|TABLE OF CONTENTS|
|I. SELF-EMPLOYMENT||IV. INTERNATIONAL TOPICS|
|Realty Commission Agents||1. Non-Resident Owners of Canadian Real Estate|
|1. Tax Topics||2. Investors in U.S. Real Estate|
|2. Revenues and Expenses||3. Emigrants/Immigrants & American Citizens|
|3. Audits and Appeals||V. TAX PLANNING|
|II. EMPLOYEE vs. SELF-EMPLOYED||1. Voluntary Disclosure Program|
|III. GENERAL TOPICS ON REAL ESTATE||2. RRSPs|
|1. Principal Residence Exemption||3. Tax-Free Savings Accounts|
|2. First-Time Buyers||4. Foreign Asset Declaration|
|3. Second Homes||5. Losses|
|4. Rental Properties||6. Legal & Accounting Fees|
|5. Conversion of Usage||7. General Anti-Avoidance Rule (GAAR)|
|8. Pension-Splitting Option & OAS CLAW-BACK|
TAXABLE INCOME INCREASES BY THE AMOUNT OF EXPENSES DISALLOWED OR INCOME ADDED.
COMBINED 2014 FEDERAL/ONTARIO TAX BRACKETS
46.4% FEDERAL/ONT. RATE ON TAXABLE INCOME
43.1% FEDERAL/ONT. RATE ON TAXABLE INCOME
FROM $87,907 TO $136,270;
33.3% FEDERAL/ONT. RATE ON TAXABLE INCOME
FROM $ 43,953 TO $87,907;
20.05% FEDERAL/ONT. RATE ON TAXABLE INCOME
FROM $ 0 to $43,953.
Ontario has a surtax of 1% on income over $150,000 and 2% over $220,000. So TOP RATES of 47.4% and 48.4%.
2014 NON-REFUNDABLE TAX CREDITS
|TYPE||FEDERAL VALUE IN 2014|
|Married/Married Equivalency||$11,138||( For spouse including same-sex/single parent. )|
|Age 65 or Over||$6,916||( Is reduced by 15% of income over about $34,567 )|
|Disability||$7,766||( T2201 Disability Certificate. Must be "markedly restricted". )|
|Infirm Dependant over 18||$6,589||( Need only be "infirm" in some capacity. )|
|Caregiver Amount||$4,530||( For a parent, grand-parent or dependent child. The credit reduces where net income is over about $15,334. This is a
credit often missed by those with an infirm dependent or a parent or grand-parent in their home.)
For any missed credits such as caregiver or the disability credit, you can file a T1ADJ and claim the missed credit to the Adjustments Division in
Sudbury for any tax return back 10 years.
Donations save taxes at about 20% on the first $200 and about 40% on amounts over $200. The Non-Refundable Tax Credits above save taxes only at the
lowest Federal/Ontario rate of about 20.05%.
TAXPERTS GROUP. CHARGES $600 PLUS HST FOR A T1 SELF-EMPLOYED RETURN INCLUDING T4A, T3, T5 AND OTHER INCOME SLIPS AND A SELF-EMPLOYED STATEMENT
INCLUDING DETAILED AUTO AND HOME-OFFICE EXPENSES. MOST OF OUR CLIENTS USE OUR FREE SELF-EMPLOYED SPREADSHEET TO TOTAL THEIR EXPENSES. THERE IS AN EXTRA
CHARGE OF $50 PLUS HST FOR THE PREPARATION OF AN HST RETURN. THE TOTAL FEE INCLUDES ,½ HOUR OF INTERVIEW AND TAX PLANNING TIME.
REALTY COMMISSION AGENTS
1. TAX TOPICS
- PERSONAL TAX & HST INSTALLMENTS
- CRA INTEREST & PENALTIES
- HST RULES & HST RETURNS/REMITTANCES
- LAND TRANSFER TAXES
- LUXURY CAPS ON CARS
- CAR PURCHASE vs. LEASE
A. PERSONAL TAX & HST INSTALLMENTS
PERSONAL TAXES. All taxpayers in Canada file their own personal tax returns. There is no such thing as a "joint return" as in the U.S. Tax instalments are commonly paid by self-employed taxpayers and those with high pension and investment income which is often the case with high earners and senior tax filers who had no tax withheld at source on interest and other investment income. Installment payments for self-employed taxpayers include Federal and Ontario taxes AND CPP self-employment premiums for which the maximum amount will be slightly over $4,855 in the 2013 tax filing. Tax instalments are due on March 15, June 15th, September 15th and December 15th. HST instalments are required if you paid more than $3,000 in the prior tax year. The payments are 4 equal amounts made up of the prior year HST paid divided by 4. If you remit $8,400 of HST in 2012, you would owe $2,100 for 2013 HST instalments which are payable by April 30th, July 30th, October 30th in 2013 with the final instalment payable by January 30th of 2014.
The Canada Revenue Agency (CRA) will automatically send notices of 2013 installment requirements based on one-quarter of the balance payable 2 tax years back - - the 2011 tax year - - for the first 2 payments and one quarter of the balance payable in the prior tax year - - the 2012 tax year - - for the last 2 installment payments. This is advantageous for those who had lower balances payable in 2011 than 2012.You can also remit 4 equal amounts based on the "prior year basis" and works if your 2012 balance was LESS than in 2011. The third option is to make instalment payments based on the "current year". This is advantageous for those with lower taxable income in 2013 than in both of 2011 and 2012. We call this "having a bad year. It requires intelligent guesswork on the part of the taxpayer. The object is to remit the least amount while avoiding installment interest charges. Many Real estate agents with substantially lower gross commissions in 2013 will remit nothing for the December 15, 2013 date if they have made the first 3 payments requested by the CRA if the total of those three payments will be equal to or greater than the actual balance you expect to pay in your 2013 T1 personal tax return. For the highest earners who usually have a lot of taxable income in the highest bracket of 46.41% - - much higher than $135,054 for 2013 we suggest using what we call "the 40% rule". To illustrate - - and assuming that your expenses remain relatively consistent - - if you grossed $300,000 in 2012 and by the first of December of 2013, you know you will gross $40,000 lower in 2013, then reduce your December instalment by $16,000 which is $40,000 TIMES 40%. This might result in paying nothing or very little for the December instalment. It is best to keep the money than wait until July of the following year for a refund. You could also reduce your January 30, 2014 HST instalment by $40,000 TIMES 13% or $5,200 based on the same principle that you grossed $40,000 LESS in 2013. Interest is charged on installment shortages from the due dates. You may adjust instalments down to reflect decreased revenues but risk interest charges if you under-remit. [ The chart at the top of this section sets out Federal/Ontario tax rates as taxable income rises. ]
HST. Those with gross self-employed earnings in 2012 of over $1,500,000 in a year must file HST returns on a quarterly basis declaring HST collected for the quarter LESS HST paid - - “In-Put Tax Credits” (ITCs). Those with less than that amount can elect to revert to annual filings for 2014 and pay instalments but the election must be filed no later than the first 90 days of 2014. The election for a new filing period is Form HST20 E “Election for HST Reporting Period” and can be downloaded at www.cra.gc.ca and mailed to the Sudbury address used for regular HST returns.
Only annual filers make HST installment payments. Instalments were required for 2013 if the HST remitted in 2012 exceeded $3,000 If you exceed the threshold, divide the actual amount you owed - - Line 109 of the HST return entitled “Net Tax” - - by 4 and equal instalments are payable on April 30th, July 30th. , October 30th and January 30th of 2014 for 2013 HST instalments. Thus, pay one-fourth of prior year remittance on these dates.
Personal tax and HST instalments are payable to the “Receiver General Canada” and you use your Social Insurance Number for tax instalments, your Business Number of 12345 6789RT0001 for HST instalments and your Business Number of 12345 6789RP0001 for payroll remittances if you have a spouse or full-time assistant on payroll. For spouses, there is no E.I. premiums withheld, they are E.I. exempt, while for assistants you withhold Federal/Ontario taxes, CPP premiums and EI premiums. As an employer, you match the employee’s CPP premiums and pay 1.4 times the EI premiums. The CRA has a useful feature on their website at cra.gc.ca. Go to “Links for Businesses” then to “Payroll”. Hit “Payroll” and under “TOPICS” go to “Payroll Deductions Online Calculator” (PDOC). Enter here and: put in name of employer and employee; indicate the province of Ontario, indicate pay period frequency. If for a spouse or majority-shareholder of a private corporation, then indicate as exempt from E.I. premiums. Once you enter the gross pay for the period, the program will break out: 1) Federal/Ontario taxes; 2) CPP premiums; and 3) E.I. premiums. In remitting your payroll using your 9-character Business Number with the extension “RP0001”, an employer must match CPP premiums and throw in 1.4 times the EI premiums for those required to pay EI premiums. PDOC is a great and user-friendly program and is upgraded each year.
NOTE:If you pay tax and HST instalments or a payroll remittance at a financial institution, the general rule is that you must pay at least one full business day before the required date. The same rule applies if you are using your Business Number to make a payroll remittance for a spouse providing services or for an administrative assistant. The payment must be made by the 15th of the month for the prior month and do so 1 day earlier if paying at a bank. The penalty for late payroll remittances is 3% of the amount remitted. Late tax and installment payments are subject to only interest charges. But, if installment interest levied exceeds $1,000 then you are subject to an additional penalty of 50% of the amount exceeding $1,000 of interest. The former “HST Number” ended in 1996 and became a “Business Number” used for all of corporate and HST filings and payroll remittances. HST filings use the 9 numbers with the extension “RT0001” while payroll remittances use the 9 numbers plus “RP0001”. Payments for your personal taxes or tax instalments include Federal and Ontario taxes and self-employed CPP premiums which are a maximum of $4,712 for 2013 and you ALWAYS use your Social Insurance Number for those payments. All checks for payroll, HST or personal taxes are made out to the “Receiver General of Canada”.
B. CRA INTEREST & PENALTIES
INTEREST.The CRA sets a quarterly prescribed rate at prime plus 4% for both personal taxes and HST.
PERSONAL TAX AND GST FILERS face a 50% penalty on any installment interest which exceeds $1,000.
LATE-FILING PENALTIES.For personal balances including Federal and Ontario taxes plus CPP premiums, on a first late personal tax filing there is a penalty of 5% plus 1% per month for up to 12 months - - a 17% maximum. On a second late filing within 3 years, the base penalty is 10% plus 2% per month for 20 months or a maximum of 50%. Regular filers have an April 30th tax filing deadline while the deadline for self-employed taxpayers including those with sideline self-employed businesses and their spouses is June15th. This latter filing deadline also applies to annual HST filers. It is advantageous to `harmonize’ filing deadlines - - have the same filing deadline for taxes and HST - - as it reduces the amount of time spent on bookkeeping. Do your tax and HST bookkeeping at the same time in the first 3 - 4 months of the year-end. Many self-employed taxpayers who are HST registrants complete and file and pay the calculated balances by April 30th to avoid interest charges which commence running on outstanding balances on May 1st. Quarterly HST filers must also file within 30 days of the end of each calendar quarter and face penalties for late filings. If you are a quarterly or annual HST filer, you must enclose payment with your HST filing or it is treated as a late filing subject to penalties. This is not so with personal tax filings. Regular tax filers or the self-employed tax filers with a June 15th personal tax deadline are not subject to penalties on taxes payable if they meet the filing deadline. They pay only interest. So those who have June15th filing deadlines for both personal taxes and HST should pay the full amount of HST payable and then as much as they can, if not all, on their personal tax balance.
As discussed above, under s. 238 (1) of the Income Tax Act (ITA) ,you can be prosecuted in the criminal courts if you fail to file a return after receiving a formal demand to file in person which cites s. 150 (2) of the ITA and prescribes a deadline of from 30 days to 120 days to file the demanded HST and tax returns. ,You are liable, on conviction, to a fine of from $1,000 to $25,000 and imprisonment for up to 12 months. In the last several years, we have had taxpayers come to our firm facing this situation. It is a heavy-handed device by the CRA to force filing and is usually resolved by a quick filing of the returns by the prescribed deadline or when a count is laid in the Ontario Court of Justice for each tax and HST not filed, the Assistant Crown Attorney usually accept a guilty plea with the minimum $1,000 fine for each charge which would be 6 counts if you owe 3 HST and tax returns - - $6,000. If you do receive the notice to file, get your tax and HST returns prepared and filed before the deadline or you may be prosecuted. Our firm knows of an incident where there were convictions and that occurred when the taxpayer essentially told the CRA to take a hike when requested to file. Not smart.
C. HST RETURNS & HST RULES/REMITTANCES
You must register if your gross earnings exceed $30,000 in a calendar year. You would be required to register if your revenues for your first 3 months of activity exceed $7,500. If you do not register for a Business Number (BN) - - called a HST Number until 1996 - - you will not recover the 100% of the HST included in your expenses. So, REGISTER even if your annual income will be less than $30,000 to get the full HST Input-Tax-Credits. Many agents often get refunds in their first year of activity when expenses exceed commissions. You can file HST on an annual basis if your annual revenues were less than $1,500,000 in 2008 or later years. You can elect to go from a quarterly to an annual filing period for 2014 but you must elect to go onto an annual filing within the first 90 days of 2014. Monthly and quarterly HST filers must file HST returns within 30 days of the period end or face penalties. This leads to more time spent on bookkeeping and requires you to then `annualize’ your 4 quarters of commissions and expenses to get yearly totals needed to complete your personal tax filing. It reduces time and cost to “harmonize’ your HST and tax filings so that both are the calendar year. Those earning over $1,500,000 of commissions in a tax year must remain on a quarterly filing basis. Annual filers alone make quarterly HST installment payments. The formula is that if you remitted more than $3,000 of HST in the previous year - - see Line 109 of your HST return entitled “Net Tax” - - then you must make quarterly HST instalments equal to 1/4 of the total HST remitted in that prior year during the subsequent year. As discussed above in the section on ”Instalments”, many agents with much lower commissions in 2013 than 2012 will forgo making any tax installment on December 15th and nothing for HST on January 30, 2012 if their first three instalments are sufficient to cover 2013 tax and HST payable.
- HST is removed from both revenues and expenses in your tax returns. You must declare all HST collected. Your commissions and your expenses, after extracting HST, then go in your business statement, the “T2125 Statement of Business Activities”, in your personal tax return.
- Register for HST. It is better to get every cent back of HST as an Input-Tax Credit - - equivalent to cash - - by deducting it against HST collected than it is to not register and leave it in your expense statement in your personal return where it will saves you 0% if your taxable income level is under the personal exemption amount of $10,780 or at only 20.05%, 33.3%, 43.1% or 46.41% depending on what other income you might have in the year.
