As some of you may already know, we own a rental property that we earn rental income from. This means we have to file a tax return for the rental income received – Form T776. Here are the basics of a rental income return along with some tax considerations.
Related: Lessons From a First-Time Landlord
The income received from the rental property is included in income for the year. You only need to claim the amount of income actually received (damage deposit not included). If the property was vacant for a period of time during the year you wouldn’t need to claim any income during that time as no income would be received.
The expenses related to a rental property are all fairly common – utilities (if not paid by the tenant), property taxes, mortgage interest, insurance, accounting fees, condo fees (if the property is a condo), maintenance costs and costs to advertise the property for rent.
Regardless of the type of expense, the main idea is that it has to be incurred for the purpose of earning rental income. As an example: you cannot deduct the costs to add sod to your own principal residence because it isn’t related to the rental property.
Things get tricky when costs are incurred that are of a higher value and may provide a lasting benefit for more than the current year. An expense is considered capital when it provides a lasting benefit for the property, is considerable in cost compared to the value of the property, and improves it beyond its current condition.
Examples of capital expenses are:
- Installing tile flooring in the bathroom (lasting benefit)
- Adding a detached garage to the property (considerable cost)
- Buying a new washer and dryer (lasting benefit)
- Replacing the current electrical and adding new electrical features (improvement beyond current condition)
Other examples are the legal costs when buying the property and furniture used when renting the property (assuming it is rented as furnished).
The easiest way to tell whether an expense is capital or not (regular) is to consider what will happen in a few years – if there is a lasting benefit or improvement that lasts more than one year (such as adding tile flooring to a bathroom) it is likely capital.
How to Report Capital Expenses
Capital expenses are divided into classes and a percentage of their total is used as an expense each year called CCA (Capital Cost Allowance). The first step when claiming a capital expense is to figure out the class. CRA has a guide to determine CCA class here.
The biggest cost in the CCA cost pool is the cost of the property, and when it was purchased determines what class it belongs to.
Related: The Basics of Capital Cost Allowance
Property owners don’t have to claim CCA if they don’t want. The benefit is that it is an expense that lowers current year net rental income but the downside is that it may increase the tax bill when the property is sold (commonly called a ‘recapture’).
Rental vs. Personal Portion
In some cases there may be a personal portion of the costs related to a rental property. An example would be if you rent out your basement but live on the main floor. In this case you’d need to determine which percentage is related to the rental portion (usually 50%) and only deduct that amount from the rental income.
Importance of Paperwork
It’s important to keep any receipts for expenses during the year – if you are audited by CRA for the rental income and can’t produce proper paperwork the expenses will likely be disallowed. The receipts also need to state the address of the property – and not your own personal residence.
Related: How Does CRA Decide Who to Audit?
For example, if you paid to have a patio installed and have the receipt but the address is shown as your own personal principal residence – CRA will assume you had a patio installed at your own home, not the rental property.
Final thoughts: the tax return for a rental property is fairly straight forward and follows rules that most people are familiar with. When in doubt about your situation it’s always best to check with a professional.