Your family’s home is generally known to be exempt from capital gains taxation because of the principal residence exemption. If the property was your principal residence for every year you owned it, you do not have to report the sale of your home on your income tax return.

To qualify for the principal residence exemption, the following conditions have to be met:

• 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
• For years after 1981, each family unit may designate only one home per year as a principal residence. A family unit includes you, your spouse or common-law partner and unmarried minor children.
• The land on which your home is located can be part of your principal residence. Usually, the amount of land that you can consider as part of your principal residence is limited to one-half hectare (1.24 acres). However, if you can show that you need more land to use and enjoy your home, you can consider more than this amount as part of your principal residence.

There are three special situations you should be aware to avoid losing the principal residence exemption of your home.

1. Be careful flipping homes.

If you buy and sell your home too often, you may lose the principal residence exemption and even the 50% capital gains inclusion break if CRA thinks you are in the business of buying and selling homes.

On Sept. 6, 2012, in the case of Sylvie Giguère (tcc-cci.gc.ca), Ms. Giguère and her spouse lost a court battle on this issue. The couple had sold seven single-family residences within a six-year period, claiming the principal residence exemption on each sale.

CRA successfully argued that the profits should be taxed as business income and penalties should apply for failure to report the income.

2. Changing your principal residence to a rental property

If you move out from your principal residence and rent it out, you can make a selection to keep the property as your principal residence for up to 4 years. This means any capital gains realized on the sale of this property during those years would be sheltered from tax. To be eligible, the following conditions have to be met.

• you have to report the net rental income you earn; and
• you cannot claim capital cost allowance (CCA) on the property.
• you do not designate any other property as your principal residence for this time.

To make this election, you have to file a letter signed by you to CRA. The letter should describe the property and state that you are making an election under subsection 45(2) of the Income Tax Act.

3. Changing part of your home to rental

You can rent part of your home and the whole property is still qualified for the principal residence exemption if you meet all these following conditions

• the part you use for rental purposes is small in relation to the whole property;
• you do not make any structural changes to the property to make it more suitable for rental purposes; and
• you do not deduct any CCA on the part you are using for rental purposes.

The principal residence exemption rules and calculations are complicated. You can check more informaton on CRA website.

If you sell a rental property for more than it cost, you have to report capital gain on your rental property. You should report it on Schedule 3 of your income tax return.

The calculation formula:

Capital Gain on your rental property = Proceeds of disposition – Adjusted cost base – Outlays and expenses

• Proceeds of disposition is usually the sale price of your property.
• The adjusted cost base (ACB) is usually the cost of your property plus any expenses to acquire it, such as commissions and legal fees. It also includes capital expenses, such as the cost of additions and improvements to the property.
• The outlays and expenses are basically your costs for selling the property. For instance, you may have had to repair some things on the property before you could sell it, or pay brokers’ or surveyors’ fees, legal fees and the cost of advertisement to sell your property.

Take advantage of the principal residence exemption (PRE) to reduce the capital gain on your rental property.

If you live in this property in certain years and you are able to design it as your principal residence for those years, you can reduce the capital gain by taking advantage of the principal residence exemption (PRE).

The principal residence exemption is claimed at the time your property is sold.

The exemption amount = Capital gain * (1+number of years designed) / number of years owned

You have to use Form T2091(IND) to designate your property as a principal residence and calculate the exemption amount of capital gain on your rental property.

For example, you bought a house for $300,000 in 2005 and sold it for $400,000 in 2014. You lived in this house from 2005 to 2009 and then rented it out. You can design the property as your principal residence for 5 years, and

The total capital gain = $400,000-$300,000 = $100,000

The exemption amount = $100,000 * (1+5) /10 = $60,000

The taxable capital gain = $100,000 – $60,000 = $40,000

From the article what you can claim as rental expenses – capital expenses, you already know you cannot deduct the total cost of the capital expense in a single year.

Instead, you should deduct depreciable capital asset over a period of several years. The deduction is capital cost allowance (CCA).

To claim capital cost allowance (CCA) correctly, first you should group your depreciable assets in to classes. This is because a specific CCA rate applies to each class.

Most common classes include:

Class 1 with a capital cost allowance (CCA) rate of 4%

Class 1 includes most buildings acquired after 1987, unless they specifically belong in another class. Class 1 also includes the cost of certain additions or alterations you made after 1987 to a Class 1 building or certain buildings of another class. You also include in these classes the parts that make up the building, such as:

• electric wiring;
• lighting fixtures;
• plumbing;
• sprinkler systems;
• heating equipment;
• air-conditioning equipment (other than window units);
• elevators; and
• escalators.