- De-register your Business Number if you cease activity. Use Form RC 145. Bank, insurance and government expenses must be entered separately as they do not include HST. See our free column sheet which automatically extricates HST from HST-subject expenditures and shows a black box on the globalized sheet for expenses which do not include HST.
- Once you register for a Business Number and charge the HST required on your commissions, the vendors are paying the 13% HST on your commission and you use that money to recover the HST paid on your expenses. You are a tax collector. You must collect and remit HST and file an HST return.
HST ON SALE OF NEW AND "SUBSTANTIALLY RENOVATED", HOMES
Good news. In information about the Excise Tax Act which relates to HST. It was announced that the definition of a “substantially renovated” home is more liberal. After HST was introduced in 1991 the Tax Courts set the test of a “substantial renovation” as the removal of more than 50% of inside walls. The CRA has announced that the new test is the removal of more than 90% of inside walls. This means that a complete ‘gut’ of the inside walls of a home will still subject the sale to HST as it will bring the home within the definition of a “new home”. The issue is one of definition.
If there is a substantial renovation bringing the property under the definition of a “new home”, the only way to avoid charging HST is for there to be a short period of bona fide personal usage - - the owners must move back in after renovations are completed. This would also apply to a residential rental property where you would have to place new tenants after completion of the renovation. An MLS listing before or immediately upon completion of renovations will trigger HST. Advise your clients to resume living in the home for at least 6 months after the completion of renovations or place new tenants and wait 6 months before listing on MLS. This short period of personal usage or of tenant occupancy takes the home out of the definition of a new home. Get advice as there is a fine line. There will need to be a few court rulings to clarify the issue.
THE “NEW” ,& “TENANT” HOME BUYER REBATES ON NEW HOMES
In Ontario, there is a two-stage rebate calculation to reduce the HST paid on new homes bought for personal usage or as rental properties after June 30th of 2010. The rebate is ,identical for both personal usage and rental properties BUT the FEDERAL portion of the rebate for properties - - a maximum of $6,300 - - reduces to NIL as cost rises from $350,000 to a NIL rebate at $450,000 or HIGHER. ,This unfair rule does not apply to the maximum of $24,000 of the Ontario rebate on the first $400,000 of home cost. ,You will get that rebate no matter the high cost of the new home purchased. The rebate for properties used for personal usage is called the New Home Buyers Rebate (NHBR). ,The rebate for rental properties is called the Tenant Home Buyer Rebate (THBR). Follow this closely since the forms to be completed, for each rebate are different . The HST rebate on new homes applies to the 13% paid on the first $450,000 of cost. You claim both an “HST new housing rebate” on the 5% included in the HST and an “Ontario new housing rebate” on the 8% included in the HST. The rebate on the 5% portion is 36% of the amount paid on a home purchased for up to $350,000 to a maximum of $6,300 and DECREASES as the cost rises to $450,000 at which point there is no rebate. The rebate on the 8% portion is 75% of the HST on the first $400,000 of cost to a maximum of $24,000. For a home costing ,$450,000 or more, you forfeit the $6,300 federal component. Your HST ,federal new housing rebate, for a $349,000 home would be $349,000 x 5% or $17,450 x 36% which totals $6,282. ,The Ontario new housing rebate would be $349,000 x 8% x 75% or $27,992 ,x 75% or $20,994, UP TO, A CAP OF $24,000 or effectively, a 75% rebate on only the first $400,000 paid. The maximum rebate is thus $6,300 plus $24,000 or $30,300 on $45,500 of HST paid on a home with an exact cost of $350,000. ,Investors who improperly apply for the NHBR rebate then place tenants in the property are ROUTINELY being caught now with the new CRA computer system showing a rental statement filed in the investor’s personal tax return. The CRA calculates a bill for repayment of the NHBR equal to the amount of the rebate plus interest and potentially, penalties.
In situations where the CRA forces a repayment from investors of rental properties under the NHBR, the CRA does not tell the investor that there is a “Tenant Home Buyer Rebate” (THBR) available to investors. You must file for this rebate within 2 years of acquiring title to the rental property and you must prove that there is a minimum of 1 year of tenant occupancy which means that you provide a copy of a Landlord-Tenant lease for at least a 1-year term. This is an area where you should get professional advice from a real estate or a tax lawyer who is familiar with the Tenant Home Buyer Rebate.
The rebate is calculated as follows and we are providing a table as the calculation is complicated. ,Remember that if the purchase price exceeds $450,000, the investor is disqualified from claiming any Federal rebate. With both the New and Tenant Home Buyers Rebate, you will pay the full 13% HST on the provincial amount over $400,000 due to the $24,000 maximum Ontario rebate and you will get no federal rebate for a new home costing $450,000 or more. The maximum $6,300 federal rebate on a home costing $350,000 reduces to NIL once the cost rises to $450,000.
New & Tenant Federal & Ontario Home Buyer Rebates
Buyers for personal or rental usage thus get a maximum of $6.300 of the former 5% Federal GST and a maximum of $24,000 on the former Ontario 8% provincial tax. Purchasers of new homes get a maximum of $6,300 of the former 5% Federal GST on a home purchased for $350,000 at which cost the rebate reduces and is lost if the cost of the home is $450,000 or higher. THUS the formulas guarantee that no applicant will get $6,300 plus $24,000 or $30,300. Under each of the “NEW” and “TENANT” rebates, the maximum is $24,000 of the former Ontario 8% provincial sales tax in each case for homes costing over $400,000. A home purchased for $400,000 will get the maximum $24,000 Ontario Rebate but will lose half of the $6,300 Federal Rebate. At a new home cost of $450,000 or higher the Federal Rebate will be NIL. Odd and complex.
HST ON COMMERCIAL, INDUSTRIAL & RETAIL PROPERTIES
Commercial/industrial/retail purchases are subject to HST. When dealing with properties with both business and residential uses, the allocation of value must be done precisely as ONLY the business component is HST-taxable. With either of the ‘mixed-usage’ properties - - zoned both commercial and residential - - or properties used exclusively for business on which the FULL 13% HST is payable, you can elect to exempt the purchase from HST as a “Going Concern” if the purchaser vouches to continue 90% or more of the existing business. Think of stores, restaurants and properties charging commercial rents. The election “Form HST 44” is filed by the registrant purchaser but must be signed by both the purchaser and the vendor. It reduces the cash needed to close. An extra 13% is a lot of cash. Have both the vendor and purchaser sign Form HST44 which exempts the sale from HST on the basis that the purchaser is going to continue 90% or more of the business activity of the vendor. Since the sale will result in a continuation of the vendor’s usage - - e.g., collecting rent on a commercial building, the purchaser would recover the HST paid as an In-Put Tax Credit ,- - ,a wash but one that avoids the purchaser from having to pay 13% on the amount related to business.
METHODS FOR FILING HST
There are three:
- QUICK METHOD: This method cannot be used by accountants, lawyers, financial consultants, actuaries, audit services and tax preparation firms amongst others. You can use it if your total of income PLUS HST - - called the ‘blended amount’ - - is less than $200,000 per year. You can elect to use this method after the first full calendar year of operations but, generally, it is only useful to computer `techies’ and others working a home-based business with low expenses such as only cell-phone, vehicle and home-office expenses. This method will not be beneficial to real estate agents whose expenses exceed 32.3% of commissions for the year. Those with high broker transaction fees and high advertising costs will not benefit from using the Quick Method. Once the blended amount exceeds $200,000 annually you are required to revert to the Simplified or Detailed method depending on whether your income for the year excluding HST is above or below $1,500,000.You can use this method ONLY if your `blended revenues’ of fees/commissions total up ,to $200,000. Pay 8.8% of the blended amount. On a blended amount of $113,000 - - $100,000 of commissions plus 13% HST - - you would remit $113,000 X 8.8% or $9,944. You can then claim the HST on capital expenditures ONLY such as computers, equipment, furniture and vehicles as an In-Put Tax Credit. If you bought a car for over $30,000 - - the ‘luxury cap’ - - you would reduce the $9,944 by the $3,900 of HST paid on the first $30,000 of the car price. Again, the Quick method rarely works for real estate agents due to the blended cap of $200,000. Those agents earning a ‘blended amount’ up to the $200,000 ceiling are likely to have expenses exceeding 32.3% of commissions so this method is unfavourable to most agents but if you have an historically low percentage of expense and stay under the $200,000 ceiling, it could be beneficial. ,Be careful here as you can only convert to the Quick Method by selecting it when registering or converting to it within the first 90 days of the current year. ,
- SIMPLIFIED METHOD: This is the most common method and used by about 95% of personal self-employed HST registrants. This is used by those with gross commissions or earnings from other business activity of up to $1,500,000. You declare the total amount of HST collected which is then reduced by claiming “In-Put Tax Credits” or “ITCs” where an expense is subject to HST. Payments to banks, insurance companies or governments are HST-exempt. So, such expenses as licenses, interest costs, car and liability insurance are not subject to HST. [ These exempt services are indicated by a black box on the middle column of our free Excel column sheets. ] You then multiply the expenses upon which you claimed HST by 11.504% to extract the HST and claim the exact amount of HST paid on the first $30,000 of a car purchase and on any computers, software, equipment, furniture or other capital expenditures. Remit the balance if HST collected exceeds your ITCs or claim a refund if the reverse is true which is common for real estate agents in their first or second year of activity - - those in their first year selling real estate often get an HST refund especially where a large number of commissions close in the next year.
- DETAILED METHOD: ,Is for those with commissions or other business revenue over $1,500,000. This is a slightly more complicated method as you must make dual entries. You must enter the exact base cost and the exact amount of HST separately and total the two amounts. Claim HST paid as an ITC against HST collected then complete the HST filing. The reality is that even CRA auditors find the accrual method as being too complicated so USE the “Simplified Method” and the CASH BASIS on a calendar year basis if revenues exceed $1,500,000 for the year and the CRA will accept this.
D. ONTARIO LAND TRANSFER TAX
The calculation for the Ontario LTT is:
- 5% or $275 on the first $55,000; plus
- 1% from $55,001 to $250,000; plus
- 1.5% from $250,001 to $400,000; plus
- 2% over $400,000
TORONTO LAND TRANSFER TAX
- 5% or $275 on the first $55,000; plus
- 1% from $55,001 to $400,000; plus
- 2% over $400,000
[ The Toronto LTT is $750 less than the Ontario LTT for homes over $400,000. ]
E. AUTOMOBILE CAPS
PURCHASE. You can depreciate only $30,000 ,and claim the maximum of $3,900 as an Input-Tax Credit if you are self-employed . Reduce the depreciable amount by any HST claimed as an Input-Tax-Credit. For cars used 90% or more in business, claim all of the HST on auto expenses as an ITC.
AUTO LOAN. Interest cap of $10 per day on the first $30,000 only of a car loan.
LEASE. A monthly cap of $800 plus taxes, but reduced if the sticker price exceeds $40,000 before the HST. There is a formula which will "flatten down" the deduction even if monthly payments are below $800 where the pre-HST sticker price exceeds the $40,000 figure.
KILOMETER CAR ALLOWANCES. For deduction purposes such as a T1M Moving Expense or the medical expense schedule and amounts claimable in the medical schedule for driving for medical treatment, you can claim up to 55 cents on the per kilometres in 2013.
F. CARS - - PURCHASE vs. LEASE
The lesson is that for a car with a cost over about$32,000 to $33,000, always lease. The extra few thousand dollars is not enough to agonize over if you prefer purchasing over leasing and especially if you get a zero interest car loan. Remember that if you buy you will get back only the HST on $30,000. Buying above $30,000 means you get not one penny of depreciation on the excess amount or HST on the excess amount. To illustrate, a $67,000 new BMW purchase means you lose the HST on $37,000 and any depreciation on that $37,000 which at the top marginal tax rate of 46.41% on 90% usage equals $15,455 of tax savings evaporating into thin air without a deduction over the ownership period. Also note, that if you are going to buy, borrow up to $30,000 to buy since you will get a full deduction on the interest paid as well as the depreciation on the first $30,000 of cost. Only pay cash if the mortgage on the house is paid off and you have `maxed out’ your RRSP contribution limit. So, borrow to buy and save your cash to make RRSP contributions - - a priority for these in either of the top two tax brackets at 43.1% and 46.4% tax rates - - then use any remaining cash for an annual pay-down on the mortgage principal on your house.The wisest scenario is to go second-hand luxury such as Mercedes, BMW, Lexus, Infiniti, Acura, Cadillac etc. where there are GREAT deals on 2- and 3-year old cars and keep the sticker price down towards the $39,883 sticker price which allows for a full deduction on your lease payments. You should note the number of “Pre-Owned” divisions at all the major luxury car dealerships. Two final points. Firstly, the standard lease contract allows only 24,000 kilometers of annual driving subject to a little bit of negotiation room up before a penalty charge is levied if you turn the car in at the end of the lease. If you work the `Highway 7 Corridor’ and are doing 40,000 kms. of driving each year or more, the mileage penalty will be so high you are likely looking at avoiding that huge cost by buying out the vehicle at the “buy-back cost”. You have set yourself up to be squeezed and this is one scenario which might lead to a purchase being preferable to leasing. Secondly and lastly, DO NOT make large `bubble’ payments on any lease deal. Where the sticker price exceeds the luxury cap of $30,000, the Income Tax Act (ITA) does not allow for deduction of these “bubble payments”. The same principle applies if you trade in your old car to reduce the contract price of the car on a lease. If you get $9,500 of trade-in value, that amount will simply apply against the Undepreciated Capital Cost of the car going into the year. If your U.C.C. is lower than $9,500, you will actually recapture depreciation and bring into income on the basis of the business proportion of the excess. On a positive note, if your Undepreciated Capital Cost is $12,500 with a trade-in value of $9,500, you will be able to depreciate the extra $3,000 which will blend in with the cost of the new car. For leases, If a `bubble payment’ is requested, explain that your tax professional warned you that you get no tax deduction for such payments when the sticker price is over $30,000. They know this and are desperate to lease the car. Pay $1,000 down at the most and first and last month’s lease payments and you will get the car. Enough said. Please read again and don’t call.
2. REVENUES & EXPENSES
ACCOUNTING & TAX PRINCIPLES Net income is simply gross revenues less qualifying expenses and the result may be a loss. Business losses, including rental losses, are first deducted against other income in the year to get Net Income for the year to a zero amount and any remaining losses - - a negative figure at Line 236 of your personal tax return - - may be carried back 3 tax years, so long as you file by the June 15th deadline, and forward for 10 years for business losses and indefinitely with net capital losses. To do a loss carry-back on business losses or on net capital losses, which can be applied against ,taxable capital gains in any of the 3 prior tax returns, you complete the Form T1A “Loss Carry-backs”.
