Spring is just around the corner, which means it's the peak market for selling rental properties. Listing a home during this time has several advantages, including maximized curb appeal and ideal springtime temperatures for moving. But have you thought about the tax implications of selling a rental property?
Learn more about rental properties and rental property tax on our blog.
What is a capital gain or loss?
When you sell a rental property, you create taxable capital gains or losses.
Capital gain/loss = The selling price minus the purchase price minus the cost to sell (realtor and legal fees)
If you have realtor fees of $11,000 and legal fees of $1,500, your total cost to sell to $12,500. This amount is deductible in your capital gain or loss calculation.
Capital gains tax on rental properties
A capital gain is taxed at 50%, but if your rental property is owned with a spouse or partner, this can be split again.
Sam bought a rental property 10 years ago for $300,000, and has been renting it out since. After listing the property, it quickly sold for $400,000. Sam wants to know how much they will owe in tax on the sale. Let’s look at the numbers:
Realtor fees: $11,000
Legal fees: $1,500
Mortgage penalties: $2,500
Total cost to sell: $15,000
Selling price: $400,000
Cost to sell: $15,000
Net selling price: $385,000
Cost of property: $300,000
Capital gain = The net selling price minus the cost of property
= $385,000 minus $300,000 = $85,000
Taxable capital gain (50%) = 50% x $85,000 = $42,500
Sam’s tax rate: 38%
Tax owing on the sale = $16,150, which is 38% x $42,500
What about the mortgage balance?
Notice how the mortgage balance did not come into the tax calculation at all? The capital gain is only about the sale price less the purchase price. It doesn’t matter if you own the house outright, or have a giant mortgage on the place.
In Sam’s scenario, there is a $200,000 mortgage on the property. It's important to note that Sam knows how much cash to expect once the sale closes:
Net selling price: $385,000
Less tax: $16,150 (Save this for when the tax is due)
Less mortgage payout: $200,000
Net cash from sale: $168,850
What if both spouses are on the title?
Sam just provided the closing documents, and we notice that both Sam and Chris are on the title. This is how the tax situation changes — if the property was 50% owned by Chris and 50% owned by Sam, they each need to claim their portion of the capital gain.
Taxable capital gain: $42,500
Sam’s portion: $21,250
Sam’s tax rate: 38%
Sam’s tax owing: $8,075
Chris’s portion: $21,250
Chris’s tax rate: 25% (based on total income)
Chris’s tax owing: $5,312
Tax owing on the sale = $13,387
Each spouse reports their half of the taxable capital gain ($21,250) on their income. This $21,250 is added to their income and taxed at the appropriate income tax rate, which depends on the spouse’s income bracket.
Rental income and deductible expenses (write-offs)
Here’s what you can deduct from your rental income:
- Interest portion of the mortgage payment
- Property tax
- Condo fees or management fees
- Utilities, phone, internet, cable
- Depreciation or Capital Cost Allowance (CCA)
- Repairs and small renovations
- Lawn care, snow removal and cleaning
- Bank fees
- Unpaid rent
- Vehicle expense, in certain circumstances
You cannot write off the principal portion of the mortgage payment; only the interest is a deduction. It's important to note that while repairs and maintenance costs are deductible, if the repair is an improvement to the property, it should probably be considered a capital improvement. This means it is capitalized as an asset, and then a portion of the cost is deductible each year, also known as depreciation or Capital Cost Allowance (CCA).
Read more about maintenance vs. capital improvements in this ATB article.
However, major improvements and costs that were not written off as a rental expense can increase your original cost base and reduce your capital gain.
Selling a rental property that was a primary residence
Did you know? If you live in a property at least one day out of the year, you can designate it as your principal residence.
If the property was ever your primary residence, only a portion of the capital gain is taxable.
If you own a property for 10 years and lived in it for four years, then 40% (4/10) of the gain is eliminated. So the taxable capital income in our example becomes $25,000 instead of $42,500.
There’s also a unique “one-plus rule” that increases your savings even more. Usually only one home can be your principal residence each year. This rule allows you to sell a home and buy a home in the same year, while having them both designated as your primary residence.
Designating a property as your primary residence can be complicated – please consult with an accountant to investigate further.
When to sell your rental property
The timing of your sale can also be a powerful tax reduction tool. Does your income vary from year to year? Selling during a lower-income year can save you money in taxes.
If you are planning on selling a property that will make a profit, consider postponing the sale until the next calendar year. You’ll incur capital gains tax that year and only have to pay by April 30th of the following year.
If you have a property that has lost money, selling it in the same year as profitable investments lets you apply the loss against the profits. This will reduce your overall capital gains tax.
If True North Accounting handles your corporate taxes, we can also handle your personal taxes. So whether you have one property, several, or if rental properties are your business, we can help you get all your deductions and be prepared for tax season with no surprises. Get in touch with us.
Read more about Corporate Tax topics that may be helpful to you and your small business.