Most land is not depreciable property. Therefore, if you want to deduct capital cost allowance (CCA) in your rental property, you can only include the cost relates to the building. The value of land must be excluded in the calculation of CCA.

Class 8 with a capital cost allowance (CCA) rate of 20%

Class 8 with a CCA rate of 20% includes certain property not included in another class. It includes

• furniture
• household appliances such as refrigerator, stoves, washing machine and dryer machine.
• tools costing $500 or more per tool
• some fixtures
• machinery
• outdoor advertising signs
• photocopiers and electronic communications equipment,such as fax machines and electronic telephone equipment, and
• other equipment you use in your rental operation.

Class 50 with a capital cost allowance (CCA) rate of 55%

It includes computer hardware and systems software for that equipment acquired after March 18, 2007.

For more information about classes of depreciable rental property and the CCA rates that apply to each class, please refer to CRA website.

The half-year rule of capital cost allowance (CCA) rate

The half-year rule states that in the year you purchase new capital asset or make additions to your rental property, you can usually only claim CCA on one-half of the cost.

For example, if you purchase a new stove for your rental property, the CCA you can claim for the stove in the first year is 50% of the full CCA, which is the cost of the stove multiple the CCA rate 20%.

This half-year rule also apples when you transfer personal property into your rental business, such as a personal computer or a vehicle.

From the previous article, you know you can claim current expenses on your rental property. There is another type of expense – capital expenses.

Capital expenses provide benefits that usually last for several years. For example, buying a new fridge, renovating the basement, and installing a new furnace are capital expenses in your rental property. You cannot deduct the full amount of the cost in the year you pay for them. Instead, you can deduct their cost over a period of several years as capital cost allowance (CCA).

Capital expenses can include:

• the purchase price of rental property;,/li>
• legal fees and other costs connected with buying the property; and
• the cost of furniture and equipment you are renting with the property.

To decide whether an amount is a current expense or a capital expense, you should consider your answers to the following questions:

1. Does the expense provide a lasting benefit?

A capital expense generally gives a lasting benefit. For example, the cost of putting vinyl siding on the exterior walls of a wooden house is a capital expense.

A current expense usually recurs after a short period. For example, the cost of painting the exterior of a wooden house is a current expense.

2. Does the expense maintain or improve the property?

An expense that improves a property beyond its original condition is probably a capital expense. If you replace wooden steps with concrete steps, the cost is a capital expense.

An expense that simply restores a property to its original condition is usually a current expense. For example, the cost of repairing wooden steps is a current expense.

3. Is the expense for a part of a property or for a separate asset?

The cost of replacing a separate asset within a property is a capital expense. For example, the cost of buying a refrigerator to use in your rental property is a capital expense. This is because a refrigerator is a separate asset and is not part of the building.

The cost of repairing a property by replacing one of its parts is usually a current expense. For instance, electrical wiring is part of a building. Therefore, an amount you spend to rewire is usually a current expense, as long as the rewiring does not improve the property beyond its original condition.

4. What is the value of the expense?

Use this test only if you cannot determine whether an expense is capital or current by considering the three previous tests.

Generally, if the cost is considerable in relation to the value of the property, it is a capital expense. This test is not a determining factor by itself. You might spend a large amount of money for maintenance and repairs to your property all at once. If this cost was for ordinary maintenance that was not done when it was necessary, it is a maintenance expense, and you deduct it as a current expense.

Capital expenses – Special situations

1. Buying an older building

If you buy an older building that you have to repair or renovate to make it suitable to rent, the cost of the work is a capital expense. This is the case even though you would usually treat these costs as current expenses.

2. Selling your property

If you make repairs to your property because you want to sell it, or you make the repairs as a condition of sale, the repairs are capital expenses. However, CRA considers the repairs to be current expenses if they were necessary and you made them to your property or were making them before you decided to sell.

If you need more information about capital expenses, please check CRA website Capital Cost Allowance –Depreciable Property.

After knowing how to calculate your rental income, you would like to know what you can claim as rental expenses. You can deduct any reasonable expenses you incur to earn rental income, including:

Advertising

You can claim advertising that your rental property is available for rent as rental expenses.

Insurance

You can deduct the premiums for insurance coverage on your rental property for the current year. If your policy gives coverage for more than one year, you can deduct only the premiums as rental expenses that relate to the current year. Deduct the remaining premiums in the year or years to which they relate.

Interest

You can claim interest on money you borrow to buy or improve your rental property as rental expenses.

You might refinance your rental property to get money for a reason other than buying or improving your rental property. If you use the funds for a business or other investments, you may be able to claim the interest expenses on Schedule 4 as investment expenses, but not rental expenses.