Business statements are based on either the accrual method which reports income if invoiced in the fiscal period and deducts expenses incurred in the same period. The most common method used is the simpler cash method, available to self-employed commission earners, which declares revenue only if received by year-end and deducts only expenses paid by the year-end. Self-employed agents may receive a T4A slip from their broker showing self-employed commissions in Box 20 and/or an “Annualized Statement of Commissions & Expenses”. You must use the figure for “Gross Revenues” which appears in the T4A slip Box 20. If you do not receive a T4A slip, use the total from the “Annualized Statement of Commissions”. If the Box 20 amount includes 100% of commissions including the broker share in the provision for commission-splitting in your “Independent Contractor” agreement commonly signed between brokers and agents, then declare the Box 20 amount as Gross Commissions AND in the T2125 “Business Statement” in your personal tax return and enter a deduction “Broker Commission Split” to factor out the broker’s share. You do not claim a figure for broker split of commissions if the figure in the T4A Box 2 is ‘net’ after the broker split of commissions has been factored out. Apart from the T4A slip, agents will enter an amount for “Broker Administrative Fees” which includes any other expenses paid by the broker on your behalf and `passed through’ to you in the annualized statement including any monthly billings. Use the ‘pass-through’ expense figure on the statement and keep the statement as your proof of the expense. Remember that the Income Tax Act requires you to keep your books and records including all receipts and invoices for expenses for a 6-year period. That means for the 6 tax years prior to the current year. For 2013, you are required to keep all documents for the tax years 2007 on. You must always keep the original documents for the cost of rental properties, cottages, stocks and mutual funds no matter the year of purchase which is commonly much more than the 6 years required for documents relating to self- employed activity.
DEDUCTIBLE EXPENSES FOR EMPLOYEES. Employee real estate agents do not collect nor remit HST and are not required to obtain a Business Number. This is because these agents usually have a dedicated office or desk space and are more hours at the broker’s office than time spent driving away from the employer’s place of business. This status is still common in commercial real estate sales where the taxpayer gets a T4 slip showing gross income with a Box 42 amount for commissions earned broken out. As well, employees will pay CPP premiums & ,EI premiums with Federal and Provincial Tax withheld. Commission employees claim expenses in the "Employee's Allowable Expenses" Form also known as the T777 Form in their personal tax return. The expense will include HST which is then, with computer-generated returns, ‘broken out’ from the expense and claimed as a cash credit in the HST 370 Rebate Form at Line 457 in their annual tax filing. So both employee commission agents and self-employed agents recover the HST in their expenses.
Employees do not collect nor remit HST. A T2200 "Declaration of Conditions of Employment ", signed by the broker, must be retained to be provided to the Canada Revenue Agency (CRA) if requested. Rules for deductibility of employee expenses are governed by Section 8 of the Income Tax Act (ITA) and are punitive when compared with the more liberal deductions allowed for self-employed agents who are governed by Section 18 of the ITA which allows the deductibility of expenses if “incurred to produce income”. Commission employees and self-employed agents have the onus of making the business connection by relating an expense to the earning of income. That means names on Business Dinner & Business Events and gift expenses. Commission employees are disallowed vehicle usage to and from their broker's office and may claim a home/office expense only if they work more hours at home than at the broker's place of business and cannot claim the mortgage interest cost in the home-office calculation. They do get to deduct the interest cost on the first $30,000 of a car purchase but they cannot deduct purchases for computer, equipment and furniture purchases for greater than $500. THIS IS UNFAIR BUT THE LAW. Thus employees must lease any computers, equipment or furniture. This rule is punitive. The ,figure of $500 is the threshold we use for “Capital Expenditures”. If less than $500 we deduct the amount as a “Current Expenditure” under “Office Supplies”.
DEDUCTIBLE EXPENSES FOR SELF-EMPLOYED AGENTS. Self-employed agents are not subject to paying Employment Insurance premiums and income tax and CPP premiums are paid on the installment basis rather than deducted from each commission. The good news is that self-employed agents may deduct any expense "reasonably connected to the earning of income". Claim all arguable expenses and don't blink if you are audited.
On starting self-employment, value furniture and equipment used for business and vehicles at FMV or at their Undepreciated Capital Cost (UCC) if deducted in prior returns on other than a self-employed basis and enter the amounts for depreciation. Claim the HST on the FMV, at commencement of self- employment, on furniture, equipment and on any car bought after 1990 in your first HST remittance. Mortgage interest, often your largest home expense, may be added to the home/office deduction. This expense ,is pro-rated based on the area used exclusively for business or on a “room-by-room basis” not counting washrooms or you can choose, “square footage basis” ,depending on what basis is most advantageous. The home/office expense must be carried forward once self-employed income is reduced to NIL. Self-employed agents may treat driving to and from the broker's place of business as deductible business usage since their home is their “primary place of business”. [ Read our Bulletin on the “New Auto Logbook Rules”. ] Dinners and event costs have been only 50% deductible since February 22, 1994 under Section 67 (1.1) of the ITA. ,The cost of food and beverages purchased for open houses is included here and only half-deductible and gift cards to restaurants and events are also included here and only 50% deductible. Cars purchased after 2001 are capped for depreciation purposes at $30,000 plus HST - - self-employed taxpayers claim back the HST as an Input-Tax-Credit (ITC) in their HST remittance - - with a monthly lease cap of $800 plus taxes. Car loan interest is capped at $10 per day. The full HST may be claimed back on the purchase of a car and on all operating expenses - gas, repairs, lease etc. - if the car is used at 90% or more for business. If you drive only 89% for business you will get only 89% of the HST back.
BUSINESS NUMBERS. Replaced HST numbers in 1996 and are used for HST and payroll returns and in corporate tax returns. You must register for a business number and charge HST if gross earnings in the year exceed $30,000. If annual revenues are under $30,000, you must still complete the BN application and claim exempt status from charging and remitting HST which is not favourable since you recover HST spent on a dollar-per-dollar basis if you obtain a Business Number.
QUARTERLY TAX INSTALMENTS. Tax instalments are paid on March 15th , June 15th, ,September 15th, and December 15th of each year and may be based on the LEAST of: 1) prior year; 2) current year; or, 3) 2 years back for first 2 payments and 1 year back for the last two. Pick the method that minimizes the payments while avoiding interest charges. For HST annual filers, they must do HST instalment payments if they paid over $3,000 in HST for the prior tax year. Take the amount and divide by 4. You then pay 4 equal amounts on April 30th, July 30th, October 30th and January 30th of the next year. The rule is you must pay by the 30th day after the end of each calendar quarter. With both personal taxes and HST payments, you pay more taxes or get a refund depending on the figures in your personal tax and HST final returns.
OPERATING OR CURRENT EXPENDITURES. We have enclosed a separate column sheet to track your revenues and all broker fees as well as an expense sheet. For both revenues and expenses govern yourself by the principles of accuracy and thoroughness. These expenditures are fully deductible subject to specific limitations such as only 50% deductibility for business dinners, events, gift certificates for those first two expenses, travel meals when more than 12 hours away from your “regular place of business” and for groceries and drinks purchased for open houses.
TAX TIP: Most accounting firms make 90% or more of their revenues from corporate clients and place little importance on preparation fees for personal tax returns. CAs and CGAs also tend to be conservative in preparing personal tax returns yet frequently charge $600 to $900 or more for self-employed tax returns. This conservatism leads them to adopt practices which prejudice their clients such as claiming only 75% business usage on a car and not claiming a home-office expense as they mistakenly believe it jeopardizes getting a full exemption on the sale of your home when claiming the Principal Residence Exemption on sale. [ See the discussion on the Home/Office expense below.] Taxperts Group staff specialize in tax filings for small corporations, personal tax returns for self-employed taxpayers and real estate investors and CRA audits and appeals. We specialize in real estate and believe that we do the best and most economical tax returns in the city. We charge only a base $600 for a self-employed personal tax return plus $50 for the HST filing which includes one-half hour of bookkeeping time and another one-half hour of time to review general tax issues and tax planning. We also routinely claim 90-95% business usage for the auto expense which accurately reflects usage in real estate sales and we always claim a home-office deduction for every one of the 700 real estate agents who use our firm. Agents became home-based once TREB required them to subscribe for the full MLS service which agents now access from their home. This was THE MAJOR CHANGE in real estate sales in the last 10 years and something which CRA auditors do not understand. It converted the real estate profession to an essentially home-based profession.
We claim deductions accurately and legally but deduct every qualifying penny. We feel our expertise saves the average agent at least $2,500 to $3,000 in taxes compared to returns prepared by other firms. The 4 Toronto-area Tax Service Offices all set up “Real Estate Audit Teams” during 2008 to go on a full-out audit attack on real estate agents. A bad audit can result in up to 30% or more of your expenses being disallowed as a result of the militant and uninformed approach adopted by CRA auditors. You will be assessed with extra taxes payable plus interest and lose the HST Input-Tax-Credits on the disallowed expenses. The latter is particularly painful with HST now up to 13%. Our firm aims to preserve 90% to 95% or more of expenses claimed in tax filings IF the agents keep good books and records as discussed on our web-site. Lawyers draft tax legislation, understand the rules in the Income Tax Act when preparing returns and represent taxpayers when a tax appeal reaches the Federal Tax Court of Canada. If audited, get someone with legal experience to act as your agent on an audit. Fees incurred on tax audits and appeals are fully deductible. Our firm obtains excellent results.
“QUALIFYING EXPENSES UNDER S. 18 (1) OF THE INCOME TAX ACT - - THE “BUSINESS CONNECTION TEST”:
Subject to specific restrictions and limitations, the general rule for the deductibility of expenses to corporations or self-employed taxpayers is set out in s. 18 (1) of the Income Tax Act. Expenses are deductible if: “incurred by the taxpayer for the purpose of gaining or producing income”. This is referred to as the “business connection test”. The onus is on the taxpayer to show that any expense claimed was incurred to earn income. This is why you need to note names on gift, dinner and event receipts. If you fail to do so, you fail the ‘business connection test’ and the expense is disallowed. If you receive a CRA letter to produce “all bank records, an automobile logbook, ledgers and all receipts and vouchers for the 2012 and 2011 personal tax years” you are being audited. This audit is referred to as “current return and 1 year back”. Get advice at once and retain an agent to represent you. Money well spent.
Our firm has free computer spreadsheets available for download from our web-site for commission agents, fee-for-service taxpayers such as consultants, professionals and tradesmen and a third one for actors, performers and models. The first task in any bookkeeping is to distinguish between expenses with HST and those without. On the expense column sheets referred to, expenses not subject to HST are indicated with the second or middle column blacked out. This includes payments to banks, insurance companies, government bodies as well as those paid outside the country or for salary, casual labour and interest costs which do not include any HST. If you are audited on HST returns, Input-Tax-Credits (ITCs) claimed in an HST filing will be disqualified if there is no HST number on the invoice for services and HST was paid. This will happen even if the expense is clearly business-related. You will be punished since the business does not set up its invoice correctly. The CRA will adopt a strict application of the law but this is typical of the punitive and unfair positions taken by CRA auditors.
“S. 230 (1) OF THE INCOME TAX ACT - - “KEEPING ACCURATE BOOKS & RECORDS”:
This section of the ,ITA ,is entitled “Records & Books” and is a little antiquated - - a typical audit letter from the CRA will refer to the need to produce “ledgers” which shows how this request has no relevance in the modern era of computerized bookkeeping software. The section reads: “Every person carrying on business shall keep records and books of account in such form and containing such information as will enable the taxes payable under this Act that should have been deducted, held or collected to be determined.” Note that this requirement applies to personal and corporate income taxes as well as to payroll issues. There is a similar provision for collecting and remitting of HST which is governed by the ,Excise Tax Act. Note also that there is no reference in this general provision or anywhere else in the Income Tax Act to maintain an automobile log-book. [ See discussion below on deducting car expenses. ] For self-employed real estate agents - - referred to as “sole proprietors” or “independent contractors” - - revenues should be determined using invoices, trade record sheets and bank records. Expenses should be documented as to their nature and there should be proof of payment. In real estate, most brokers issue a T4A slip with a Box 20 amount for gross commissions and/or an annualized “Statement of Commissions & Expenses”. The latter should conform to the T4A slip in terms of gross commissions and will also show any commission split to the broker as per the standard agreement called an “Independent Contractor” agreement which was adopted by the real estate industry around 1986 when agents commenced going off employee status to self-employed status. That development resulted from an Ontario Court of Appeal (OCA ) decision wherein Justices of the OCA concluded that real estate agents ought never to have been on employee status since there were virtually none of the indicia of an employer-employee relationship. The Court said the real estate agents 1) did not work fixed hours, 2) did not work at a fixed location, 3) operated with little or no supervision from the broker, and 4) bought their own equipment such as cars and computers whereas these items were routinely provided by an employer in employment situations. A close look at these points made in the decision explains why many if not most agents working in the area of commercial real estate, when they might be in the broker’s office 6 hours or more each day, are still on payroll status. They are governed by the more punitive rules for deduction under Section 8 of the Income Tax Act as discussed above.
POINTS FOR KEEPING GOOD RECORDS AND PROTECTING YOURSELF IF AUDITED:
- Set up a business checking account and deposit all commissions, referral fees received from mortgage brokers and fees received for such as a tenant placement into a rental unit into the account. Do not mix any personal income such as from cashing an RRSP or selling shares or any personal expenses or activity into the account - - known as ‘commingling’ business and personal activity.
- Pay all business expenses out of the account. This would include all house expenses or rent if a tenant if you are claiming a home/office expense which is the case with 99% of self-employed agents. The amount of the home used for business will be indicated in the breakout between personal and business usage of your home in your personal tax return. Pay your spouse from this account if they are on payroll as an administrative assistant or to your children if they invoice at least monthly and pay them by cheque for casual labour.
- Have any overdraft privileges and any money drawn on a line-of-credit set up on this business checking account. This will allow you to claim all bank and interest charges as fully deductible since they are against an account wherein no personal expenditures are commingled. Arrange to receive your bank statements as you can also pull out all interest and service charges from the bank statement. Request copies of your cancelled cheques as invoices might be misplaced and the check can serve as proof of an expense. e.g., a check for $525 noted by you as paid to “The Printing House Circulars” will allow our firm to get the deduction on the basis that the nature of the expense and the name of the payee lead to the only reasonable conclusion that the expense was business-related.
