashflows by maximizing depreciation. The government
wanted to accelerate taxation and did not foresee the dramatic reduction
in real estate values.
Condominiums are treated entirely as building and a final DEPRECIATION
deduction may be claimed in the rental statement in the year of
sale. [Properties composed of both land and building allocate the
acquisition cost and proceeds from sale between them. E.g., a 60%
allocation to building and 40% to land. Since land cannot be depreciated,
any loss would be allocated as a 40% capital loss. For unimproved
land, interest and taxes can only be applied against rental income
on each separate piece of land and then is capitalized to apply
against any gain on sale. The gain is taxed as ordinary income and
not as a taxable gain. ] Any rental loss resulting from the terminal
loss treatment is fully deductible against all other income in the
year of sale and any excess may be carried back 3 years and forward
7 years. If you own MORE than one rental unit in a condominium the
final depreciation deduction may be claimed ONLY when the LAST unit
is sold. Tax refunds may be used to buy a better property.
A caution. Revenue Canada had used the MOLDOWAN
case to argue that some properties had no "reasonable expectation
of profit". Fortunately, the more recent TONN case decided
in December of 1995 favors rental investors. The courts will still
look at key factors such as the size of the original down payment
to see if rental profits were likely.
The above points will allow you to look for tax-driven
Rental properties sold at profit - - other than
any recapture of previously claimed depreciation which is fully
taxable - - are treated as capital gains with a 50% inclusion rate.
Realty agents and brokers must beware of having their own gains
from the sale of rental properties taxed fully and not as capital
gains. The test of whether a sale qualifies as a capital disposition
and thus eligible for capital gains treatment is: 1) similarity
to your ordinary course of business; 2) nature of the property;
3) whether their have been acts of sale such as improvements versus
acts or expenditures to increase rents: 4) the number and frequency
of transactions; and, 5) the period of ownership. The primary intent
on purchase to qualify the eventual sale for capital gains must
be the earning of rental income. We recommend that if an agent or
broker buys a bargain property that they hold for at least 2 years
so that they will not be seen as speculating in real estate - -
flipping - - and fully taxed on the gain. Investors in real estate
must be careful to avoid this same negative treatment.
5. Conversions of Usage.
Properties can be converted from personal to rental usage and vice-versa.
For tax purposes, such conversions are treated as deemed dispositions
and subject to taxation. If you move out of a Principal Residence
you can file an Election under s. 45 of the ITA to postpone tax
consequences for up to 4 years and to decide whether to use the
PRE designation on that property - - the elector is tracking the
market to see which property enjoys the greatest appreciation. No
depreciation can be claimed on the converted property during this
4-year period. If you move more than 40 kilometers for self-employment
purposes, the s. 45 Election is good indefinitely so long as you
claim no depreciation against rental income. If you move into a
property previously used for rental purposes, you can designate
the home you move from for the purposes of the PRE and file a s.
45 election on the property you move into so long as you have not
claimed depreciation on the rental property since 1984. This latter
Election is indefinite. A final point on conversions. Terminal losses
may be claimed in the case of a conversion of usage. A move into
a rental property which has lost substantial value results in a
"deemed disposition" and will crystallize deductible losses.
You can sell an investor's home to put them into a rental condominium
to `crystallize' tax deductions on the rental property.
1.Non-Resident Owners of Canadian Real
Non-resident Owners of Rental Property.
Rental payments to non-residents are subject to withholding
tax. Tenants or agents for non-residents owners of rental property
in Canada are required to withhold 25% of the gross rent paid and
remit it to Revenue Canada by the 15th of the month following receipt.
The non-resident is not required to file a tax return, but may elect
to do so to obtain a tax refund based on the net income. Alternatively,
the non-resident owner may file annually prior to January 1st of
each year or prior to receipt of the first rent payment a Form NR6
election with Revenue Canada. There is an election in the Form NR6
to file a Canadian T1159 tax return within 6 months after the tax
year-end. Non-residents can claim personal tax credits only if 90%
of their world income is in Canada and they are subject to tax at
the regular tax rates for Canadians. A designated agent is required
to sign the NR6 and thereafter will withhold 25% of the net rent
proceeds - - the remittance might be NIL - - and remit to Revenue
Canada. If the non-resident fails to file the tax return within
the 6 months, the agent is liable for any taxes less amounts actually
Sale of Real Estate by Non-residents.
