# Reduce taxes by buying investment real estate?



## caninvestor (Apr 20, 2016)

I own a couple of rental properties that are generating positive cash flow. The only problem is I end up with a tax bill in the thousands because the income I'm required to report is much higher than my actual cash flow (I can't deduct the principle portion of my mortgage for instance). Even if I take CCA, which has its pros and cons, I still end up with tax owing. Is there some deduction or some other creative way of tax structuring that I'm missing?


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## Davis (Nov 11, 2014)

The principle you're paying down is like the money that people save outside of RRSPs and TFSAs - there is no tax deduction, but that also means you won't pay tax on it when you use it for future spending, unlike RRSP or RRIF withdrawals. Aside from CCA, there probably isn't anything you're overlooking. Check the CRA Rental Income Guide to see what is deductible and make sure you are claiming those things.


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## Just a Guy (Mar 27, 2012)

Depending on the number of properties you own, there are many things you can write off. These can include things like travel to and from the property, interest, property tax, upgrades, tools, phone, computers, accountants, lawyers, etc. The general rule of thumb is "anything that you need to help you make money" is usually considered a deduction.

The general truth about deductions is, the government doesn't let you keep the actual money. Let's say, sir simplicity's sake, that everyone was required to contribute 1/3 of their income to taxes. The taxes are collected to benefit society as a "whole", so any money collected will be spend on "society". With tax deductions, the government is basically saying you can choose how your 1/3 is spend instead of the government. So instead of giving the government money to create employment on your behalf, you can pay an accountant to do your taxes for you. Instead of the government "stimulating the economy", you go out and buy tools. Either way, the government expects society to get 1/3 or the equivalent spent on society. If you get some benefits out of the process (getting your taxes done saves you time and frustration, owning tools you can reuse) that's okay, but you never get to keep the money yourself is the idea.

That being said, the idea that you are being taxed, it will never cost you more money than you are making. If you are paying taxes, you are always making more money than you are paying. Bumping yourself into a higher tax bracket, the higher tax amount only applies to any money made over that threshold so, if the threshold is 50k, and you make 51k, 50 k is taxed at the lower rate and only 1k is taxed at the higher rate.

The fact that you pay taxes, especially when it comes to rentals since there are so many deductions, is a sign that you are making a ton of cash and have a good investment...or that you have a lousy accountant I guess.


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## Eclectic12 (Oct 20, 2010)

caninvestor said:


> ...The only problem is I end up with a tax bill in the thousands because the income I'm required to report is much higher than my actual cash flow (I can't deduct the principle portion of my mortgage for instance) ...


Are the taxes not a sign of successful business?

The part about "income to report is much higher than my actual cash flow" sounds like there is something wrong. When I used to rent out a room of my house, the cash flow was the rent - which would then be reduced by the expenses (ex. portions of utilities, interest etc.). Maybe I am missing something but I would have thought that worst case, the income would equal the rent but the more usual situation would be that the income net of the deductions would be less than what was paid to you.

For example, tenant pays $10K rent which is reported as income. Write offs that are available such as mortgage interest, insurance, utilities etc. should mean that the net increase to your other income is less than $10K. It may still translate to thousands in additional taxes.




caninvestor said:


> ... Even if I take CCA, which has its pros and cons, I still end up with tax owing.


That is the point of a business, right? Net of expenses, one makes money.

From what little reading I've done, worst case the CCA likely will reduce your taxes now then be re-captured at the sale of the property. Surely this is the better tax situation, or am I missing something?




caninvestor said:


> ... Is there some deduction or some other creative way of tax structuring that I'm missing?


Use these links to make sure you haven't missed any deductions (or hire a professional).
http://www.cra-arc.gc.ca/rental/
http://www.taxtips.ca/personaltax/propertyrental/rentalexpenses.htm

The rental income ends up being with any other sources of income (ex. employment, investments) so things like charitable donations, RRSP contribution/deductions etc. will help.


Cheers


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## RCB (Jan 11, 2014)

I feel your pain. We were absolutely hammered on tax on rental income for 2015. An unusual income situation for my husband involving a lump sum payout from employer, lots of overtime hours, payment as a union trustee... To top it off, one of our rentals finally moved from us renting it from my father to purchasing it. No more deducting the amount we paid to rent it (the mortgage amount). At the same time, our rents increased. WHAM!

But it means we're making money. Good money. I don't have to work money.


