How to avoid capital gains tax on rental property in Canada?
Thursday Nov 24th, 2022
How to avoid capital gains tax on rental property in Canada?
If you’ve landed on this page, you most likely googled “How to avoid capital gains tax on a rental property in Canada”. Our real estate professionals at Toronto Condo Team covers everything you what you need to know about capital gains tax for rental properties in Canada. You might have to pay capital gains tax if you have a rental property. This type of tax occurs when a person sells more than the purchase amount. However, there are ways to avoid paying this tax. It could be done by claiming the principal residence exemption or carrying forward capital losses from previous years.
What is Considered Capital Gains in Canada?
A capital gain is a profit you make when you sell an asset. It is the difference between your property's purchase and sale price minus any expenses related to selling it. You will have to report capital gain on your income tax return.
You may be able to defer reporting it in some cases. Although, you will have to pay taxes on any gains. This is not deferred when you sell in future. This will also occur when you are selling another property.
What Is Capital Gains Tax in Canada?
Capital gains tax is a tax on the profit you make when you sell an asset. The capital gains tax rate depends on your income tax bracket. Besides, there are two major capital gains: short-term and long-term.
You realize Long-term capital gains when you own assets for more than a year. In addition, short-term capital gains are reversed. You have owned these assets for more than one year. Regarding real estate sales, only half of your profits will be taxed.
How to Avoid Capital Gains Tax on Rental Property in Canada?
You can avoid capital gains tax on your rental property in Canada through the following:
- Deferring the sale and repurchase of the property
- using the principal residence exemption
- transferring ownership to a spouse or common-law partner
- designating gifted and inherited property as a principal residence
- incorporating your rental property business.
There are two ways to avoid paying capital gains tax: deferred disposition and rollover. A deferred disposition is when you sell an asset but do not receive payment until later in life. In this case, no tax would be payable on any profits from selling the asset until you receive them.
A rollover will occur when you sell an asset. Although, you will reinvest the realized amounts proceeds in another similar asset. You should do this within 60 days from the date of sale. Thus, this will be deferring any potential capital gains taxes that would have been owed if you had cashed out after selling.
1. Defer your capital gain with a sale and repurchase agreement
If you are selling your principal residence and then buying it back within one year. You can defer the capital gain by following this simple process:
- Sell the property at fair market value to an arm's-length party.
- Buy back the property for at least the actual purchase amount. For example, the transaction is taken as tax-free under CRA rules only if the sale is more than $300k and you have repurchased it for more than $315k.
Note that if you do not use some form of a financial institution to complete these transactions. Then, the list prices may not be accurate enough to ensure that they qualify as "fair market value." If this happens and your sale/repurchase doesn't qualify under CRA rules. Then all gains on sale proceeds will be taxed as regular income!
2. Utilise the principal residence exemption
The principal residence exemption is a tax rule that allows you to claim capital gains on selling your primary home. To qualify for this exemption, you must meet all of the following criteria:
- The property must be your principal residence, meaning it's where you live most of the year. A property is a principal residence if you are regularly living by yourself or with members of your family.
- You must have lived in the house for at least one year before selling it. Suppose you lived in it for less than one full year before selling. For example, if you moved out after six months and then put it back up for sale. In that case, this requirement won't apply—but only if there was nothing unusual about these circumstances.
3. Transfer ownership of the property to a spouse or common-law partner
You can transfer ownership of your property to a spouse or common-law partner without paying capital gains tax. This can be done at any time, and the spouse or common-law partner must be living as the principal residence.
If you've owned the property for less than three years, you'll still have to pay capital gains tax on half of your profit from selling it. If you've owned it for over three years, but less than five years, 75% of your profit will be taxable.
And if you sell after five years, no capital gains tax is due on the property's sale price. But note that if the land was subdivided during that period, there might still be some taxable windfall.
If you sell your principal residence, the tax rules are more lenient. You can exclude up to $500,000 of gain from capital gains tax. Only if you've owned the home for at least two years and lived in it as your principal residence for one year.
4. Designate gifted and inherited property as a principal residence
Suppose you have received gifted or inherited property. This would include capital property from a family member or friend and intend to designate the property as a principal residence for tax purposes. In that case, you must complete Form T2091(IND) Residential Real Property of the Income Tax Act.