If the funds are for personal use, you cannot deduct the interest expenses.

You cannot deduct the repayments of principal on your mortgage or loan on your rental property.

Office expenses

You can deduct the cost of office expenses as rental expenses. These include small items such as pens, pencils, paper clips, stationery, and stamps.

Legal, accounting, and other professional fees

You can deduct fees for legal services to prepare leases or collect overdue rents as rental expenses.

You can also deduct amounts paid for bookkeeping services, audits of your records, and preparing financial statements. You may be able to deduct fees and expenses for advice and help to prepare your income tax return and any related information returns.

Management and administration fees

You can deduct the amounts paid to a person or a company to manage your property as rental expenses.

Maintenance and repairs

If you pay for repairs to your property, you can deduct the cost of labour and materials. However, you cannot deduct the value of your own labour.

Salaries, wages, and benefits

You can deduct amounts paid or payable to superintendents, maintenance personnel, and others you employ to take care of your rental property. You cannot deduct the value of your own services.

Property taxes

You can deduct property taxes of your rental property for the period when it was available for rent.

Utilities

You can deduct expenses for utilities, such as gas, oil, electricity, water, and cable, if your rental arrangement specifies that you pay for the utilities.

Travel and Motor vehicle expenses as rental expenses

There are two situations:

1. If you own one rental property, you can deduct reasonable travel motor vehicle expenses if you meet all the following conditions:

• you receive income from only one rental property that is in the general area where you live;
• you personally do part, or all, of the necessary repairs and maintenance on the property; and
• you have motor vehicle expenses to transport tools and materials to the rental property.

You cannot deduct motor vehicle expenses you incur to collect rents. These are personal expenses.

2. If you own two or more rental properties, in addition to the expenses listed above, you can deduct reasonable motor vehicle expenses you incur to do any of the following:

• collect rents;
• supervise repairs; and
• generally manage the properties

Other rental expenses include:

• Landscaping costs
• Condominium fees
• And other reasonable rental expenses

Personal portion of your rental expenses

If you rent part of the building where you live, you can claim the rental expenses that relate to the rented part of the building. You have to divide the total expenses of the building between your personal part and the rented part. You can split the total expenses using square meters or the number of rooms you are renting in the building, as long as the split is reasonable.

All these rental expenses listed above are current expenses. According to CRA, current or operating expenses are recurring expenses that provide a short-term benefit. You can deduct 100% current expenses from your gross rental income in the year you incur them.

There is another type of expense – capital expenses, which we will discuss in next article:What you can claim as rental expenses – capital expenses.

If you have got rental income from renting out your property or part of your home, you have to report your rental income and expenses by filling out a Form T776 Statement of Real Estate Rentals as part of your T1 Income Tax Form. The first step is to calculate your rental income correctly.

Here’s what you need to know to make sure you are coming up with the right number.

1. Share of ownership of your rental property

Before you can determine how much of the rental income to declare, you need to know the share of the property you own. If you are the sole owner, Canada Revenue Agency considers you to be the only owner, and you declare all of the income. If you and your spouse, common-law partner, friend or other person own the rental property, CRA considers you to be co-owners. As co-owners, you declare a portion of the rent as decided in a written or verbal agreement between the owners.

You should report the rental income the same way for each year you own that rental property. In other words, you cannot change the percentage of the rental income or loss you report each year unless the percentage of your ownership in the property changes.

2. You cannot claim rental loss by renting below fair market value.

Fair market value is the price of your property would rent on the open market if put up for rent. If CRA suspect you are renting your property below fair market value, they can use “comparable” rental price in the area to determine fair market value.

If you lose money because you rent a property to a person you know for less money than you would to a person you don’t know, you cannot claim a rental loss. However, you can claim a rental loss if you are renting the property to a relative for the same rate as you would charge other tenants and you reasonably expect to make a profit.

If you ask your son or daughter, or another relative living with you, to pay a small amount for the upkeep of your house or to cover the cost of groceries, you do not report this amount in your income, and you cannot claim rental expenses.

3. Accounting methods used in calculating rental income.

There are two methods you can use to claim rental income: the accrual method and the cash method.

The cash method is used if you have no, or a small amount receivable and no expenses at the end of the tax year. Using the cash method, you claim the rental income and expense deductions in the year they were earned and paid.

The accrual method requires that you claim rental income and expenses in the year they were due or payable whether you collected them or paid them in that year.

In most cases, you should calculate your rental income using the accrual method. According to this method, you:

• include rents in income for the year in which they are due, whether or not you receive them in that year; and
• deduct your expenses in the year you incur them, no matter when you pay them.