Generally, the Income Tax Act (ITA) requires prepayment of income
tax attributable to sales of Taxable Canadian Property (TCP) by
non-residents. The purchaser of the property from the non-resident
must withhold 33 1/3% of the purchase price and remit it within
30 days from the end of the month of the purchase. The non-resident
vendor may make application to the District Taxing Office (DTO)
where the property is located on Form T2062 and pay or provide acceptable
security in a sum equal to 33 1/3% of the estimated capital gain
on the sale. The DTO will issue a Clearance Certificate (T2064)
which will have a 'certificate limit' on it and provided the property
is not sold for a price in excess of the 'certificate limit' the
purchaser is not required to withhold any sum. If the purchase price
exceeds the 'certificate limit', the purchaser is required to withhold
33 1/3% of the amount by which the purchase price exceeds the certificate
If the T2062 is not filed prior to the purchase
date, the vendor must file it within 10 days after the purchase
date. The non-resident vendor may pay the tax on the capital gain
realized or deposit acceptable security and the DTO will issue a
clearance certificate on T2068. Upon receipt of the T2068, the requirement
of the purchaser to withhold ceases.
Sale of Canadian Residence.
Canadian residents emigrating have to consider the tax impact of
retaining a Canadian residential property. The Principal Residence
Election is an annual election and upon emigration, by definition
is not available to non-residents. Therefore, for each year the
emigrant owns the Canadian residence, a larger percentage of the
gain on the sale will be a taxable capital gain because of the averaging
effect of the Principal Residence Designation Form T2061.
2. Investors in U.S. Real Estate
Recent Canadian legislation, effective as of 1996,
requires Canadians to disclose specified foreign assets held outside
Canada, if the total fair market value exceeds $100,000. The purpose
of the declaration is to track assets outside Canada to ensure that
worldwide income on property is being reported and for capturing
all assets for departure tax upon emigration or tax on deemed dispositions
upon death. This legislation is currently being reconsidered because
of the negative reaction from recent emigrants who have large offshore
assets and are moving out of Canada rather than make these disclosures.
Foreign rental properties worth more than $100,000 alone or combined
must be reported. Assets not included are those used in active business
of the reporting person and personal use assets of the reporting
person including personal homes.
Many Canadians have rental properties in the U.S.
as well as personal homes. All rental income and gains on the sale
of realty in the U.S. must be reported in Canadian tax returns.
This income is reportable in a U.S. federal tax return - - some
states require state filings where tax will be levied - - and is
taxed first in the U.S. since the U.S. is the `source' country.
You are required to file a 1040NR U.S. federal income tax return
and, since the 1996 filing, obtain a Taxpayer Identification Number
(TIN) from the IRS even if you have used a U.S. Social Security
Number for previous filings. You must discontinue using the SSN.
The rules for depreciation of rental buildings
differ. In Canada you cannot use depreciation to create or increase
a loss. In the U.S. you must take the prescribed depreciation in
the annual filing and carry forward any losses to apply against
gains on sale. The U.S. has draconian non-compliance provisions
for non-residents and U.S. citizens who do not file. Failure to
file can result in being taxed on the gross rents during ownership
on an annual basis with no right to reduce tax based on operating
expenses or depreciation. On sale, you will be imputed to have claimed
the prescribed depreciation annually, then taxed on the recapture
as ordinary income to the extent this imputed depreciation reduces
your cost base of the property below original cost. You will also
pay capital gains tax to the extent the proceeds of sale exceed
your original cost.
Any federal and state taxes paid in the U.S. can
be used to offset Canadian taxes through the Foreign Tax Credit
Schedule in the Canadian return. The US requires purchasers to withhold
a portion of the purchase price which is remitted to the I.R.S.
when buying real estate from non-residents of the U.S. Note that
in the event of death, you are subject to estate taxes in the U.S.
but under the U.S.- Canada Tax Treaty the exempt amount is rising
to $600,000 (U.S.) pro-rated based on the proportion that your U.S.
holdings represent of your world assets.