- The CRA routinely requests the bank records for your `business’ and personal accounts on an audit. This is a new attack to purportedly identify undeclared income. We have to point out to CRA auditors that all payments made to agents go through your broker’s trust account and are totaled in a T4A slip and/or the broker’s annual statement. The request for the bank records for your personal accounts amounts to a CRA `fishing expedition’. If you have set up a business account as suggested here, we tell the CRA that we will not provide records on personal accounts as they are not relevant. We cannot adopt this strategy if you are running your commissions and expenses through a joint bank account set up with your spouse which includes or for any accounts which include ,personal expenses. You will complicate an audit and incur more time and cost if operating with a joint account or mixing personal items into your “business account’. More explaining to do.
- Document expenses thoroughly. The more proof, the better. If you use a credit card, keep the credit card `chit’ and cash register print-out if given. Note on the ‘chit’ or cash register tape the nature of the expense if it is a gift, business dinner, event or for any expense CAPABLE of being seen as personal in nature. The CRA will characterize as “personal” virtually every expense that could be seen as personal unless the business connection is noted. Also, the typical CRA auditor will attempt to disallow every expense where your only proof is a credit card statement. Our firm where get you gas, auto repairs and other obvious business-related expenses such as a payment to The Printing House if you have only credit card statements as proof of an expenditure. You WILL lose almost all other expenses as YOU will not be able to remember what the expense involved. That would include for flowers, gifts, dinners and anything of a personal nature.
- Get a credit card for your business account and then use that credit card exclusively for business expenses and use a second credit card exclusively for personal expenditures. CRA auditors will always try and argue agents are trying to run personal expenses such as wardrobe, gifts and dinners through the Business Statement. This challenge can be rebutted by providing the credit card statements for the card used for personal usage and showing those types of personal expenditures in those credit card statements. This will knock the wind out of the CRA auditor who says that personal expenses are being disguised as business-related.
- Get into good record-keeping habits. This will allow you to claim every possible cent in your Business Statement and get you good results on an audit. Bad record-keeping will lose you a lot of money on an audit and turn the audit experience, which is inconvenient and time-consuming at best, into a financial nightmare.
- The general rule is that the better, if not meticulous, proof of business expenses you keep, the better your expenses will hold up to challenge on an audit. The goal of CRA auditors is to attempt to disallow 30% or more of expenses claimed as non-deductible by reducing the business proportion of auto usage, unfairly disallowing the home/office deduction and disqualifying as many expenses as possible as “personal” or “not connected to business”. A tax grab mentality. Keep good records and aim to get from 95% to 100% of your expenses if audited. Full-time agents who want to deduct 90% and higher for vehicle usage and avoid having to keep hand-prepared auto logbooks as provided by the CRA should subscribe for the Odotrack ,GPS computerized logbook service as discussed in our Bulletin “Motor Vehicle and Home-Office Deductions”.
GO TO OUR BULLETIN FOR THE AUTOMOBILE AND HOME-OFFICE DEDUCTION. ,WITH THE CRA NOW FORMALLY ,REQUIRING AN AUTO LOGBOOK, AGENTS FACE GETTING ,A MAXIMUM OF ONLY 75% BUSINESS USAGE AND LESS ABSENT A LOGBOOK. THE NEW LOGBOOK RULES WILL INCREASE THE NUMBER OF CRA AUDITS. NO LOGBOOK EQUALS A, BIG REDUCTION OF AUTO BUSINESS USAGE. AGENTS WITH A COMPUTERIZED LOGBOOK CAN USE THE NEW RULES TO GET 90% AND MORE AUTO DEDUCTIBILTY WHILE THE CRA WILL HAVE NO GROUNDS TO REDUCE VEHICLE EXPENSES CLAIMED. READ IT !!!
CRA REASONS FOR DISALLOWING EXPENSES AND ADDING INCOME
Since the “business connection” limitation on expenses as set out in s.18 (1) of the ITA is general in nature, CRA auditors will cite general reasons for disallowing expenses. Auditors are often militant, unreasonable and unfair. Auditors are often unfamiliar with trade and industry practices for real estate agents. They do not know the difference between an `agent’ open house versus a `public’ open house. Reasons cited for disallowing expenses include:
- “personal in nature”. Any gifts, dinner and event expenses or purchases of flowers will be characterized as personal unless you notate the name of the client and, preferably, an address if a vendor or purchaser or even an address where an offer was made. Generally, CRA auditors will characterize as personal anything capable of being viewed as personal in nature.
- “insufficiently documented” and/or “no proof of payment”. You need an invoice with a clear description of the type of product or service with a clear indication that payment was made. Credit card statements are not sufficient proof of an expense but since basic reasonableness is required of auditors our firm will always get the amounts for gas and car repairs but you are in jeopardy of losing the other expenses on credit card statements that are not backed up by the original credit card `chit’ or an invoice. Keep the credit card `chit’ and/or the cash register tape and note the nature of the expense and notate a name if the expense is a gift, business dinner or event expense. Your credit card statement should be only a fall-back or secondary form of documentation of expenses.
- A new attack based by CRA auditors being a variation of “insufficiently documented” relates to paying a business expense via automatic bank payments for such as car or computer lease expenses, your cell-phone and internet expense for Bell or Rogers, monthly car insurance, monthly flat-fee flyer printing and distribution etc. Keep the original contract and connect it to the automatic debit on your bank statement. CRA auditors will play stupid and say that the short notation that routinely appears in your bank statement is not sufficiently clear to conclude that it is business expense. This disgraceful practice is becoming more common on the part of auditors. Auditors will try and argue that expenses are not clearly of a business nature. Insist that the expense IS business-related. So deduct, don’t blink and fight for every expense.
- “not clearly connected to business”. This is a variation of the previous reason. It can involve an invoice or automatic bank payments. Where auditors can note that an expense is not clearly of a business nature - - the implication being it is capable of being viewed as personal in nature - - they will conclude it is personal in nature. This is common with such expenses as furniture for ‘dressing/staging’ of client homes or a chair bought for usage in your home-office area. Do not let an auditor bully you out of a deduction.
- They will try to disallow a home-office expense in virtually every audit by contriving reasons like “space is provided at the broker’s office” or, the legally incorrect excuse that “the agent has not given proof that they meet clients at their home on a regular basis”. [ Re-read the points which we made on this issue in our Bulletin “Motor Vehicle and Home-Office Deductions”. Our firm has never lost the home- office deduction in over 24 years of representing real estate agents on CRA audits. ]
- CRA auditors will propose to reduce the business proportion of car usage by 20-30% or more based on your failure to provide an automobile log-book. Claim 90-95% business usage and be prepared to concede only 5% of business usage on an audit. In many cases where we get only 75% business usage on an audit, we appeal and the appeal officers are more receptive to raising the business proportion to 85% to close the appeal.
- CRA auditors will ask for 12 monthly bank statements for all of you and your spouse’s bank accounts. If you have been commingling business and personal expenses within or between accounts, they will track the deposit of your real estate commissions then ask you to explain deposits of over $1,000 for ALL of your other accounts. There is usually an innocent explanation as a lot of deposits into your main business account will be mere bank transfers into the account to allow you to pay business expenses. We have had fights with CRA auditors saying that the record-keeping section of the ITA - - s.230 (1) -- does not require you to track personal transactions that do not relate to business. We usually get all transactions explained but it is time-consuming and exasperating. Where agents have set up a dedicated checking account with a related business-dedicated credit card, when the auditors ask for bank statements for all accounts we tell them that we will ONLY provide the 12 bank and credit card statements related to business. We are lawyers so they whine to us that their Team Leader has instructed them to request all other bank statements and when we tell them to go fish, they drop the request. DO NOT provide to auditors any records that do not relate to business. They can only audit the current and 2 prior tax years. Give them no records for any tax years prior to that. Go fish!!!! You must keep your business records for 6 years back but that does not mean you are going to give them records for anything before the last 3 tax filings. Auditors are bullies. Bully them back.
HEADINGS IN OUR COLUMN SHEET FOR SELF-EMPLOYED AGENTS:
Expenses for real estate agents on the spreadsheet are discussed below by reference to the number for the specific heading on the sheet:
- [ THIS ENTRY IS FOR “COMMISSIONS” ]
- BROKER ADMINISTRATION FEES. This is a `basket' heading. It includes all monthly fees, desk fees or any other charges. Break out the broker split of commissions if it is included in Gross Income in a T4A slip in Box 20 as we have discussed several times and do the same if the annualized statement of commissions earned in the year shows the full 100% of commissions before breaking out the contractual portion of commissions due to the broker. Always deduct any ‘pass-through’ expenses billed to you by the broker. The broker may incur expenses on behalf of an agent such as a major newspaper advertising then `pass through’ the agent’s share of that expense. This will be the case for every expense paid by the broker on the agent’s behalf and will show on the industry standard annualized “Statement of Commission and Expenses” prepared by virtually every broker. Keep the amount in the broker statement under this heading and DO NOT break it out to the headings number 3 and on. Our firm enters the expense under “Realty Broker Administration Fees” and uses the specific amount noted by the broker as paid for HST since the broker statement will include a mixture of expenses some of which are subject to HST and expenses not subject to HST. Examples of the latter include E.& O Insurance, Provincial Licence Fees and any interest costs such as fees charged by the broker if they advance money on commissions. The rule is that the broker statement serves as your receipt for any ‘pass-through expenses as they are always clearly laid out and totalled so leave the figures for the total for expenses paid and HST paid intact and do not break any expense out to the other headings. Note that this method is much simpler than breaking an expense out to one of the specific headings below which will confuse your preparer and any CRA auditor.
- ACCOUNTING & LEGAL FEES. Include all professional fees including bookkeeping, tax preparation fees, CRA audit and appeal fees and legal fees where a lawyer’s opinion might be needed on the legal aspect of a sale. This occurs on complex issues such as how to allocate HST payable when involved in the sale of a “divided-usage” asset such as a property zoned and used for both commercial and residential purposes. The residential component is exempt from HST. This might include a mortgage discharge fee paid by you at the request of a client but such an expense could as easily be entered under the “Advertising, Promotion & Gift” heading. Do not agonize over semantics. Put it in a heading that is comfortable for you but do not make the mistake of putting an expense like a business dinner or event under the advertising heading at full deductibility when the ITA at s. 67.1 (1) limits such expenses to 50% deductibility. [ See the discussion on the Stapley decision under the dinner/event heading where gift certificates to restaurants were limited to 50% deductibility.] Professional fees paid for audits and appeals at CRA Tax Service Offices or for full appeals to the Federal Tax Court if you are so unlucky to end up there may be deducted under this heading and you will recoup the 13% HST paid for those fees. Taxpayers who are not self-employed must deduct such expenses at Line 232 of their personal tax return under “Other Deductions” and the specific heading “Legal and Accounting Fees” and they will not recover HST.
- ADVERTISING, PROMOTION, GIFTS. This a very general type of expense and give yourself wide latitude in entering an expenditure under this heading. Any expense is fully deductible. This expense heading should include all promotional expenses such as newspaper and other advertising, circulars, gifts including cash gifts, giveaway items and distribution costs paid by you to third parties other than the broker. [ See the discussion on “Referral Fees” below. ] You should put names on all gift, dinner and event expenses to make the `business connection’ and do it when you incur your expense. If you don’t do so and get audited, you will have to rebuild the names from your diary and trade record sheets to enter on the receipt before submitting your receipts and vouchers to the auditor. The rule is, no name, no deduction. Our firm recommends, in the name of thoroughness, that you also note an address such as that of the property sold, property bought or even a property on which a failed offer was made. Every extra detail helps. If you pay a client rebate from a commission that is FULLY declared in your Gross Income, but agreed to prior to close, enter the client rebate as “Client Rebate” as a business deduction and do not pay nor deduct HST. Again, you can only deduct it if it is included in the T4A slip Box 20 and/or in the annual summary of commissions provided by your broker.
A common expense, not understood by CRA auditors, is that for “dressing or staging”. This relates to purchases and such as storage and moving/cartage costs for items to be placed in more expensive homes to `dress them up’ to be more presentable to purchasers. If you buy furniture, rugs, carpets, art etc., any item over $500 should be capitalized under our expense heading # 24 to Class 8 for “Equipment & Furniture”. For purchases under $500 enter them under this advertising/promotional heading for full deductibility. Any cartage costs for these items, to and from your home or rented storage space, even if for more than $500, should be entered here for full deductibility.
- CONVENTIONS, SEMINARS, TRAINING. The general rule on the part of the CRA which we believe is reasonable restricts an agent to 2 conventions per fiscal year. The costs of the RECO Continuing Education courses is not caught by that restriction and those costs may be entered here and are fully deductible. Often the broker pays for those courses and passes the cost through to the agent in which case it will be included in the “Real Estate Broker Administration Fee” under expense heading 2. Deduct under this heading the costs of any of those courses that YOU pay which would always be the case for such courses taken by you on the internet. Regarding conventions, pick the better ones held in Vancouver or Los Angeles if your international broker or an international real estate body is putting it on. You can get the convention deduction plus airfare, hotel and one-half of your own dinners as a deduction. Note your own meals during a conference are better entered under our expense heading 14 “Travel Dinners” which includes your meals when you are more than 12 hours away from your “regular place of business” which we interpret as travelling outside the GTA area overnight. If you attend a conference in Vancouver and then take a 1-week side-trip to Whistler, keep the receipts for the side-trip for the rental car, hotel, meals etc. to show a CRA auditor that you did NOT deduct them in your return as they were personal in nature. Have fun with the limitation. Special real estate training courses offered by such as “ Robbins”, “Hobbs/Herder” or any other sales training courses go here. We have gotten payments of from $10,000 to $25,000 here for our clients. On audit the CRA will try to invoke s. 67 of the ITA which gives a general discretion to disallow an expense as not “reasonable in the circumstances” and try to disallow the expense as TOO HIGH!!!!! This is contrary to the correct legal position and defies common sense. The CRA can use the s. 67 test to challenge almost any large expenditure but since these sales training seminar expenses are incurred for business and are customized expressly for the real estate industry we have NEVER lost this expense on a CRA audit. We make the argument that since they are customized for real estate that they meet the “business connection test” and the size of the expenditure is irrelevant. We are usually able to show to the CRA that there was a substantial increase in commissions in subsequent years which shows that it was money well spent. We have also succeeded in preserving these large expenditures by arguing that they are part of “trade and industry practice” and specially tailored for real estate agents.
- DELIVERY, COURIER, TAXIS. This heading is self-explanatory. Note the business connection on the receipt such as “Delivery of Agreement of Purchase and Sale for Signing” etc. Again, every extra detail helps.
