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Tax

Tax Write offs from Real Estate

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Part 2

Tax Write Offs from Real EstateFeature Reader Request Article

(If you missed Part One, you can check it out here).

It felt like I won the lottery at tax time this year. My cheque from the government was five figures. I am not bragging about this, because the reality is that the sale of my Toronto Condo happened at a net loss to me after real estate agent fees and our Toronto tri-plex cost us almost $30,000 last year. So, the money I got from the government didn’t come close to easing the financial pain I experienced in 2006, but it did make me glad they were investments and not solely my homes. Had they been only my homes, that money would have been gone for good.

So, how can you maximize the tax write offs from real estate investments? Personally, I always consult my accountant. In over 15 years of using an accountant, I have only once paid him more than I have gotten back from the government. But, I don’t just rely on him, I do have a decent understanding of what qualifies as current and capital expenses.

First, the definitions. An easy way to think of a CAPITAL EXPENSE is that it provides a lasting benefit and improves the property beyond it’s original condition as most renovations do. If it’s a separate asset like a new stove or fridge then it can usually be treated as a capital expense. Typically these expenses are significant (in the thousands of dollars). Usually these expenses must be deducted over several years versus current expenses which usually get fully deducted in the year they are incurred.

Some examples of capital expenses include:

  • The purchase price of rental property,
  • Fees associated with the purchase of the property such as legal fees,
  • Purchase of furniture or appliances to go in the property,
  • The addition of a deck to the property, or the addition of another bathroom.

A CURRENT EXPENSE is generally something that repairs the property to its original condition, for example a coat of paint or repairing stairs. The expense is usually one that recurs on a regular basis and provides a short term benefit. Some common current expenses include:

  • Costs of renting the property out (property manager, advertising, cleaning costs),
  • Insurance on the property,
  • Interest on your mortgage (note that your principal repayment is not deductible),
  • Maintenance and repairs that restore the property or item to it’s original condition,
  • Property taxes,
  • Your hired help: accounting fees, property manager fees, cleaning people’s wages, consultants, lawyers),
  • Utilities,
  • Travel costs to collect rent, view or work on the property (note that this includes transportation costs but not typically lodging or food),
  • And office expenses that are directly related to your investment (things like long distance fax charges and telephone bills we have expensed but pens and paper we have not, although you can if it’s directly related to your investment activities).

Published:October 29, 2007

THE DISCLAIMER: Neither of us have any legal training, nor do either of us have extensive accounting training. We are not experts and we always consult with our accountants and legal counsel before we make decisions. We pay money to get quality advice when we need it and always advise our friends, family and readers to do the same.

 

Tax Write offs from Real Estate

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Tax Write Offs from Real Estate

 

If you are paying taxes, it means you are making money.If you are paying a lot of taxes, then it stands to reason that you are making a lot of money. However much you make, it doesn’t make it any less painful to pass it along to the government though. Unfortunately I haven’t been faced with the problem of paying a big bundle of tax to the government (but I am hoping I have that problem really soon!!), but I have been through enough in the last seven years to give you a few pointers on some ways to minimize taxes surrounding residential real estate dispositions.

I know taxes might seem boring, but we know someone out there is interested in it because we are going down this long and dusty road at a reader’s request. There is so much to cover that this will be part one of a series. To roll it out, let’s start with the basics. As a real estate investor, you will pay tax on the rental income you earn on the property as well as on any capital gains when you sell. The amount of tax you pay on rental income can be reduced dramatically by expenses such as maintenance, property management, capital cost allowance (depreciation), interest on your mortgage (but not the principal pay down), and other money spent to run your property. In another edition we will come back to some of the elements above. For this edition, let’s focus in on the second major area you will pay tax on, and that is on Capital Gains when you sell your investment.

A Capital Gain occurs when you sell your property for more than you paid for it. You do not realize your capital gains until you sell.

To calculate your capital gain take the:
Money from the sale of your property
SUBTRACT
Costs of disposition (real estate agent fees, lawyers etc.)
SUBTRACT
What you paid for the property.

You will owe tax on 50% of the amount from the above calculation if the resulting number is positive (a capital gain). This amount gets added (or subtracted if it’s a net loss) to your personal income and you are taxed accordingly.

