Brought to you by the Chartered Professional Accountants of Ontario
With housing prices at all time highs and still continuing to rise, many Canadians may be considering real estate investments as an attractive alternative to volatile stock markets and the low interest rates earned on many types of investments.
“Many people are very successful with their real estate investments,” admits Jethro Bushenbaum, a Toronto-based CPA, CA. “For every one of them, however, there are many more who either just break even or lose money. Real estate investing is like any other type of investment. It contains risks, which investors need to understand and mitigate if they are to be successful.”
According to Bushenbaum, a common mistake made by those who lose money is the belief that real estate investment is a passive activity, in which they will earn solid returns with few demands on their time and attention. “In fact, managing a real estate investment and the risks associated with it is a big job,” Bushenbaum says. “If you’re renovating a property for resale, you’ve got to manage contractors. If you’re holding the property and renting it out, you’ve got the responsibilities of being a landlord. Trying to do either is difficult for someone without prior experience, especially when they also have another full-time career.”
The first step an investor needs to take in advance of any purchase is to prepare a detailed budget for their investment, says Irwin Choleva, CPA, CA, a partner with the accounting firm of Shimmerman Penn LLP in Toronto.
“Crunch the numbers to make sure the investment really does make sense,” he advises. “A lot of real estate investments look attractive at the outset. But remember, in real estate there are always unexpected costs that will quickly eat into your anticipated returns – the renovation or rebuild takes longer than contemplated, you can’t find a tenant as quickly as you’d hoped, and so on. If you overlook something significant, your budgeted profit may be greatly reduced. Therefore, contingencies need to be built into your forecast.”
Another important consideration is determining how the investment will be structured. For example, will it be purchased by an individual, a partnership or a corporation?
“Many people who purchase properties, which they intend to rent out, prefer to do so through a corporation since that provides them with personal liability protection,” says Chad Saikaley, a CPA, CA with Ginsberg Gluzman Fage & Levitz, LLP in Ottawa. “In the past, there was also a modest tax rate advantage to owning rental properties through a corporation. This tax rate advantage was largely eliminated in 2014, although corporations can still provide family income splitting benefits in some situations.”
Saikaley advises investors to consult a Chartered Professional Accountant about the tax and liability implications involved in owning real estate through a corporation.
Be prepared for the tax man
Choleva says one of the costs most often overlooked in real estate investing is the HST that may be payable on the property. “HST is not payable on the purchase of used residential properties bought by builders. Builders often forget that once those properties are renovated they may be considered as new and, therefore, HST would be applicable at the time of sale or change in use,” Choleva says.
The Canada Revenue Agency generally considers a residential property to be new if 90 percent or more of the property is renovated. It can also be deemed new if the use of the property changes, for example, if a hotel is converted to a residential rental property. “Since real estate can only be sold for what the market will bear, buyers usually won’t agree to pay the HST on top of the sale price,” Choleva says. “Instead, the seller has to take the HST out of the potential profit they earn on the sale. If that hasn’t been factored into the budget, that amount, which may be several thousand dollars, may diminish the expected profit.”
Real estate investors whose renovated properties are HST liable can offset some of that tax liability with input tax credits (ITCs), says Saikaley.
“All of the HST a builder pays on building supplies and contractor fees can be applied to reduce the amount of HST that must be paid on the sale of the property,” Saikaley says. “It’s important, therefore, for builders to ensure they keep all the records and receipts showing the HST they’ve paid.”
Builders who sell substantially rebuilt properties normally pay the HST out of the proceeds of the sale. Investors who act as landlords face a bigger challenge. Since the purchase of used residential homes that are substantially renovated, or buildings that are converted from a non-residential to a residential property, also incur HST, the investor must self-assess the amount of HST payable based on the market value of the property.
“An unexpected HST liability on a rental property is often a major financial strain for these investors since, unlike in the case of a resale, they won’t have the sale proceeds to apply to the tax,” Saikaley says. “They can get some relief through the GST/HST New Residential Rental Property Rebate, which can provide a rebate up to a maximum of $27,150 per rental unit.”
Buying and reselling pre-build condos
The Canada Revenue Agency has increased its scrutiny on condominium properties that were purchased pre-construction and later sold close to or soon after the project was completed.
“At issue is whether the sale proceeds are considered to be a capital gain or normal business income,” explains Bushenbaum.
People who buy properties with the intention of reselling them at a profit must declare the income they receive from the sale as normal business income. An individual who buys a condo with the intention of living in it, but then chooses not to because of a later change in personal circumstances may be able to have the sales proceeds designated as a capital gain, in which case only half of the sales amount would need to be declared as taxable income.
“If there is an actual event – a change in family or economic circumstances – that can be documented and show the person’s intent was not to purchase for resale, my experience has been that the CRA will usually agree that the sales proceeds are a capital gain,” Bushenbaum says.