- DUES ( TREB, OREA ETC.) and any other professional organization fees which include HST. Leave these expenses under “Broker Administrative Fees” if paid by the broker and billed to you. Recreational club membership fees including curling, health clubs and golf fees are strictly disallowed. You can deduct visitor green fees and business dinners at your golf club subject to the 50% rule if you keep clear itemized records of such expenses.
- ENTERTAINMENT & MEALS: AT 100%. Enter the full amount of each of these expenses in the appropriate column. The spreadsheet will then break out 50% of the HST component as a cash credit in the form of an In-Put Tax Credit (ITC) in your HST filing. The reminder of the expense including the ,½ of the HST expense not claimed as an ITC is then halved for deduction purposes in your tax return. ( In other words the column sheet `adds back’ in to the expense the HST not claimed for refund purposes in your HST remittance.) The costs of business dinners, cultural and sports events and groceries and drinks bought for open houses have been restricted to 50% deductibility since Feb. 22, 1994 under S. 67.1 (1) of the ITA. The Stapley decision of February 2006 ruled that gift certificates to restaurants and events were caught by this provision and subject to the 50% deductibility limitation. Give gift certificates to Home Depot or the Bay but avoid those for restaurants or events. The CRA has not yet tried to apply the s. 67.1 (1) limitation to LCBO or BEER Store purchases if gifted to a client so continue to enter those expenses under heading #4 as “Gifts” for a full deduction. NOTE: the ‘business connection’ test requires all employed and self-employed agents to put a name and address - - where bought, sold or an offer tendered - - on all dinner, event and gift items. Make the notation on the credit card chit and/or invoice from the venue, store or restaurant at the time of purchase to be smart. If you do not and are audited, you will have to engage in that exercise relying on your diary, trade record sheets and memory which can be a grueling task.
- EQUIPMENT RENTAL/SHORT-TERM AUTO. For such expenses as leases of computers, faxes, phone systems, furniture and other equipment used directly in the course of your business. Short-term car rentals- - a day up to a month or more - - may be deducted in their entirety so long as the vehicle was needed to continue your real estate sales.
- OFFICE SUPPLIES, POSTAGE ETC Again, a `basket' category which includes all expenses connected to such supplies e.g., computer, software, furniture and equipment expenditures under $500 for which you get full deductibility. With a capital expenditure - - items over $500 - - you deduct half of the normal rate in the year of purchase, known as the “half-year rule”. To illustrate, a $3,000 Class 10 computer purchase with a rate of 30% for that class will give you only a $450 Capital Cost Allowance deduction in that year - - ,½ of 30% of the cost. Thus $450 of the $3,000 in the first year then 30% of $2,550 or $765 in the next year, then 30% of $1,785 in year three etc. This is an example of the “declining balance basis” used under depreciation rules for capital expenditures.
- PARKING AND 407 FEES. ,Are 100% deductible. This includes single parking fees, business parking paid on a monthly basis at your broker’s place of business, or for Highway 407 usage related to business. Remember our rule that agents are at work 24/7. Be aggressive. Residential tenants who pay a segregated parking cost should pull that amount form the amount for residential rent entered for the "Home/Office" calculation and enter it in the detailed auto calculation headed “Parking - Apartment”. This will give you a 90 to 95% deduction under the auto heading versus a 20% deduction if one-fifth of your apartments is used for business under the home-office calculation. Downtown apartment parking can be $100 to $125 per month but it will be ‘buried’ in your rent payment. Break it out and enter it under the area for vehicle deduction. NOTE: Parking tickets or moving violation costs have not been deductible since May of 2004 after the Income Tax Act was expressly changed to prohibit deductibility on such fines and penalties even if incurred in the “course of earning income”.
- SUBCONTRACT & CONSULTING FEES. These include payments to anyone doing business and charging HST. It includes invoiced services such as the `computer guy', a promotion/advertising consultant and even a fellow agent who bills you for covering an open house or whom you pay when a commission is split and the full amount is declared in your Gross Commissions. We enter the latter as a “Sub-Commission” in the tax return which signifies that you made a payment to another agent. Enter the amount split out of your gross commissions and paid to the other agent by you and claim the HST on the sub-commission as an Input-Tax-Credit.
- TEL., CELLULAR, INTERNET, PAGER, HOME L.D. Segregate out the business long distance charges on your home phone and claim the full cost of fax/internet and dedicated business lines. The basic cost of your first residential telephone land-line is deemed to be for personal usage and thus non-deductible. We feel this position is reasonable. Our firm deducts a figure of $30 a month or $360 a year from the annual total for telephone as a ‘tip of the hat’ to this position on the part of the CRA. Any extra features such as call forwarding or second lines plus the full internet costs - - essential to use the MLS service - - and business long distance are deductible. Some agents rely solely on their cell-phones and have no telephone at home they are probably unmarried with no children - - and can safely argue their full telephone costs are deductible and any personal usage is inconsequential for an agent working 60- to 80-hour weeks in real estate. As a general rule, our firm deducts 100% of cellphone charges on the basis that any personal use of the cell is inconsequential in the context that ages are on their for hours each day conducting business.
- TRAVEL: 100% OF MEALS. You must be 12 hours from your "regular place of business" such as the GTA. This expense refers to your own cost of dining. You need not be with a client. Enter the full amount in this column and the software will break out ,½ of the HST as an ITC and limit deductibility to 50% as with business dinners and events.
- TRAVEL: 100% HOTEL/FARES/CLEANING. As above, you must be 12 hours away from the GTA - - the CRA usually expects you to be away overnight - - but these expenses are fully deductible. The costs of your two allowed conventions each year should not be entered here. Deduct air fares, hotels, car rentals where you are out of the GTA - - Hong Kong or London, England or even London, Ontario will do - - if you stay overnight to meet with clients or scout for rental properties and homes suitable for purchase by your clients as their residence. Note the purpose of the trip in your diary to make the “business connection”.
- You can modify this box for other HST-Included Expenses. Enter anything not expressly covered elsewhere but keep records and name the box so that you, your tax preparer and a CRA auditor will see the business nature of the expense. If you pay regular sub-commissions to a partner or adult child who is licenced in real estate and to whom you pay regular percentages of commissions, this line should be titled “Sub-Commissions” and used for that purpose. Remember to go to the columns on the right and put the title “Sub-Commissions” in the top box.
- INTEREST & BANK CHARGES. No HST here. Where you have set up a business checking account and draw on lines-of-credit directly into the account to ensure full deductibility. Deduct such all bank service charges/fees and over-draft interest costs. This is also the column where you should enter all fees and interest charged on brokered commissions - - where you borrow on a future commission. The black box on columns 17 through 21 show that there is no HST in these expense headings. Do not commingle business expenses in a separate account from your primary chequing account or pay for expenses out of a joint account with your spouse. The CRA will disallow the entire interest cost as ”commingled with personal banking”. You then have a fight as to what percentage of interest relates to business expenses paid out that account. Further reason to set up a dedicated business account matched with a dedicated credit card used exclusively for business expenses.
- E. & O. , INS., ,LICENCES. No HST here. Enter here if you pay these expenses directly where they are not paid by your broker and billed to you. It covers professional liability insurance, errors and omissions, RECO or other licences. Do not include life insurance premiums since they are not deductible. Also, do not claim disability income replacement premiums or the latter will be taxable if you claim under the policy. They remain tax-free if you do not deduct the premium.
- PRIVATE HEALTH PREMIUMS. No HST here. Any taxpayer for whom gross commissions make up 90% of working revenue - - that does not usually include part-time agents - - can deduct the full cost of individual or family private health premiums such as Blue Cross and including any travel health insurance during the year. This can provide up to 46.4% tax savings to the highest earners. The medical schedule disqualifies an amount equal to 3% of Net Income in their personal tax return then gives tax savings at less than 21% on the balance. This 1998 change was a huge tax-saver for high earners and CRA auditors are often not aware of this rule even though it has been in place for 10 years. Send the auditor to our web-site and refer them to S. 118.2 (2) (q) of the Income Tax Act if they threaten to disallow it. It is deductible as a current expenditure in your Business Statement.
- REFERRAL FEES. No HST here. These are fees paid to persons not registered as agents. The province says you ought not to pay them but the Income Tax Act is federal and they are seen as deductible by the CRA if they are both “documented and receipted”. Keep a two-sentence standardized invoice for such payments or get a full and formal receipt on payment clearly showing the purpose of the payment. Our firm moves these fees from Line 20 in the column sheet up to Line 4 under the advertising, promotion heading in tax returns to avoid using the term “Referral Fee” in a tax return. The use of that term might attract CRA attention as they will jump on that type of expense and require strict proof of a connection to business and strict proof of payment.
- SALARIES, PAYROLL/CASUAL LABOUR. No HST here. Spouses providing administrative support must be put on payroll with deductions for tax and CPP premiums but not for EI. Your cost here is the gross pay made to a spouse or other employee PLUS your matching share of the CPP as an employer AND the matching EI premium if paid to someone other than a spouse such as a full-time administrative assistant. Children working more than 15 hours a week for you should be put on payroll with taxes and CPP withheld plus EI premiums if they are 18 or older. You match CPP equally and pay 1.4 times the employee’s EI premium payable. For your children working less than 15 hours a week, they may be paid on a “Casual Labour: basis which means no HST. They should give you a detailed monthly invoice identifying dates and hours worked and the rate of pay. It is recommended that you pay them by cheque or get a full formal receipt if you pay cash. Payments to family members are scrutinized more closely by the CRA. Dealings must meet the `business efficacy test’. You must pay them on a Fair-Market-Value basis for services rendered and in the same manner that you would deal with a third party. So for casual labour payments with family members or strangers, the rule is a detailed invoice and a formal receipt if paid by cash and a cancelled check if paid by check. You make payroll remittances by the ,15th ,of the each month for the prior month using your Business Number. You match the CPP and pay 1.4 times EI premiums payable for your children or third parties. No HST is charged on salaries and payroll costs. The test for "employment status" is generally 1) work provided for fixed hours on a regular basis; 2) at a fixed location; 3) with equipment such as computers and desks provided by the employer; and, 4) a level of supervision and delegation of tasks. If your spouse is not put on payroll you will face an outright disallowance of payments to the spouse.
- DETAILED VEHICLE EXPENSES. This has always been the most contentious issue on audit and the rules have been dramatically changed with recent developments. Our Bulletin on the auto and home-office deduction shows that there are entirely new ground-rules since the CRA announced that maintaining an auto logbook is mandatory. Read it again. The CRA is hoping that 95% of agents will be too lazy to maintain the manual logbook designed by the CRA. With 75% being the maximum business driving allowed by the CRA when you have no logbook, only the very highest-earning agents will get that figure. Those with commissions above $400,000 will get 75%, those in the $150,000 to $400,000 range will get 65% while lower earners might get only 55% business driving. The point is that the CRA is on the verge of setting up a punitive downward sliding scale for business driving. Agents should not let this happen. Agents can go on the offensive by getting the computerized GPS logbook program provided by Odotrack and for which the cost is fully deductible. Go to their web-site at odotrack.ca. You will set yourself up for claiming an unchallengeable 90% or more business proportion of driving. Your data is saved on a server and you can push a button and print out a detailed list of 5,000 trips or more, business and personal, in a year if a CRA auditor is dumb enough to ask for a detailed breakdown of driving.
Your vehicle deduction carries over from the “Detailed Vehicle Expenses" summary in your T2125 Business Statement and includes gas & oil, repairs, washes, CAA fees, lease costs and depreciation on owned vehicles. Keep all receipts including the credit card ‘chit’ for gas purchases and repairs. Remember that a typical audit is frequently referred to as a “receipts and vouchers” review. Claim the full amount of vehicle HST as an Input-Tax-Credit if you drive 90% or more business and the actual proportion of HST if less than 90%. This is the “90% equals 100% rule”. Note that car insurance and license costs do not include HST. They along with the interest on car loans are deductible depending on the business proportion of driving.
Canada Revenue Agency auditors will now demand production of the CRA-prescribed automobile logbook. The very few real estate agent clients who use our firm and keep a log-book routinely do about 90% and up to about 95% or more business usage from their log entries. Our firm will go up to 95%, and occasionally higher, for high-earning agents.
The WATT case of the ,Federal Tax Court, was an appeal from an audit where only 10% of vehicle usage was allowed expressly because no auto to logbook was provided. The appellant got no increase on appeal and the Justice ruled that “the taxpayer could have easily logged any business driving.” The Justice in this case stated that any taxpayer who wanted more than 75% business driving had the onus to keep an auto logbook. This was a terrible decision. The reality in Watt was that the taxpayer was an employee with only a small side-line consulting business with ONLY 2 clients. Of course this taxpayer could log his business driving. This is not true of real estate agents who might do 5,000 car trips in a year. Neither audit officers nor Justices understand how much driving is done by real estate agents.
The October 2010 announcement by the CRA that formal ,auto logbooks ,are required as of January 1, 2009 makes all of the case law moot. The new reality is that any agent seeking to claim more than 75% business driving needs to maintain an auto logbook. Our firm urges all agents to get a computerized logbook program and we routinely claims 90% to 95% business usage of the vehicle if the real estate agent has two or more vehicles at home, doesn’t golf or ski, does not have access to a cottage and explains to us that they work long hours seven days a week. We know that only 1 in 50 agents will get audited annually - - this figure will rise with the new logbook rule - - ,as the Audit Divisions have small staffs. If an auditor drops the business usage down to 75% or lower, our firm usually gets that figure back up to 85% to 90% from a CRA appeals officer on an internal appeal within the CRA. Appeals officers will disregard the logbook requirement and are more receptive to strong evidence of extensive business driving and they allow a higher proportion to close the file. Those with computerized systems will get every percentage point of business driving and the auto expense will be virtually unchallengeable by the CRA.
An example of “deduct and don’t blink if challenged” is our firm’s practice of deducting 90% to 95% business driving on the agent’s primary car and a high percentage on a second luxury vehicle used when soliciting a listing from owners of the most expensive homes. The proportion of business usage is based on distance driven - - a “usage test”. If the Mercedes used for special appointments is driven only 3,000 km. a year and 2,400 km. relates to business, claim 80% business usage. Log the driving of both vehicles. If the agent uses the less expensive car to the bulk of business driving, we will go 90% to 95% on that primary vehicle. Note that if you have a spouse on payroll as an administrative assistant, you should put the spouse’s car in your name and pay all of the purchase and operating expenses. Our firm will then deduct the business driving on the assistant’s car in YOUR business statement where you might save at your higher tax brackets of 43.1% and 46.4%. We do this with many of our high-performing agents and have maintained the deduction on audit. Keep in mind that it is common on an audit to have to explain basic real estate trade and industry practices to CRA auditors. Most auditors do not know the difference between an `agent’ open house versus a ‘public’ open house, ,that groceries need to be purchased for open houses and what “dressing and staging fees” are.