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## caninvestor (Apr 20, 2016)

I am just a regular working stiff who is used to getting refunds every year so having to pay taxes every April is not something I'm used to before I got into investment properties. The thing I find unfair is that my actual cashflow is net of the principal I have to pay on my mortgage, so why can I not deduct the mortgage principal for tax purposes since I' don't see any of that money? As far as CCA, it is basically a tax shifting strategy like RRSPs and not a way to reduce taxes. Basically you have to count on being in a lower tax bracket when you retire whereas I would rather strive to be in higher tax bracket when I retire. I guess only the super rich who can do offshoring and the like can actually manage to pay less taxes by having a business.


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## nobleea (Oct 11, 2013)

caninvestor said:


> I am just a regular working stiff who is used to getting refunds every year so having to pay taxes every April is not something I'm used to before I got into investment properties. The thing I find unfair is that my actual cashflow is net of the principal I have to pay on my mortgage, so why can I not deduct the mortgage principal for tax purposes since I' don't see any of that money? As far as CCA, it is basically a tax shifting strategy like RRSPs and not a way to reduce taxes. Basically you have to count on being in a lower tax bracket when you retire whereas I would rather strive to be in higher tax bracket when I retire. I guess only the super rich who can do offshoring and the like can actually manage to pay less taxes by having a business.


You do see that principal payment money. You just can't access it for a while (until you sell). And that money is tax free since it is part of your cost base. The money will increase your networth, though it may not feel like it. As you are finding, it is possible to be cash flow positive before taxes, but negative after taxes. As long as the sum of the principal repayments during a year exceed the taxes you had to pay, you're ahead of the game (assuming no increase in property value).


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## Davis (Nov 11, 2014)

What you pay down in principal is not a cost of doing business. It is an investment. I hold stocks in my taxable account that pay their dividends to me in shares instead of cash, which means I don't see the money now. But it is still income for me, and so it is taxable. 

You don't get a tax deduction for investing in stuff generally, and that is what paying down the principal is. You also won't pay tax on your principal when you sell the property and take the money - you only pay tax on half the capital gain. 

You are right that claiming CCA will increase the capital gain you realize later, but half of that gain is tax free. Generally it is better to pay tax on 50 cents later than to pay tax on $1 now. 

You should be aware though that your net income from your property means you can contribute more to your RRSP. Claiming CCA reduces your RRSP contribution room.

In the end, we all have to pay tax. There are few ways to avoid tax legally. Generally you can just delay paying it.


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## Eclectic12 (Oct 20, 2010)

caninvestor said:


> I am just a regular working stiff who is used to getting refunds every year so having to pay taxes every April is not something I'm used to before I got into investment properties.


Perhaps this is part of the problem?

Getting refunds when filing one's return around April of the next year means you over paid your taxes during the year. It is an interest free loan to the gov't. Would you be happy to buy a new car in Jan then the following April be told "you paid too much, here is your refund with no interest"?


Cheers


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## caninvestor (Apr 20, 2016)

Davis said:


> What you pay down in principal is not a cost of doing business. It is an investment. I hold stocks in my taxable account that pay their dividends to me in shares instead of cash, which means I don't see the money now. But it is still income for me, and so it is taxable.
> 
> You don't get a tax deduction for investing in stuff generally, and that is what paying down the principal is. You also won't pay tax on your principal when you sell the property and take the money - you only pay tax on half the capital gain.
> 
> ...


From my understanding, CCA has nothing to do with capital gains. When you sell the property, you must include or "recapture" every dollar you took as CCA as regular taxable income.


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## nobleea (Oct 11, 2013)

caninvestor said:


> From my understanding, CCA has nothing to do with capital gains. When you sell the property, you must include or "recapture" every dollar you took as CCA as regular taxable income.


I believe CCA reduces your cost base. And your cost base is used to calculate your capital gains. So they're kind of interrelated.


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## caninvestor (Apr 20, 2016)

The recapture, which is the sum of all the CCA deductions you have taken, will be included back as regular income in the year you sell. That portion cannot be included as a capital gain.


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## Davis (Nov 11, 2014)

I'm pretty sure you're wrong, caninvestor. I agree with nobleea: the CCA you claim reduces your Undepreciated Capital Cost (UCC). Your capital gain is the proceeds of disposition minus UCC. Your taxable capital gain is 50% of your capital gain. You include only your taxable capital gain in income. 

So you buy a house for $500,000, and claim $100,000 of CCA over a period of time. Your UCC is now $400,000. If you sell the house for what you paid, i.e. $500,000, your capital gain is $100,000, and your taxable capital gain is half that: $50,000. You include that amount in your taxable income. If your tax rate is 40%, then you will pay $20,000 in tax because of the gain.