The form must be submitted along with the gift/inheritance tax slips and other relevant documents about your acquisition of this piece of real estate. Once you submit Form T2091(IND), CRA will determine whether they can accept your declaration regarding this matter via their internal guidelines and criteria.
If you have a residential property acquired through means other than inheritance or gift, such as purchasing a new home or condo, then you are not required to complete Form T2091(IND) Residential Real Property. However, if you intend to designate it as a principal residence for tax purposes, then CRA may still require documentation from your builder regarding the status of the property.
5. Incorporate your rental property business
A corporation is a separate legal entity that you create to conduct business. The main advantage of incorporating your rental property business is that it can shield you from personal liability. This means creditors cannot sue you personally if the corporation owes them money. In addition, a corporation pays lower taxes than an individual and can save on tax rates through dividend income splitting between shareholders.
However, incorporating your rental property business has some drawbacks. It involves extra paperwork and costs more than just operating as an unincorporated sole proprietor.
For example, if you have employees working for your company, you have to pay EI premiums on top of their base salary yearly. Also, suppose one shareholder owns 90% or more of a Canadian-controlled private corporation. In that case, they'll be subject to additional reporting requirements, making it more complicated for them to buy or sell shares in the future.
6. Keep your earnings in a tax shelter
One of the best ways to avoid capital gains tax on rental property in Canada is by keeping your earnings in a tax shelter.
A tax shelter is a special account designed to shelter your income from taxes. There are two kinds: Registered Retirement Savings Plans (RRSP) and Tax-Free Savings Accounts (TFSA). The benefits of using these accounts include ensuring that you don't pay more than the minimum amount of capital gains tax, plus they allow you to defer paying the tax until retirement, when it will be lower.
A tax shelter is an asset that allows you to defer the payment of taxes on your income. You can do this by contributing to a Registered Retirement Savings Plans (RRSP) or purchasing shares in a company that pays dividends. Either way, your earnings are sheltered from taxation until you withdraw them from the plan or sell your stocks after they increase in value.
The most common way people use tax shelters is through RRSPs, which allow Canadians over 18 years old to contribute up to 18% of their annual income into a retirement fund with no tax consequences until they withdraw it at age 71.
RRSPs are particularly useful for those who want to avoid capital gains tax on the rental property because they allow investors to put money into an account and take it out later without paying taxes until then.
The other way people use tax shelters is through dividend-paying stocks. This means buying shares in companies such as banks or utility companies that pay them out as dividends yearly based on how much profit they made over time.
7. Use capital gain reserve
Another way to avoid capital gains tax on rental property Canada-related income is to use the Capital Gain Reserve (CGR). The CGR is a special account that allows you to defer the capital gain realized on selling the property until you sell another.
You can use this account to offset capital gains from other properties or even claim a refund once you have sold your property. This is useful for those who need more time to pay off debts and save money before purchasing another home or investment property.
The CGR can also reduce the capital gains tax you owe when you sell a property. This is because only 50% of the gain realized on the sale of a property is taxable, and any losses from previous sales can offset this.
8. Offset capital losses
There's a good chance you've made capital losses on the rental property or will make them in the future. To offset capital gains, they make use of Capital losses. This means that if you are losing money on a rental property, you're still holding onto it. Then, those losses are valuable. Unfortunately, there are limits on how much of your total taxable income can be covered by these write-offs:
- You can use up to $30000 of net capital losses against your other income in any year. If your total net capital gains were more than $30000 but less than $60000, all of your net capital losses will go to waste (unless you have other sources of income).
- You cannot carry back excess losses of this kind. Forward it into future tax years until expiry.
If you're wondering how to avoid capital gains tax on rental property in Canada, we have the answer for you. Capital gains tax refers to profits from an asset's sale. In this view, some of the realized amount will be in government coffers.
For most Canadians, this means paying income tax on profits from selling their principal residence or other assets. However, there are instances where capital gains taxes do not apply — and one of them is when renting out your property!
Because rental income does not count as income for tax purposes, hence, the law does claim taxes on the profits. That means if you sell your home or other real estate assets at a loss, no one will ask for any money back from those sales either! This article provides all the details on how avoiding capital gains tax while renting out properties in Canada works so that you can make informed financial decisions about your investment portfolio now or in years to come. We are not tax experts or certified accountants this blog is for informational purpose only.