- - 32 ,CAPITAL PURCHASES. Also known as capital expenditures. Claim the HST on up to $30,000 of car value in the period acquired. If starting self-employment, claim the HST on the Fair-Market-Value (FMV) of the car at commencement of self-employed activity. Use the Undepreciated Capital Cost (UCC) as an acquisition figure if moving from employee usage to self-employed activity. For items costing less than $500 including taxes, we enter them as fully deductible under the “Office Supplies” heading. This threshold we use has always been accepted by CRA auditors. If starting self-employment, use the FMV of computers, software and office equipment such as printers, faxes, telephones, furniture and decorations used in the area of the home used exclusively for business. Once starting self-employment enter the exact cost on the invoice and the exact HST paid as shown in the invoice. So, use actual invoices to get the exact HST to be claimed as an Input-Tax-Credit in your HST filing. In other, words, do not use the “Simplified Method” for capital purchases which breaks HST out at 11.504% of the total cost.
- OFFICE-IN-HOME. Our bulletin on the auto and home-office deductions shows that the CRA must now acknowledge that EVERY agent gets the home-office deduction since, with industry changes, the home is “the primary place of business”., The home-office deduction is an area where CRA auditors demonstrate that they are not sufficiently well-trained to understand common trade and industry practices in the real estate industry. It has been our experience that CRA auditors will seek to contrive a reason to disallow the home-office expense without ,understanding what the correct law is for deductibility of this expense. Too often we have seen auditors, without ever speaking to the agent or the agent’s broker, disallow this expense by citing “space for office usage is provided by the broker” or no evidence has been provided that “the taxpayer fails to meet clients at their home on a regular basis”. The first reason involves disallowing the expense without seeking evidence to support it and is unprofessional. The second ,reason ,relating to ,“fails to meet clients” demonstrates incompetence since 1) they are not familiar with the practice in real estate sales; 2) they have failed to obtain evidence to support the position AND 3) that they are ignorant of the correct law. The requirement to meet clients at your home on a regular basis applies to those taxpayers who pay commercial rent to a landlord AND who, additionally want to claim a home-office deduction - - what we call the “lawyer- doctor rule”. This is set out in s. 18 (12) (a) (ii) of the ,Income Tax Act. For self-employed real estate agents, even if they pay their broker for inside segregated space, they have an automatic right to claim a home-office expense if the home is used as their “primary place of business”. That is the correct law and is set out in s. 18 (12) (a) (i) of the ITA. The movement to a home-based industry is directly related to the change by TREB and other real estate boards around the year 2000 which required all registered agents to subscribe and pay for the MLS service. That service was previously only provided to the broker and explained the line-up of agents at computer terminals at the broker’s office. CRA auditors are unaware of the change made by TREB as regards the MLS service being charged to EVERY agent and that all agents have set up this service from their home computer. Agents can deduct a home-office using a room-by-room basis or square footage basis for areas in the home used exclusively for business. [ Do not have a guest bed or television in the room you might claim for this deduction.]
Since agents are hooked up to MLS at home and use it through-out the day, book appointments from home, keep their business records, computers, equipment and furniture in their office area, do administration, correspondence and bookkeeping at home including doing their banking from home, it is clear that the home is the “primary place of business”. Both the automobile and home-office deduction are governed by the “usage test”. You must give evidence of usage with a logbook and describe what tasks are performed at home to get the home-office deduction. Today, brokers only want the agents in the office if they are dropping off a signed offer. Explain all of ,this to a CRA auditor. In over 26 years, our firm has never lost the home-office deduction on a CRA audit. It amounts to a common sense deduction.
On the “Simplified Method” you are entitled to claim the business proportion of HST paid as an Input- Tax-Credit on home utilities, repairs, landscape and yard maintenance. You cannot claim it on condo fees. You can claim a home/office expense and even rent out part of your home so long as such “incidental business usage’ of the home does not exceed 49% of the floor-space. The general rule is that so long as a home is used “primarily” for personal purposes - - read 51% of the floor-space - - the gain on sale of the home is completely exempt under the Principal Residence Exemption (PRE). A caution. The PRE is lost on any proportion of the home on which brick or frame depreciation is claimed against gross rents or in a home/office calculation in a self-employed statement. The rule is thus NEVER claim brick or frame depreciation on any portion of your home used as an office or rented out to a tenant.
3. AUDITS AND APPEALS
If you keep good records, you are ready for an audit. The CRA can only reassess tax returns up to 3 years from the date of the original assessment. They can re-open returns more than 3 years after the date of an assessment if there is proof of “carelessness” in the more recent returns being reviewed. Our firm has never had the CRA open statute-barred returns beyond the three years in our 26 years of handling ,audits. We shout louder than they shout. There is a detailed discussion below in the section “III. GENERAL DISCUSSIONS ON REAL ESTATE” on how, in 2013,, the Canada Revenue Agency is now trying to circumvent the 3-year limitation rule.
The rule for deductibility is general in that an expense must be incurred for earning income. CRA auditors thus use general reasons, as discussed in detail above, ,for disallowing expenses. Auditors are pressured by their Team Leaders and department heads to disallow expenses to assess for more taxable income - - a crude form of a `tax grab’. The other point about CRA auditors is that most have never practiced public accounting which includes preparing financial statements and preparing corporate and personal tax returns. Many CRA auditors also have only little or no formal training in accounting or even bookkeeping courses. The end result is that these auditors have no real understanding of the realities of operating a business. About 99% of CRA auditors do not have even a rudimentary understanding of trade and industry practices in real estate sales. If audited print out our detailed discussion of the expense headings relating to our spreadsheet and insist that the auditor read it before commencing their audit.
CRA auditors will, typically, try to disallow about 30% and more of your expenses for the 2 tax years being reviewed - - usually the most recent tax filing plus the prior year filing called a “review of the current return and one year back”. By auditing 10 agents for the 2 most recent years rather than 7 agents for 3 years, auditors avoid the risk of the 3-year limitation period for reassessing returns expiring. Aim to maintain 95% of expenses or more and keeping good ,records guarantees that result. The onus is on you to relate expenses to the earning of income. That means names on gift and business dinner or event expenses to meet the ”business connection” test. A CRA audit could lead to three results. The first result involves the disallowance of expenses and addition of undeclared income which results in you being reassessed with a higher net income in the tax year(s). You will be reassessed for additional taxes and interest payable based on the 4 tax brackets for personal tax filings. For example, a taxpayer already at $150,000 net self-employed income before being reassessed for a higher net income as a result of a substantial disallowance of expenses will pay 46.4% on the additional income plus interest at the rate of prime plus 4% which rate is prescribed quarterly by the CRA. The second consequence of an audit is that you may be reassessed penalties of up to 50%, upon which interest will be added, if there is a finding that you “knowingly filed a false return”. ,The penalties are in addition to reassessed tax payable. The third scenario, is a finding by the CRA that you have filed a “false or deceptive return” which can include deliberate non-declaration of income, destroying or altering records, making false or deceptive entries all for the purpose of evading taxes., You might face prosecution in the criminal courts under Section 239 (1) of the ITA ,and, if found guilty beyond a reasonable doubt, face penalties of from 50% to 200% of the tax evaded and up to 2 years in jail. [ See our extensive discussion on penalties below. ]
You should give CRA auditors only documents specifically requested although you cannot be seen to obstruct them. A fine line. This explains the earlier detailed discussion on maintaining a separate business checking account into which all commissions should be deposited and all business-related expenses paid. Never let them interfere with your business operations. You can insist that they review your receipts and vouchers at the office of your tax preparer or authorized agent. Our firm has two areas reserved for usage by CRA auditors reviewing taxpayer records. If you use our computerized spreadsheet, the auditors will compare the expense receipts and vouchers to your column entries which you can print out from the software. At a minimum, CRA auditors will insist on calculator tapes attached to each batch of expenses such as gas, office supplies, business dinners, advertising and promotion etc. If you fail to use a spreadsheet or calculator with a tape when you total your expenses annually, you will have to enter them in the column sheet or provide calculator tapes for each expense heading if audited. CRA auditors will not accept expense receipts which are not totalled in one of the two ways described. This is reasonable as they should not be expected to do your bookkeeping for you. You do not need to keep ledgers. That is an old term from the age before computers. Only registered charities and publicly-listed companies need records and returns prepared and audited by CA firms.
Keep business records for 6 years. Retain and authorize a professional agent to act on your behalf on a CRA audit. The CRA can audit a return only up to 3 years from the date of an assessment unless you sign a document waiving the 3-year limitation. NEVER sign that document unless you obtain professional advice to do so. Lacking a waiver, the CRA can go beyond the 3 years only in cases of non-declaration of income, falsified expenses or of "misrepresentation" which may include carelessness. You need not and should not talk to a CRA auditor. You are allowed to be represented exclusively by your authorized agent. If you chat with an auditor, we guarantee that statements about driving habits, hobbies, business practices, etc. will commonly be interpreted prejudicially to you. You will be asked to produce an auto logbook and we have had enough discussion about how to attack that requirement. Any full-time agent who does not get a system like Odotrack is unwise. They will cost themselves money by, unnecessarily, going conservative on business driving and still have their figure reduced on audit which means thousands of dollars down the toilet.
You will be asked to produce receipts/vouchers - - categorized and totalled - - for all items on the T2125 “business statement” on your tax return. Self-employed agents who have a room OR area used exclusively for business get a home/office expense as of right. Your home simply needs to be your “primary place of business”. Again, see the discussion on the home-office expenses for real estate agents which is expense heading #33, or even better, read our Bulletin entitled “Motor Vehicle Deduction” listed separately on our website under newsletters and bulletins. The requirement to meet clients at home on a “regular basis” only applies to self-employed taxpayers who pay commercial rent and want to take an additional home/ office expense.
PENALTIES ON AUDITS
The worst case scenarios for the worst of the tax cheats or even those too lazy to file on time, are the various penalty provisions in the ITA. In the last few years, the CRA has taken to prosecuting, in the criminal courts, taxpayers who have not filed personal, corporate and HST returns. The more grave situations relate to those who engage in falsification of records or the filing of a false tax return. ,Section 239 (1) of the ITA involves knowingly filing a false return and will get you in the criminal courts on a summary conviction charge and subject you to fines of from 50% to 200% of the taxes evaded and up to 2 years in prison while s. 239 (2), where they proceed by indictment, provides for 100% to 200% penalties and up to 5 years in jail. These sections are reserved for those acting in a criminally fraudulent manner involving vast sums of money with their tax filings. The standard of proof is that of “beyond a reasonable” doubt as seen on T.V. and in the movies. A new unjustified practice of the CRA is to use s. 238 (1) of the ITA ,in cases of the non-filings of tax and HST returns to seek fines of from $1,000 to $25,000 and a jail term not exceeding 12 months on each non-filed return. The reality is that they are plea-bargaining for a fine of $1,000 on each count of a non-filed tax or HST return. More below. This amounts to a heavy-handed method of tax collection and the fines are ‘gravy’ to the CRA as they will still get taxes, late-filing penalties and interest once the returns are filed. The more serious charges which WILL get you jail time relate to making a “false or deceptive return” where a taxpayer: “destroyed or altered records to evade tax, made false or deceptive entries” or “willfully evaded or attempted to evade taxes”. Remember, this is how the F.B.I. in the U.S. got Al Capone. A famous case of the Supreme Court of Canada reads: “it is the right of every taxpayer to aggressively attempt to minimize taxes.” (Our Emphasis) You have some latitude but not a licence to cheat.
CRA auditors will routinely try to scare taxpayers by threatening to levy 50% penalties under s. 163(2) of the ITA on the tax related to disallowed expenses or what they clumsily deem to be undeclared income. That section is entitled “False Statements or Omissions”. The CRA auditors do not realize that the courts have set a very high threshold for the CRA to meet in levying 50% penalties under s. 163 (2). You can get a fuller discussion below under the section “III. GENERAL DISCUSSIONS ON REAL ESTATE”.,, This 50% penalty will only stand in cases of extreme misconduct bordering on criminal conduct so the CRA auditors are blustering and trying to intimidate the taxpayer being audited. The section covers taxpayers who: “knowingly, or under circumstances amounting to gross negligence..” falsify records or tax returns. The penalties can be imposed by an auditor but will likely be reversed on an internal appeal to the Appeals Division at the CRA and have even less chance of holding up once a file is appealed to the Federal Tax Court. The evidentiary test is a “balance of probabilities”. Some protection comes from the onus of proof. Section 163 (3) reads: “the burden of establishing the facts justifying the assessment of the penalty is on the Minister.” For the latter, read the CRA. In over 26 years of business, none of our clients have been levied the 50% penalty or been prosecuted criminally. One method to avoid penalties is to cite “third party error”. This means that you attribute any mistakes or omissions to your accountant/bookkeeper. We argue that our client had no knowledge of any error and signed their tax return without reviewing it. There must be evidence that the taxpayer KNEW that they were filing a false return and there are several arguments, “third party error” being one, to rebut the levying of this penalty.
The leading case on the applicability of penalties under s. 163 (2) is Venne v The Queen  84 DTC6247(TCC). In that case, the court dealt with a taxpayer who stated that he failed to report private mortgage interest payments received based on the advice of his bookkeeper. The Court ruled that he should not be assessed penalties as this clearly was not an act of gross negligence but went further. The court refused to apply penalties even though it noted that the taxpayer’s misrepresentations of amounts in the returns were attributable to neglect and despite its view that the taxpayer failed to exercise reasonable care in filing his tax returns. Notwithstanding the apparently egregious actions of the tax- payer, the Court held that the Crown failed to establish that the taxpayer knowingly made false statements in his returns. The CRA onus to sustain penalties remains very high even in the face of egregious misconduct on the part an unsympathetic taxpayer like Venne. Generally, the courts have consistently looked upon the invocation of penalties on the part of the CRA as penal in nature and are extremely reluctant to let penalties stand and thus have imposed a strict interpretation of subsection 163(2) of the ITA thus limiting the power of the CRA to levy penalties. (See Maatouk which was a 1998 decision of the Tax Court of Canada.) For the CRA to levy penalties they must establish that there is gross negligence or fraud and must show that the taxpayer acted knowingly with an improper motive and intention or acted with wanton disregard for the law. Anything less than such a finding, or if any reasonable interpretation of the facts favors the taxpayer, results in the inapplicability of penalties. In a human light, it must be remembered that even judges file taxes and to not want to give the CRA an easy time in invoking any of the penalty provisions.