Need to consider the consequences of selling the
Canadian residence versus changing its use to rental property. You
can file a s. 45 election under the ITA to postpone taxes for Canadian
purposes on the deemed disposition. But as per U.S. taxes, if the
immigrant to the U.S. rents out the Canadian property, the property
is classed as an investment property and will not qualify for the
U.S. residential tax exemption. The cost basis for calculating gain
on sale is the original cost not FMV at the date of the conversion
of use to rental usage. Upon sale, all of the gain will be taxable
on the U.S. Tax return. This also true for rental properties as
their cost base for U.S. tax purposes is their original cost. The
deemed disposition under Canadian law by virtue of emigration triggers
capital gains tax on the rental property. You can provide for this
with 6 equal annual tax payments to Revenue Canada based on the
calculated tax and subject to interest and the posting of security.
In U.S. terms you will pay taxes on the full gain based on your
original cost and you must sell the property within 5 years for
any credit in a U.S. tax filing for the calculated Canadian tax
resulting from the deemed disposition. In U.S. terms, all or nothing.
The lesson is to sell your home and rental properties before moving
to the U.S.
Canadian tax rules are based on residency which requires living
in Canada for at least 183 days a year with a "settled intention"
to remain here. U.S. tax rules, in contrast, are based on citizenship
although both jurisdictions tax based on worldwide income with the
source country taxing first and foreign tax credits provisions to
offset or reduce double taxation.
Immigrants to Canada are deemed to have acquired
capital assets owned at the date of immigration at FMV at that date.
This will be the basis against which gains will be subsequently
calculated for Canada tax. Excepted from this rule is Taxable Canadian
Property owned by the immigrant on the date of immigration which
1) real property situate in Canada;
2) capital property used to carry on a business in Canada;
3) certain shares in public corporations; and
4) Canadian resource property.
The Canadian and U.S. governments are freely exchanging
information to as part of reciprocal assistance to enforce the tax
laws of the countries. The U.S. has built up a huge computer database
of real property transactions in the U.S. Revenue Canada has access
to this information. Conversely, there are an estimated 250,000
residents of Ontario who have U.S. citizenship and the I.R.S. now
has access to Canadian data. The I.R.S. has been recently mandating
that these U.S. citizens - - Overseas Filers of U.S. taxes - - satisfy
U.S. tax compliance rules and file the current U.S. return along
with the prior 6 years worth of filings.
6. Tax Planning
Defer income and accumulate tax-free. The `lag' formula is 18% of
the prior year's EARNED INCOME to a maximum of $18,000 based on
$100,000 of income. Unused RRSP eligibility may be carried forward
indefinitely. Hope for an inheritance. [Those under 69 in 1996 will
have to convert RRSPs to RRIFs or annuities in the year that they
turn 69 -- formally age 71.] If cash-starved, transfer stocks or
mutual funds to your RRSP.
Since May of 1985, capital losses are only deductible against capital
gains. Business losses and rental losses are deducted against all
other income in the year incurred then carried back 3 years and
forward 7 years.
3. Limited Partnerships.
These deductions have the same effect as RRSP deductions. These
investments provide interest deductions along with partnership deductions.
Emphasis should remain on investment value and real estate limited
partnerships could do well in the current market.
4. Labor-Sponsored Venture Capital Corporations
A $5,000 purchase of a labor-sponsored venture capital corporation
(LSVCC) gives 30% tax credits with a federal tax credit of $725
and an equal provincial tax credit. You may roll the LSIF into an
RRSP for a contribution deduction or even buy the funds from within
an RRSP before March 1, 2007 to get the tax credits for 2006 taxes.
You must leave the LSIF intact for 8 years. Medical funds are popular.
5. Odds & Ends.
Legal/accounting costs relating to (re-)assessments and tax appeals
are deductible. Every transaction may be challenged by C.C.R.a.
as done PRIMARILY for tax reasons and not for business purposes
and disallowed under the general anti-avoidance rule (GAAR). Get
advice before getting too clever. Put spouses and children on payroll
according to the rules for income-splitting. RRSP loans are not
deductible. Emphasize repayments of non-deductible loans first while
leaving deductible loans intact. Sell stocks/mutual funds to buy
a larger home or invest in real estate then borrow to buy stocks/mutual
funds at a later date with an interest-deductible loan.
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