Tax considerations for rental and investment properties
Discover the tax implications of owning or purchasing a rental property within Canada.
By ATB Wealth 24 March 2023 8 min read
Whether you’re interested in acquiring rental properties for income or capital appreciation, we explain common tax considerations for individual Canadian residents who own—or want to own—rental and investment properties within the country.1
Tax rates and common deductions for rental income
When you earn rental income, you must disclose that income on your tax return. If you co-own a property, you will report only your portion of the income. This income is taxed at your marginal rate, similar to interest income. In Alberta as of 2023, these rates range from 25% to 48%.
Only your “net” rental income is taxable. In most cases, you can reduce your taxes by deducting expenses related to earning rental income. Common deductible expenses include property taxes, insurance premiums, condo fees, utilities and advertising. You can usually deduct mortgage interest as well, but the principal portion of mortgage payments is not deductible. Take all of these expenses into account when determining the profitability of your investment.
You may also consider claiming capital cost allowance (CCA) against your building and other capital assets used for earning rental income, like appliances and tenant improvements. CCA is a tax deduction similar to depreciation. It allows you to deduct the cost of your capital investment over the course of a number of years.
However, the CCA deductions that you claim will often be reversed and included in income at the time of sale. In many cases, CCA deductions are a valuable tax deferral, rather than a true tax savings. Before claiming CCA on a rental property, talk with your tax advisor. You can also review how CCA impacts your ability to claim the principal residence exemption on rental properties.
If your rental expenses exceed your rental revenue in a given year, you will have a rental loss. Rental losses are generally deductible against your other sources of income if the expenses were incurred with a reasonable expectation of profit. For example, a rental loss could occur in a year when a tenant moves out and the property is vacant until a new tenant moves in.
There are some limits on claiming rental losses. CCA deductions cannot be used to create or increase a rental loss. Also, rental losses cannot be used unless you are legitimately trying to earn a profit. If the property is realizing consistent losses each year, or if you’ve been renting the property to a personal connection for less than fair market rent, the loss may not be usable.
Maintenance versus capital improvements
Not all expenses are deductible against your rental income, even if they clearly relate to your property. The Canada Revenue Agency (CRA) draws a distinction between current expenses, which are deductible, and capital expenses, which are non-deductible.
A capital expense has a lasting benefit or overall improvement to your property beyond its original state. For example, replacing your roof, adding a sunroom or deck would be capital expenses, since their benefits are enjoyed over a period of time. Although capital expenses are not deductible, they still have some tax benefits. Most capital expenses are added to your tax cost of the property. This can allow you to claim the expense over the course of several years as a CCA deduction, which means you can claim depreciation against the improvement.
In contrast, a current expense is intended to maintain, repair or restore the property to its original condition, or is consumed without a lasting benefit. While replacing your fence might be a capital cost, the cost of sanding and repainting an old fence is likely a current expense, since it’s simply repairing or maintaining existing property. Property taxes are also a current expense, since they provide no lasting benefit to the property. Current expenses should be deductible in the year you incur the expense, rather than spread over time like a capital expense.
It’s not always clear whether an expense is current or capital. Some simple maintenance or repair jobs can count as capital improvements or renovations. For example, rewiring a home could be a current expense in some cases and a capital expense in others. Consult with a qualified tax advisor when you carry out repairs, maintenance or renovation on an investment property to claim the proper tax treatment for the expense.
Construction, major renovations and soft costs
Even simple current expenses like mortgage interest may not be deductible when your rental property is in the process of construction or renovation. For example, if you buy a fixer-upper home with the plan to renovate it and lease it to tenants, the tax treatment will be different while you renovate. During that time, your ability to deduct “soft costs” like mortgage interest, professional fees and property taxes may be restricted or denied entirely, and be treated as a capital cost instead. The period of construction or renovation is considered complete once the project is finished, or once you’ve leased the building space that was under construction or renovation—even if some of the project remains incomplete.
The rules surrounding soft costs can be difficult to interpret. In general, soft costs related to the ownership of land are typically treated as capital costs. Soft costs relating solely to the construction or renovation of a building may be deductible, but usually only to the amount of your rental income during the renovation period.
