Tax Traps: Claiming Expenses on Rental Properties

Who are the landlords in Canada today?  Stats Canada has found that just over four in five rental income earners were in couple families (81.0%), about 48% were aged 45 to 64 and most lived in Toronto (21.2%), Montréal (13.5%) or Vancouver (10.7%).  Net rental income was just under $5,000 for profitable ventures, but for the others, median losses of just over $3,000 were reported.  Of course, those losses could come under the scrutiny of a tax auditor, as some expenses are claimable, some are restricted and some are capital in nature.  What’s claimable is discussed below.

Common Rental Expenses.  Most expenses to earn rental income will be deductible in the year paid. However, some exceptions apply:

• Expenses must be matched to the rental income. For example, if the taxpayer pays insurance in advance, only that portion of the insurance that relates to the rental period may be deducted.
• Repairs that improve the property beyond its original condition or the addition of new appliances or equipment are considered to be capital expenditures and must be deducted over the life of the asset created using Capital Cost Allowance.

Advertising

• Amounts paid to advertise the availability of the rental property are deductible.

Home Office Expenses

• Reasonable home office expenses may be claimed against rental income. When a home office is in a shared workspace, the expenses must be prorated on the basis of the area of the workspace to the area of the home and hours used to earn income per week to total hours in the week.Note that the rules that limit the claiming of home office expenses to business income do not apply to rental income

Insurance

• The cost of insurance coverage for the year is deductible. If the insurance is paid in advance, claim only the portion that applies to the rental year.

Interest. Interest on a mortgage to purchase the property plus any interest on additional loans to improve the rental property may be deducted. However, if an additional mortgage is taken out and the proceeds are used for some other purpose, the mortgage interest is not deductible as a rental expense. If the mortgage funds were used for another investment, then they may be deductible as carrying charges. Other charges relating to the acquisition of a mortgage are not deductible in the year paid but amortized (under S. 20(1)(e)) over a five-year period starting at the time they were incurred.

Note that if the interest costs relate to the acquisition of depreciable property, the taxpayer may elect under S. 21(1) to add the interest to the capital cost of the asset rather than deduct it in the year paid.

Maintenance and Repairs. The cost of regular maintenance and minor repairs is a deductible expense. For major repairs, it must be determined if the cost is a current expense or capital in nature.  This is a major tax trap as many unsuspecting taxpayer claim these costs as expenses – 100% deductible – when they really need to be claimed under the CCA (Capital Cost Allowance) rules. 

Management and Administration Fees

• If the taxpayer paid a third party to manage or otherwise look after some aspect of the rental property, the amount paid is deductible.

Motor Vehicle Expenses

• If the taxpayer owns only one rental property, then motor vehicle expenses to collect rent are not deductible. CRA considers these to be personal expenses. However, if the taxpayer personally makes repairs to the property, then the cost of transporting tools and materials to the property may be deducted.
• If the taxpayer owns rental properties at two or more sites away from the taxpayer's place of residence, then CRA will allow motor vehicle costs to collect rent, supervise repairs or otherwise manage the properties.

Office Supplies

• Supplies needed to earn rental income are deductible.

Legal, Accounting and Other Professional Fees

• Legal fees to prepare leases or to collect rent are deductible. Legal fees to acquire the property form part of the cost of the property. Legal fees on disposition are outlays and expenses, which will reduce any capital gains on the sale. Accounting fees to prepare statements, keep books or prepare the tax return are deductible.

Property Taxes

• Property taxes applicable to the period when the rental was available for rent are deductible.

Travel Costs

• See Motor Vehicle Expenses above. The same rules apply. Travel costs do not include the cost of accommodation, which CRA considers to be a personal expense.

Utilities

• The cost of light, heat, water, etc., paid by the landlord and not reimbursed by the tenant, are deductible. Amounts charged to tenants are deductible if the amount paid by the tenants is included in rental income.

Other Deductible Expenses.  The following are some miscellaneous costs that may be deducted:

• Landscaping costs may be deducted in the year paid.
• Lease cancellation payments - deduct that portion of the payment that relates to the period of the cancelled lease each year.
• Condominium fees applicable to the period when the rental condo was available for rent may be deducted.

Renovations made or equipment purchased to make the rental property accessible to individuals with a mobility impairment may be deducted under S. 20(1)(qq) and 20(1)(rr).

Bottom line:  The Stats Canada study tells us that more younger people (age 30 to 44) have added a second income source from rental ventures.  It also appears that low borrowing costs helped these families buy properties in the hope of also create wealth with future capital gains.   However, as costs rise with interest rates, there may be an opportunity for tax and financial advisors to shore up their knowledge on this specialized area of tax law, create new relationships with these younger future wealth owners and help them maintain and build their asset base.

Excerpted from the 2023 Advanced Tax Update Course..