II. EMPLOYEE VS. SELF-EMPLOYED
1. DEDUCTIBLE EXPENSES
Deductions denied to employees:
- Driving to and from the employer’s office;
- A home/office expense unless they work more hours at home than their employers place of business and, even then, they cannot include mortgage interest in the calculation. Only commission employees can add insurance and property taxes to utilities and repairs in claiming the home-office calculation;
- All bank and interest costs;
- Tax preparation fees;
- Private health premiums for the family which can only be claimed as medical expenses; and,
- Computer, furniture & equipment depreciation. If you buy these items and their cost exceeds $500 - - the threshold for capitalizing an expense - - they will be disallowed as an expense. If under $500, you can deduct them as a current expenditure under “Office Supplies”. Very unfair.
Be aggressive and claim all arguable expenses. Employees also face the same limit on employee expenses: 1) Only 50% of business dinners and events. 2) Auto purchases are capped at $30,000 plus taxes. 3) Auto leases are capped at $800 per month plus taxes and are reduced if the “sticker price’ is above about $39,990. 4) Car loan interest has a $10 per day limit on the first $30,000 of a car loan.
KEEP CLEAN RECORDS. Just as with self-employed taxpayers, the onus is on you to connect expenses to the earning of income. Attach names of all recipients of gifts and names of dinner guests etc. and note business connections on receipts. Expenses will be disallowed by the CRA for same reasons as discussed under the heading for self-employed taxpayers. ( SEE ABOVE ):
III. GENERAL TOPICS ON REAL ESTATE
THE FIRST 5 TOPICS ARE 2013 DEVELOPMENTS
Housing prices in the GTA and in the Vancouver B.C. area have risen steadily since 1997 and, starting in 2013, the Canada Revenue Agency Audit Divisions are being opportunistic and have adopted abusive audit practices to tax the, gains on the resale of properties - -, a clear-cut ‘tax grab’. These practices are aimed at taxing gains, on the resale of personal homes including new homes, condos and on the resale of residential rental properties. These attacks start with CRA officers - - who do NOT identify themselves as being with the Audit Division - - sending taxpayers a seemingly innocuous questionnaire on recent sales of residential properties. The target of the CRA is to gather data which is prejudicial to taxpayers and to allow the CRA to reassess for extra taxes payable including:(1) Taxing the assignment of real estate offers before a close;
(2) Demanding refunds of the New Home Buyers Rebate;
(3) Denying Principal Residence Exemption treatment on sales of personal-use-properties;
(4) Taxing the full gain on sales of rental properties by denying capital disposition treatment which exempts half of any gain from taxation;
(5) Reopening tax returns beyond the 3-year limitation period for reassessing returns and reassessing for taxes payable in these statute-barred tax years.
(6) Militant and unreasonable audits of real estate agents.
The new militancy on the part of the Audit Divisions of the CRA has its origin in Harper and Flaherty making the huge mistake, of reducing the GST rate from 7% to 5%. This has lead to the Tory government running up huge annual deficits with tax revenues down by about $12 billion a year. As a result of this critical error, there is little room left for any significant personal or corporate tax breaks and federal spending is being cut by billions of dollars. The most offensive consequence of this chain of events was to convert the Audit Divisions to profit-makers by implementing abusive and unfair audit practices.
To understand tax planning and decision-making in business, you must always keep your eye on the combined Federal/Ontario tax brackets. Joint ownership of rental properties affords the flexibility of splitting net rents and capital gains over to a co-owner in a lower tax bracket. Conversely, the tax brackets determine the amount of extra taxes payable if sales of real estate are taxed higher or a substantial amount of business expenses are disallowed when auditing real estate agents. The tax brackets as set out at the top of the “Personal Taxes” section are 20.05%; 33.3%; 43.1% and a top combined Federal/Ontario rate of 46.4%. Higher earners will pay much more if reassessed on an audit.
TAX TREATMENTS ON THE SALE OF REAL ESTATE. When residential properties are sold, there are only, FOUR, tax treatments possible. While you can never claim a loss on the sale of a personal-use-property - - home, cottage, boats etc. - - you can use the Principal Residence Exemption, (PRE) to exempt most or all of a gain from taxation. The exemption is a year-by-year designation but there is a 1-year “bonus year” allowed in using the PRE. If you both live in a home for years and rent out the property for years during the, ownership period, then the property is treated as a “mixed-usage property”. You can designate it for each full or part year of personal usage. So, if you live in a home for 7 full- or part-years and rent it for 5, full years, the exempt portion would be:
7 + 1 over 12 or 8/12ths, of the calculated gain on sale
With a calculated gain of $300,000, you would exempt two-thirds of the gain or $200,000. Of the remaining $100,000, you would have a $50,000 taxable capital gain which is split in the case of joint ownership. The T2091 “Designation of Principal Residence” form needs to be completed to calculate the taxable gain on a mixed-usage property.
When you use a home primarily for personal purposes - - at least 51% of the home - - then any gain is entirely exempt. If you rent a basement apartment making up 34% of your home and claim a 10% home/office expense in a self-employed business statement, then 44% of the home is used for business but the gain is still fully exempt. The 44% business usage is defined as “incidental business usage to the primary purpose of personal usage” and the full gain is exempt under the PRE..
If your use your home primarily - - at least 51% - - for personal purposes, you are only required to attach a note to your tax return claiming, PRE, status giving, the property address and indicating for, which years you are designating the property for PRE purposes. ALWAYS SAVE the PRE for your personal use property with the greatest increase in value.
The third, tax treatment is to process the sale as a Capital Disposition. This usually involves the sale of a rental property or of a second personal home on which you are NOT claiming PRE status and, in this situation, you will pay taxes on only half of the capital gain.
The fourth situation is where you pay full tax on a gain since the gain is treated as “regular income”. The most common examples are where you sell an offer before the closing date and, where you buy a property and ‘flip’ it for a fast profit. Gains will be fully taxed if you have an expertise in real estate, sell a rental property shortly after acquisition and have a high number of purchases and sales. The CRA with its new 2013 abusive audit practices seems to be saying that there will be full tax on a principal residence sold before at least 12 months of personal usage.
1. ASSIGNMENT OF OFFERS., The CRA knows that new homes or condos have seen a huge increase in market value between having an offer accepted and obtaining ownership for from 3- to 5-year, years or longer after the original offer is finalized., CRA is catching purchasers who sell their offer before the official close for an amount including their deposit plus an extra amount to reflect the substantial increase in market value. Gains on these transactions are fully taxable.
To catch these transaction, the CRA requires developers to keep a registry of all persons who sign an Agreement of Purchase and Sale for a new condo or home and to note the amount of the deposit and of, the purchase price. The CRA will use the Teranet service to check the deed against the developers registry of those making the original offer. If the names are different, there will be an audit, and severe consequences. Taxpayers usually treat the gain as a capital disposition and others might not declare the gain at all.
If you do not declare the gain or treated it as a capital disposition, you should consider retaining a lawyer and doing a “Voluntary Disclosure Application”. The application must be: (a), “voluntary” meaning the CRA has not commenced action; (b) provide full disclosure; (c), it must involve the potential of a CRA penalty; and (d) the information must be at least 1 year overdue.,, Our firms’, experience is that the, CRA is happy to get the taxes plus interest and penalties are invariably waived. Those caught not declaring the gain face 50% penalties under s. 163 (2) of the Income Tax Act (ITA) and ALSO face prosecution in the criminal courts under s.239 (1) of the ITA with further penalties of from 50% to 200% of taxes payable and up to 2 years in jail. One or more of these taxpayers will be prosecuted, to send a message of deterrence to the public.
2. NEW HOME BUYERS REBATE. This HST rebate is available to anyone who buys for personal usage a new or “substantially renovated home”. Under the Excise Tax Act which governs HST, the maximum HST rebate is $30,300 on the first $45,500 of HST on a home bought for $350,000. The Courts have identified personal homes as those with a “period of personal occupancy” and also a home where there is a “bona fide period of personal usage”. The period of occupancy required is unclear so the CRA is attacking purchasers who sell quickly. The CRA deems the purchaser to have had a ‘primary motive’ of profit and will demand, repayment of the, HST rebate and will tax the full gain by arguing that the taxpayer did not have the primary intent of personal usage. An ambush
Some investors are ticking off ‘personal” when buying an investment property then renting out the property. They, too are being forced to refund the New Home Buyers Rebate and when they do, the CRA does not inform them that there is an almost equivalent Tenant Home Buyer Rebate if you can prove 12 months of tenant occupancy. Contact your investors. If investors were forced to refund the original rebate, advise them to reapply for the tenant rebate. They must do so within 2 years of purchase.
3. PRINCIPAL RESIDENCE EXEMPTION., The CRA is using Teranet to identify fast sales of personal homes and rental properties. The questionnaire which they send to taxpayers requires that ALL homes bought and/or sold in the last 5 years be listed. For personal homes, the CRA will demand proof, of occupancy including all bills paid while living in the home and such things as proof of changing one’s driving license to that address. This started in early 2013 and, the CRA seems to be focusing, so far, on condos but they will likely broaden their search.,,,
Where there is a resale within a year, the trend is for CRA auditors to insist on repayment of the HST rebate, deny PRE status and tax the full gain and intimidate the vendors by threatening to levy a 50% penalty under s. 163 (2) of the ITA which is overkill since this requires that a taxpayer, “knowingly filed a false return”. The CRA is deeming the taxpayer to have had, the primary intention of, so to speak, cashing in their profit and will tax the full gain as an “Adventure in the Nature of Trade” which concept has normally been invoked when a purchaser ‘flips’ a property . Our firm is having success in defending these attacks by citing the provision that these consequences will not apply where the sale was the result of a material change in personal circumstances which can include serious health problems, a change in financial circumstances or the end of an engagement or marriage between signing the offer, taking possession and selling the home.,
4. TAXING THE FULL GAINS AS “REGULAR INCOME”. The 3 main factors which will lead the CRA to deny capital disposition treatment is where there is an expertise in real estate, secondly, the property was sold quickly and, lastly, where there is a high number and frequency of transactions. If, you assign an offer or ‘flip’ a property, the gain will be fully taxed.
If you are a real estate agent or sophisticated investor and you sell a rental rent property less than 18 months after acquisition, the CRA will reassess and tax the full gain as ‘regular income’., If agents or investors rent their investment property for at least 18 months and preferably 2 years or more, our firm is successfully arguing that the sale should be treated as a capital disposition with half the gain exempt on the basis that, agents and investors should be allowed capital disposition treatment as does the average taxpayer. CRA auditors are routinely demanding that the HST be repaid, taxing the full gain and levying 50% penalties with the expectation that most taxpayers will not appeal or get incompetent representation.,
5. DISREGARDING THE 3-YEAR LIMITATION ON REASSESSING TAX RETURNS. The limitation on reassessing tax returns more than 3 years after the date of the original assessment is, a safeguard provided to taxpayers and the CRA will need to prove gross misconduct to get around this limitation. The CRA is citing s. 152(4) of the ITA which sets out that the limitation does not apply if a taxpayer has made a “misrepresentation”, in a tax return and auditors, are relying on the most trifling of errors to get at statute-barred returns.
The law is that any word must be construed in the context of the surrounding language. Section 154 (2) of the ITA reads: “attributable to neglect, carelessness or willful default or has committed any fraud in filing the return.”, The 3 types of “misrepresentation”, are, “fraudulent”, “negligent” or,, “innocent” misrepresentation with the last involving mere inadvertence. The incorrect position of CRA auditors is that ANY act of misrepresentation is sufficient. Our firm is convinced that the CRA will have to prove fraud, gross negligence or willful blindness amounting to knowingly filing a false return to get around the limitation. A low threshold would open the floodgates for CRA audits and make the limitation period meaningless. The courts will support our position on this issue.
6. MIILITANT & UNFAIR AUDITS OF REAL ESTATE AGENTS. We have discussed this issue at length. CRA auditors will review the two most recent tax returns on the basis of the “sufficiency of receipts and vouchers”. Receipts must be categorized by type and totaled on tapes or spreadsheets. ,Auditors routinely disallow between 20% to 40% of expenses and reduce the business driving to 75% or lower where no logbook is provided.,, Reasons for disallowance include:,, “no proof of payment”, “insufficiently documented”; “not clearly connected to business” and “personal in nature”. You can get a lot of disallowed expenses restored by appealing the disallowances to the CRA Appeals Division.
The law is that all expenses must be: “incurred for the purpose of earning income”. This explains the need to provide names for business dinners, events and gifts. Self-employed taxpayers can pay a spouse for administrative support but the spouse, MUST be put on payroll with taxes and CPP premiums withheld. Any payment to a spouse for “Casual Labor” will be disallowed. Keep all of your credit card ‘chits”. Credit card statements will not be treated as sufficient proof of an expense. .
You may claim a home/office expense based on a square footage or, room-by-room basis whichever is most favorable., Since agents installed the MLS service in their home, and since most tasks are performed at home including, record-keeping, drafting documents, banking, using MLS, booking, appointments etc. then under the “usage test ”as it relates to s. 18 (12)(a) (i) of the ITA ,your home is your “principal place of business”. You do not need to meet clients at your home and you are doing “business driving” once you leave the driveway.
The CRA has set up new vehicle logbook rules and provides a prescribed manual logbook. In the first year, a taxpayer, must log 12 months of driving to get a ,“full logbook” which will give a “base” proportion of, say, 89% of, business use. The logging of each trip must include a) the date; b) the departure and destination addresses; c) the purpose of the trip; and d) the exact distance driven. In any subsequent year, you need to log, ONLY any consecutive3-month period, to get a “simplified logbook”. The agent can select their busiest 3-month period and will likely get a figure of, 90% business driving or higher on the 3-month basis. You need not log the other, 9 months, but should do so if related to business dinners, events and gifts.
The CRA set up the manual system knowing that agents would not want to spend 150 hours a year to track their driving. The good news is that there are a number of computerized programs which are CRA-approved which record all of the data required by the CRA and cut the time for logging down to about 15-20 hours per year which is manageable. Without intending to promote a product, our research shows that the best product available is Odotrack which uses a GPS system and is the only system which stores all of the data required by the CRA on a main server which server is accessed by a password. The system also records business dinners, events and gift expenses, which are the most commonly audited expenses. Once you hit the business button on their dashboard unit, it automatically enters the data. Check out the product at www.odotrack.ca. It will print out the 12 months of data or 3-consecutive months on request. Keep all of your vehicle receipts, and your business proportion of driving will be ‘bullet-proof’ from a CRA attack.