Even when soft costs are deductible, they cannot be used to create a loss for tax purposes during the period of construction or renovation. Tell your tax advisor about any renovations or construction so that expenses are reported correctly.
Sale of rental property
In most cases, the principal residence exemption is not available for rental properties, so expect to pay tax on any capital gain realized on the sale of a rental property. The amount of your capital gain is usually the sale price of the property, minus the amount you originally paid to acquire it, the costs you incurred to sell the property and the cost of any capital improvements you made while you owned the property. Half of that gain is included in your income and is taxable at your marginal rate.
If you’ve claimed CCA deductions to offset your rental income, you may have additional tax to pay upon sale. CCA is intended to give you credit for the reduction in your property’s value over time due to wear and tear, but property values for real estate often increase instead. As a result, CCA deductions are often just a tax deferral—you reduce your taxable income when you claim CCA, but you add it back to income as “recapture” if your sale price is higher than the tax-depreciated value of the property. This recapture is taxable as regular income at your marginal tax rate. For example, if your building was bought for $10,000 and you claimed $1,000 of CCA, its tax-depreciated cost is now only $9,000. If you then sold it for $15,000, you would have to re-include that $1,000 of CCA in income.
You could have your tax advisor prepare a tax estimate before selling your rental property to clarify how much after-tax cash you will receive on a sale and avoid any unexpected tax surprises.
The anti-flipping rule
On Jan. 1, 2023, a new federal anti-flipping rule took effect. The goal of this new rule is to ensure that people who buy Canadian real estate for the purpose of resale will be taxed on their profits as regular business income, rather than as capital gains. Not only does this mean that profits are taxed at a higher rate, it also prevents the seller from claiming the principal residence exemption on the sale.
The new anti-flipping rule uses a strict test. It applies if you sell real estate that you owned for less than 365 consecutive days, unless an exception applies. This applies to any sales occurring after January 1, 2023, so this rule can affect properties acquired before that date.
Unexpected life events may require you to sell your property less than 12 months after purchasing it. Fortunately, there are a few exceptions that allow you to avoid the anti-flipping rule. These rule might not apply if the sale is caused by or in anticipation of one of the following events (among others):
- Death, illness or disability of the seller or a related person.
- A new related person joining your household (like the birth of a child) or the seller joining a related person’s household (like moving in with an elderly parent to care for them).
- The breakdown of a marriage or common-law partnership, in some cases.
- Involuntary loss of employment of the seller, or their spouse or common-law partner.
- Relocating to a new residence to be at least 40 kilometres closer to a new workplace or post-secondary institution, in some cases.
- A threat to the personal safety of the seller or a related person.
- Involuntary destruction or expropriation of the property.
- Insolvency of the seller.
Talk about this anti-flipping rule with your tax advisor if you’re selling real estate that you acquired fewer than 365 days ago.
Other taxes and fees
There are several provincial fees and taxes that could apply to your rental property. In Alberta, fees for land transfer and estate probate are minor. However, if you own property in another province like British Columbia these other taxes and fees can become significant. Additional fees may apply to property in certain municipalities, like Kelowna, Vancouver and Toronto. You don’t avoid these taxes and fees by being an Alberta resident. In the event you own or are considering purchasing real estate in another province, talk with your tax advisor to understand the provincial and municipal taxes and fees that could apply.
Interested in learning more about investing in rental properties? Read our comprehensive article.
This summary may not apply to non-residents, corporate investors, or real property located outside of Canada.
The information provided in this article is a simplified general summary and is not intended to replace or serve as a substitute for professional advice. Professional tax advice should always be obtained when dealing with taxation issues as each individual’s situation is different. This information has been obtained from sources believed to be reliable but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. This information is subject to change and ATB Securities Inc. (Member Investment Industry Regulatory Organization of Canada and Canadian Investor Protection Fund), ATB Investment Management Inc. and ATB Insurance Advisors Inc. reserves the right to change the information without prior notice, and does not undertake to provide updated information should a change occur. ATB Financial, ATB Investment Management Inc., ATB Securities Inc. and ATB Insurance Advisors Inc. do not accept any liability whatsoever for any losses arising from the use of this document or its contents.
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