If you also had a 40% tax rate when you were claiming the $100,000; of CCA deductions, you would have saved $40,000 in tax as you went.

This is a simplification: tax rates are more completed than that, and it would take a long time to claim $100,000 in CCA, but you get there picture, I'm sure.


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## Davis (Nov 11, 2014)

I've learned something by reading this guide: http://www.cra-arc.gc.ca/E/pub/tg/t4037/t4037-e.html#P640_61355

Recapture occurs when the UCC of a CCA class has a negative balance at the end of the year. I'm not sure how that happens, but that is how it is explained in the guide under "depreciable property". 

If you have recapture, they you have to included the full amount which is taxed as ordinary income, as caninvestor said. Recapture is unlikely to occur for real estate through as you're only claiming 4% per year, however. In most cases, you will have a positive UCC balance when you sell, so you will have a capital gain, as I've described above.


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## caninvestor (Apr 20, 2016)

Davis said:


> I'm pretty sure you're wrong, caninvestor. I agree with nobleea: the CCA you claim reduces your Undepreciated Capital Cost (UCC). Your capital gain is the proceeds of disposition minus UCC. Your taxable capital gain is 50% of your capital gain. You include only your taxable capital gain in income.
> 
> So you buy a house for $500,000, and claim $100,000 of CCA over a period of time. Your UCC is now $400,000. If you sell the house for what you paid, i.e. $500,000, your capital gain is $100,000, and your taxable capital gain is half that: $50,000. You include that amount in your taxable income. If your tax rate is 40%, then you will pay $20,000 in tax because of the gain.
> 
> ...


Using your example, you would add back $100,000 that you took as CCA over the years to your taxable income when you sell. Just like with RRSPs, you use deductions to reduce your taxable income in years when your earnings are higher. Upon retirement, when presumably you will be in a lower income bracket, you withdraw them and add everything you took as deductions back to your taxable income. In your example, the UCC balance of $400,000 increases back to $500,000 due to the recapture of $100,000 in CCA. The capital gains would be what you sell it for minus $500,000, or in this case $0. What nobleea said is nice but I think its too good to be true when it comes to CRA.


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## Eclectic12 (Oct 20, 2010)

^^^^

Do you need a lower income in retirement to end up better off why deferring the income tax?

In the short term, one would ... in the longer term, say thirty years - having use of the money may mean one comes out ahead. I can recall in the retirement thread a poster starting off thinking that his projections of a higher income at withdrawal from the RRSP would mean he would lose out on the tax rate trade-off. When he ran projections comparing the two, he was surprised that by investing the tax money, despite the drag of having to pay taxes on the investments ... he projected ending up after-taxes with more money than by skipping using the RRSP.


CCA has the disadvantage of lumping the income recapture into the same year as a large CG so it is not clear if similar projections for CCA would end up with the same result.


Cheers


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## domelight (Oct 12, 2012)

Lets assume you buy a house for 500,000 and then depreciate it down to 100,000 (you've claimed 400,000 in expense)
Now lets say you sell the house for 300,000 then 300,000 minus 100,000 is 200,000 is recapture. Straight up taxed income, not much different than a T4 job.

Now lets say you you sold the same house for 700,000. Now the amount you claimed as an expense over the year's 400,000 is recapture and straight income. and the 200,000 profit you made over the purchase price (700,000 - 500,000) is the capital gain which you pay 50% on or 100,00.
So 400,000 in recapture and 100,000 capital gain means you have taxable income of 500,000 in the year you sell the house.

Rental income and or associated recapture DOES NOT earn RRSP room.

Further note is CRA requires all rental properties to be reported separately largely for the reason you cannot use depreciation to create or increase o loss on rental. If you combine the properties to one statement you could create the situation to use depreciation from one property that is in a loss to offset the profit of another.


There's probably not much you can do about the taxes presumably due to the principal element getting higher and the interest element getting lower , but you may feel better if you fund your own mortgage using your RRSP's. If you have the funds in your RRSP to cover the mortgage or can make it happen then you should consult an accountant knowledgeable of the transaction for advice on the interest rate.


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## Eclectic12 (Oct 20, 2010)

^^^^

It looks to me that the examples above both include claiming CCA ... which the OP seems to prefer to avoiding claiming.


The comparison I was thinking about it where one claims CCA for many years to reduce the yearly taxes then invests them. The use of the tax savings has the potential to counter the additional tax the CCA recapture is going to add to an already high income year, from the sale of the rental (i.e. income from rental to sale, CG from the sale, CCA recapture plus all other sources of income).

Or did I miss something?


Cheers


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