If the property you are selling is your principal residence, then it is exempt from tax. According to Canada Revenue Agency, a property qualifies as your principal residence if in that year of filing:

  • you acquire only to get the right to inhabit
  • you own the property alone or jointly with another person
  • you, your current or former spouse or common-law partner, or any of your children lived in it at some time during the year
  • and, you designate the property as your principal residence.

Now, what if you live in the home for a few years, and then move out and rent it out for a few years as I did with the condo that I owned in Toronto? In that situation, the answer for me was that the condo could still be considered my principal residence for four years after I changed it’s use. The catch is that I could not claim capital cost allowance on the condo, nor could I claim any other property as my principal residence at the same time. For me, this choice was easy because I moved into a property Dave and I already owned and had been treating as a rental property from the accounting sense of things. It was easier to keep the condo as my primary residence and continue to treat my new “home” as a rental property for accounting purposes. It’s important to note that you and your significant other (including common law or same sex partner) cannot own two principal residences at the same time for tax purposes. You must choose one during the over-lapping period.

It’s complicated and that is why both Dave and I have accountants that we consult with on a regular basis to get the best advice.

THE DISCLAIMER: Neither of us have any legal training, nor do either of us have extensive accounting training. We are not experts and we always consult with our accountants and legal counsel before we make decisions. We pay money to get quality advice when we need it and always advise our friends, family and readers to do the same.

Money Pit Properties

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Money Pit Properties Niagara

 

I was so excited to get out there and build up my positive cashflow from rental properties. Fresh from a real estate investing course from one of those late night gurus, I was motivated, armed and very dangerous. I bought a triplex (Money Pit!) in Niagara Falls, ON for $113,000. I got it cheap and I put down only 10% because the vendor was willing to give me a promissory note for a small loan (there weren’t 90% loan-to-value mortgages from lenders like there are now). They teach you at these courses to find the motivated sellers that will “hold paper” on the property, and I found one!

It was an older building with tenants on disability or other forms of government support. It looked a little rough, but it seemed to only need cosmetic touch ups. When I bought it, the numbers indicated that I would earn about $400/month after expenses and financing so I figured that I would be able to afford the odd repair.

As I set out painting, replacing carpets and putting in things like new doors, I uncovered some serious problems such as:

  • a leaky roof
  • electrical wiring was not safe
  • plumbing was old and falling apart
  • mould in the bathrooms
  • rotten wood.

On top of all of that, I received complaints regularly from a tenant that thought everything should be fixed overnight. Inside his unit I discovered a complete mess. He’d destroyed the walls, had cats that had urinated throughout his unit and destroyed all the window ledges. This tenant eventually called the city of Niagara Falls who then inspected the unit and ordered me to make a variety of repairs to his suite – most of which were directly caused by the tenant or his cats! Because the laws in Ontario do not allow landlords to collect a damage deposit, the only recourse is to use last month’s rent or take the tenant to Small Claims Court to recoup your costs. It’s just not worth the effort to take a tenant with no money to court.

After weighing my options (and my costs and time), I decided rather than spending several thousand dollars repairing the money pit, I would try to sell it “as is”. If you have ever seen “as is” in a sales listing, be careful. This often means there are conditions of the building that are less than stellar and require a thorough inspection and/or repair.

Because I had the orders from the city to repair the problems with the unit, and because I was stressed out dealing with the tenants, I sold the property for $104,000. Yes, that’s $9,000 less than I what I had paid 2 years earlier in an appreciating market and after spending about $10,000 in repairs. To throw even more money away, I had to pay legal fees and the sales commission to my realtor. All in all, I lost about $25,000 in 2 years! That’s why I called it the Anti Investment.

The good news?

* A good portion of the loss was a tax write-off;
* I will NEVER purchase a property like that again;
* Hopefully you will learn from my mistake and be very careful in your future purchases.

Although I lost a considerable amount of money, getting rid of the property at a loss (and as fast as possible) was the best thing to do because I got my life back. The stress of dealing with money pit properties (and problematic tenants) is so draining. l was ecstatic once it sold. I could breathe again – even if my wallet was a LOT lighter!

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