Are you a landlord? Then you might be wondering how to avoid capital gains tax on your rental property in Canada.
To make things clear, by avoid, we mean tax avoidance and not tax evasion.
Avoid, in this case, means legal ways to reduce the amount of tax owed on your profits. When you sell your rental property, there can be capital gains taxes to pay.
However, if you play the game right, you can minimize the tax bite from the Canada Revenue Agency (CRA). Here’s how to do it.
What Is Capital Gains On A Rental Property?
Depending on how much money you collect in rent versus what you spend to hold the property, you might have positive cash flow as well as appreciation in property value. That is not what drives capital gains.
Capital gains are what you profit when you sell the rental property for above what you paid for it. Your rental property is an investment, not your principal residence. By the way, even if you own a duplex and only rent out one unit, that unit is an investment property.
You can expect a capital gain when you sell a rental property if you don’t owe any debt on the property, or you sold it for profit despite any outstanding loans.
What Is Capital Gains Tax?
In Canada, capital gains tax is levied on capital gains. The CRA taxes 50% of gains up to $250,000, and 66.7% of gains over $250,000.
The rate at which your gains will be taxed depends on your income tax bracket. Your capital gains are added to your taxable income, which must be declared when you file your taxes and are taxed at your marginal tax rate.
How To Avoid Capital Gains Tax On Property In Canada
If you sell your investment property for more than what you paid for it, there are things you can do to protect that profit. Consider the following strategies to minimize how much you’ll have to pay in capital gains taxes.
Sell Your Real Estate Property At The Right Time For You
If possible, wait until January 1st of the next year before selling your rental property. This way, you can push out your capital gains tax payment to April 30th of the following year.
Why Would You Want To Do That?
- You are expecting a tax loss in the coming year and you want to use it to offset your capital gains.
- You want to add one more year of contribution room to your tax-free accounts before to maximize the amount of your profits you can put into them.
- Your earnings fluctuate year to year.
You may want to wait to sell the property during a slower income year if your earnings tend to fluctuate from one year to the next. The Canadian income tax structure requires taxpayers to pay higher tax rates for higher income thresholds.
The more money you make, the higher the tax bracket you’ll fall under, which means you’ll be charged more when you pay your income taxes. By selling your property during a slower income year, you can reduce your tax burden.
Contribute To Your RRSP
Your tax-deferred registered retirement savings plan (RRSP) account helps you save for retirement, but it can also be used to hedge against taxation.
When you sell your rental property, you can contribute some or all of your profits to your RRSP. Doing so will lower your taxable income, and therefore reduce the amount of taxes you have to pay in that taxation year.
Let’s look at a very simple example:
| You bought your rental property for $300,000 and sold it for $400,000. Your capital gain is $400,000 – $300,000 = $100,000 Capital gains apply to 50% of your profit $100,000 x 50% = $50,000 You owe capital gains tax on $50,000. The other $50,000 is yours tax-free. |
In this case, your taxable income would increase by $50,000 if you added the profit to your income. Your marginal tax rate applies to that extra $50,000, which means that you owe more to taxes.
Instead, you could contribute part of the $50,000 to your RRSP (depending on the contribution room you have available) to reduce your total income and pay fewer taxes.
Keep in mind that you will need to have contribution room in your RRSP before making a sizable contribution from the proceeds of your property sale.
Contribute To Your TFSA
A Tax-Free Savings Account (TFSA) lets you hold investments like cash, mutual funds, stocks, and bonds and withdraw any gains from the account tax-free. The profits you earn from the money in the account do not have to be declared for tax purposes.
Here is the important part: any income earned in the account — including interest on your capital gains — is typically tax-free, even when you withdraw it.
Keep in mind that there’s a contribution limit that caps the amount you can contribute to your TFSA every year. However, any unused contributions can be rolled over to the next year. Remember that, unlike an RRSP, contributions to a TFSA do not reduce your total income.
Use Your Capital Losses
A capital loss occurs when you experience a financial loss from selling an investment, like a rental property. Similar to capital gains, a capital loss is only realized and becomes relevant for tax purposes when the investment is sold.
Of course, just because it is called a capital loss doesn’t mean it is a bad thing. It doesn’t affect your credit score and it doesn’t mean that you did anything wrong. In fact, a capital loss helps you for around 3 years.
How Do Capital Losses Reduce Your Capital Gain Taxes?
You can use your capital losses to offset any capital gains you realized in the taxation year. This can be helpful when you’re trying to reduce your tax bill.
You can also apply capital losses to any capital gains you realized in the previous 3 years, or carry your capital losses forward to lower any capital gains you may earn in the future.
For instance, let’s say you sell a property and earn a capital gain of $50,000. Under normal circumstances, you’d declare 50% of your gains ($25,000) as your taxable income.
But if you sell another investment in the same year and take a loss of $15,000 on it, you can deduct the $15,000 loss from your $50,000 gain to get $35,000. You would then take 50% ($17,500) of this amount to declare as your taxable income.
This reduced amount would lead to much lower capital gains taxes.
Capital Gain Reserve
You could avoid paying higher taxes on your capital gains if you spread out the tax payment over up to 5 years instead of paying one lump sum upfront. However, this could be risky.
While you might have the cash available today, it’s possible that you may not have enough in the future when the payments are due. For this option, as well as all options, it’s important to speak with a tax professional.
Transfer Ownership Of The Property
If you’re married or are in a common-law relationship, you can transfer the ownership of the property to avoid paying capital gains taxes. However, the person receiving ownership must live in the property as their principal residence.
Make Your Real Estate Property Into An Incorporated Business
A corporation is a legal entity within which to conduct business and is distinct from its owners. You can choose to incorporate your rental property business to reduce your tax obligations since corporations pay less tax than individuals. Plus, you can save on tax rates by splitting dividend income amongst shareholders.
However, incorporating your rental property business involves ongoing administrative costs, which are usually much higher for a corporation than a sole proprietorship.
Can You Offset Your Capital Gains With Tax Deductions?
Landlords can write off certain expenses related to renting out and eventually selling real estate. These include the following tax-deductible costs, including:
- Advertising
- Home insurance
- Mortgage interest
- Property taxes
- Property management fees
- Utilities
- Repairs and maintenance
- Office expenses
- Legal and accounting fees
- Salaries
- Travel expenses
You can reduce the amount from the sale of the property when calculating capital gains by deducting these expenses, which can bring down the overall amount of capital gains taxes you need to pay.
How To Avoid Capital Gains Tax On Rental Property in Canada: Tax Avoidance And Not Tax Evasion
The profit you make on the sale of an investment property can be significantly affected by capital gains taxes. But there are ways to pay much less in taxes while still complying with tax regulations in Canada.
You can effectively minimize how much you pay to the government using the above-mentioned strategies and maximize what you keep in your pocket. Make sure you speak with a tax specialist to help you come up with a strategy that works best for you.