1. PRINCIPAL RESIDENCE EXEMPTION (PRE)
Keep in mind the aggressive CRA challenges of fast sales of new condos discussed in the section above about new 2103 audit practices. This exemption was created in 1972 when capital gains taxation was introduced. This differs from the basic $100,000 Capital Gains Exemption which ran from 1985 to 1994. The PRE has NO DOLLAR LIMIT. [ The U.S. version of this exemption allows the exemption of $250,000 for each taxpayer per sale of their home. Some Americans sell and move to restart the $250,000 exemption. ] The Principal Residence Exemption is often referred to as the most generous provision of the Income Tax Act. Many people use the tax-free status of their principal residence as a `tax shelter’ by buying a larger home and for many, the tax- free dollars in their home is their biggest retirement nest-egg. Each married couple, including common-law spouses since 1993 and same-sex couples since 2001, and their children have only one PRE. The PRE covers the building and up to about 1.6 acres of land unless it can be shown that a larger area of land is required for the "enjoyment and use" of the property. Parents are buying their adult children homes to give them a start in their careers and to give them an asset providing tax-free dollars on sale. With low returns from cash investments and a volatile stock market, it can be a wise move to sell and `BUMP UP' to a larger home. Low mortgage interest rates suggest that this is a very, very good time to be buying real estate for any reason. A $900,000 `dream' home doubling in value gives more tax-free dollars than a $400,000 bungalow or condo doubling in value. Real estate agents recommending this prudent approach will get both a commission on the sale and on the purchase of the new home. Mortgage-free owners will be most interested in this approach especially if they have cash investments giving low interest returns or cottages, stocks and mutual funds with a high ACB through use of the Capital Gains Election form in their 1994 tax return.
Conversely, many home-owners are cash-starved. They have low incomes and over-sized homes. This might include seniors, widow(er)s and those suffering career dislocations. With recent job lay-offs, two-income homes have become single-income homes. These are all candidates for a 'BUMP DOWN'. This involves selling the current home for TAX-FREE dollars, buying a less expensive home and investing the excess cash for added income. This buying a less expensive home is prudent for those with reverse mortgages under such as the much-publicized “CHIP” program where they lend up to 40% of appraised value and the interest compounds until the owner(s) sell or die. Sell the home, buy a less expensive property and pay off the reverse mortgage. The seller will still have a substantial amount of tax-free dollars to draw on and to invest for an extra stream of income. An agent arranging this is rationalizing and consolidating the seller’s finance. Those who used the CHIP program should have sold and bought down to a more affordable mortgage-free home instead and invested any excess cash.
Owners fear losing the principal residence exemption if their home is not used solely for personal usage. This is a misconception. You MAY rent out part of your home to tenants - - termed “ancillary usage” or “incidental business usage” - - and even operate a home/office in your house so long as the MAJORITY of floor-space - read 51% - is for personal usage. The exemption is lost on any part of the home on which depreciation is claimed. Never claim depreciation on your own home. Against rent collected, you may claim a PROPORTIONATE share of expenses such as insurance, repairs, utilities, mortgage interest and taxes and often have a NIL or low net rent and thus get the rent `tax-free' or with little taxes. Complete the Form T776 “Rental Statement” and indicate the percentage of the home used for personal purposes. Revenue Canada will not allow losses in this situation where the proportion of expenses exceeds rent collected. Be content with getting the rent tax-free or, with positive cash-flows, paying taxes and using the rent to pay down the mortgage.
2. FIRST-TIME BUYERS
The Ontario government still offers the LAND TRANSFER TAX REFUND to first-time buyers of newly built homes. The maximum rebate of $2,000 covers a home costing up to $200,000 for Agreements of Purchase and Sale signed after March 31, 1998. The city of Toronto exempts first-time buyers from Toronto Land Transfer Tax on the first $400,000 of cost. The Federal government gives first-time buyers a $5,000 credit which saves $750 of federal tax.
Federal government provides the greatest incentive to first-time buyers through the HOME BUYERS PLAN which was converted to a first-time buyers program on March 1, 1994. Each taxpayer can with- draw up to $25,000 with no tax withheld from your RRSP starting in 2009 -- the prior limit was $20,000 - - towards a home purchase, whether new or a resale, upon production to the RRSP trustee of a signed “Agreement of Purchase and Sale”. This amounts to an interest-free loan to yourself from your own RRSP. No taxes are withheld on the withdrawal. You, or both taxpayers if it is a joint purchase, cannot have owned a home during the 4 years preceding the year of withdrawal - since January 1, 2008 for a 2012 withdrawal. RRSP contributions must be left in for 90 days to qualify under the plan. RRSP contributions for the tax year 2011 savings may be bought until up to the first 60 days of 2012 and qualify to be withdrawn under the HBP if left in for 90 days. Get your timing right. The withdrawal is repaid in up to 15 equal instalments starting 2 years after the year of withdrawal - - in the year 2014 for 2012 withdrawals. On $25,000, the annual repayment into your RRSP which is non-deductible is $1,666. Failure to make the prescribed minimum repayment in a year results in the `shortfall' amount being included in income and an excess repayment will `average down' subsequent payments. Only make excess payments if your home is mortgage-free and you have used up all of your regular RRSP contribution limit. Otherwise save your cash to pay down the mortgage or make RRSP contributions. If there is an HBP balance owing in the year after you turn 71 which means that you cannot have an RRSP account the balance will be divided by the number of years remaining in the 15-year repayment period and that amount will be included in come each year. Do not sweat it. In your retirement years, most taxpayers are in the first tax bracket at 20.05% and the maximum inclusion is $1,666.
The Home Buyers Plan is often combined with a high-ratio mortgage to get first-time buyers into affordable homes. Those with high residential rents will be most interested in this approach. Many `top- up' their RRSPs when using the HBP and un-used RRSP contribution limits have accumulated since 1991 - - no more "use it or lose it". Each spouse including `common-law' spouses qualify. The higher earner can make a spousal contribution to increase the spouse's RRSPs to $25,000 and the rule attributing the income to the contributor -- normally you need to leave a spousal contribution in for the year of contribution and the 2 subsequent years or the withdrawal is deemed to be income of the original contributor -- is not applied for withdrawals under the HBP. But, if you cohabit with a spouse who owned a home in the 4 prior years before the withdrawal, NEITHER OF YOU qualify. Rules:
- You must purchase a Canadian home including mobile homes and houseboats.
- Complete the FORM 1036 for the qualifying withdrawal. No taxes are withheld. Certify that it will be used as your principal residence for 1 year after the close.
- Leave RRSP contributions you want to qualify inside the RRSP for at least 90 days. To meet this requirement, you can make the withdrawal up to 30 days after the close of ownership.
- With $25,000 for each joint purchaser, you could get a conventional first mortgage. This would avoid the CMHC insurance costs which are required of a high-ratio mortgage.
- Make your required HBP repayment into an RRSP within 60 days of the year-end. If you do not make the minimum repayment, any shortfall is fully taxed as income.
- DO NOT sign a realty offer for a close within 60 days of a `top-up’ RRSP contribution.
- DON’T die. Any balance is taxed unless a surviving spouse assumes the repayments.
- DO NOT emigrate without repaying any balance within 60 days of leaving Canada or it falls into income. (Withdraw RRSPs as a non-resident after repaying the HBP amount and waiting until the year after emigrating when withdrawals are subject to only a flat 25% tax rate.) RRSP withdrawals made in the year after emigrating are subject to ONLY 25% withholding tax. If you withdraw before emigrating, you could end up paying the highest rate of 46.4% on the RRSP withdrawal. Tell the trustee of your RRSP to designate your RRSP account as having a non-resident status before you emigrate if it advantageous to leave your RRSP account intact. Get advice.
- You cannot have an RRSP account in the year after you turn 71. Repay any balance by the end of the year you turn 71. You can then convert your RRSP account to a RRIF account as you are required to do and the HBP balance will NOT fall into income. If you do not repay any HBP balance by the end of the year in which you turn 71, the remaining required annual payments will fall into income until the balance is repaid.
3. SECOND HOMES/COTTAGES
Each individual or married couple and their children under 18 are entitled to one principal residence exemption. This explains the transfer of cottages to 18-year old children until they buy their own home. The home is deemed to have been transferred at Fair-Market-Value and the parent will incur any capital gains tax. The 1994 tax return allowed taxpayers to use a Capital Gains Election of up to $100,000 each to raise the 'book value' on second homes and rental properties. The election benefited any cottages and rental properties owned before about 1988.The new higher "elected cost base" -- potentially $200,000 higher if joint owners - - will then reduce the amount of the taxable capital gain on sale. As stated above, second homes and rental properties, along with stocks and mutual funds, can provide after-tax dollars to buy new properties or a larger principal residence.
The PRE allowed each spouse to own a home until 1982. If a home and cottage are owned jointly from 1972 to the present, and a couple is selling their city home to move to the cottage, or vice-versa, the use of the PRE designation by joint owners on a property for the period 1972 to the year of sale will preclude the use of the PRE on the other home when it is sold. [Being able to use the PRE for the 1972- 1982 period will exempt from taxation the proportion of the gain made up of 11 over the number of years you owned before selling. If sold in 2009, with ownership of 37 years, you will exempt 11 OVER 37 or 11/37th of the calculated capital gain on the second home. The PRE is a year-by-year designation. You would designate the cottage for the 1972 through 1982 years and save the full PRE for your city home where the dollar gain is higher. There could be substantial tax savings when selling the second home. The answer is to transfer the joint half-interest between spouses so that each owns a home out- right. The transferee assumes the exempt status of the transferor. This reorganization exempts from tax the appreciation from 1971 to 1982 on two properties. The PRE can be used on the eventual sale of the cottage but subject to the attribution of 1/2 the gain on sale to the original joint owner. The Ontario government will not charge LTT for spousal transfers if each appears on the original deed. No downside.
You usually save the PRE for your primary home as it has likely gone up the most in value. Remember that so long as any home you own is used for up to 51% personal usage that it is fully exempt from taxation under the PRE. With cottages or second homes, designate them for the PRE for 1 year - - the PRE is a year-by-year designation - - as the T2091 form “Designation of a Principal Residence” has a bonus year. You get the number of years designated PLUS 1. On sale of your primary home in Toronto, the bonus year fills in the gap for using the PRE on a cottage sale. To illustrate, you own a cottage for 26 years, and designate it for 1 year you will exempt from taxation 1 + 1 over 26 or one-thirteenth of the gain. So, on a $260,000 gain, you will exempt 1/13 or $20,000 of gain. Our firm is possibly the only firm in the city that uses this legitimate technique. Children selling the cottage to get cash to put their parent in a care facility are the types to come to our firm to get this intelligent treatment on the sale of the cottage.
4. RENTAL PROPERTIES
Keep in mind the above discussion of the new 2013 CRA audit practices where the CRA is, tracking fast sales of rental properties. Investors should hold rental properties for at least 18 months and preferably 2 years before selling if they want the sale to qualify as a “capital disposition” in which case one-half of the gain is exempt from taxation. If investors sell too quickly, the full gain will be taxed as “regular income”.
The cardinal rule here is to never incorporate to buy residential rental properties. Ignore anything an accountant or real estate lawyer tells you about incorporating an numbered company to buy a rental property. If the sole income of a corporation is rent, net rental income will be taxed as passive income at a punitive rate of about 46%. The CRA does not want companies owning rental properties or generating other passive income inside a corporation such as interest, dividends or capital gains. These forms of passive income are taxed at the high punitive rate. You will then pay another 15% and higher tax on the dividends paid out from after-tax dollars. You have thus created the `Frankenstein’ of a corporation where rent is taxed, and eventual capital gains, at a combined corporate/personal tax rate of about 54.64% or higher. The highest personal tax rate is 46.4% and you can use brick depreciation in your personal return to reduce net rental income to NIL which defers taxes until the depreciation is recaptured on sale. This is a form of deferring taxable income like an RRSP, but you will recapture the brick depreciation on sale. Only those in the 43.1% or 46.4% tax brackets should claim brick depreciation. This approach gives the deferral of taxable income until the depreciation is recaptured on sale and taxed, at most, at that highest personal rate of 46.4%. Thus you pay later with dollars devalued by way of inflation. So, you save a lot of taxes by buying in your name and that of your partner and declaring the rent and capital gains in your personal tax return. So buy in your personal name and that of your spouse or investment partners. You will NOT need the limited liability of a corporation to protect yourself. Simply get your insurance agent to get you enough “slip and fall” and “wrongful death” liability coverage to cover the worst case scenario. Several extra million dollars of such coverage will only cost you several hundred dollars each year for that extra coverage and the insurance premiums are fully deductible against rent. This is a lot less costly than the $1,200 to $1,500 cost of incorporation and the extra $1,200 and up accounting fees to do an annual corporate filing for a numbered company owning a rental property with a combined tax rate of over 54%.
Corporations whose sole income is rent will have income treated as income from property and thus passive income not equivalent to business income. Only “active corporations” providing goods and/or services to the public get the Small Business Deduction (SBD) and a combined federal/ provincial corporate rate of about 16% on the first $500,000 of taxable income which will rise to $750,000 over the next few years. An example of business activity is the ownership and management of a hotel/motel operation. This is of relevance to investors who might avoid pure rental properties and acquire a hotel/motel operation to qualify as a Canadian-Controlled-Private-Corporation (CCPC) and thus as a corporation in “active business’ eligible for both the SBD and for the purposes of the $500,000 Lifetime Capital Gains Exemption per shareholder who sells common shares in such a corporation held for at least 2 years. That makes sense.
The important thing to acknowledge about rental properties is, that in the current market, interest rates are at historical lows -- get a fixed-rate with a 5-year term mortgage as a variable rate mortgage will now likely see rates floating up and there are a lot of properties out there. Those with cash and borrowing power rule and can ‘bottom-feed' in a real estate market where prices have dropped. Acquiring rental properties if prices drop then flatten makes economic sense. There are even a lot of foreclosures and powers of sale at low prices. Rental properties will carry themselves since there is some proportion between cost and revenues. Look for bargains and investors should seek positive cash-flows. Be prepared to put 30% down and hold for 5 years or more or you are not a suitable candidate to be buying rental properties. On sale, gains are taxed preferentially with only 50% of a capital gain included in income.
On sale, taxes can be spread by creating a “mortgage reserve” in the T2017 Schedule where all of the proceeds of the gain are not received in the year of sale. These situations are common with duplexes, triplexes and the like where one investor is selling to another and the purchaser wants to put in less cash. A common arrangement is a 70% first mortgage, a 20% second vendor take-back mortgage with 10% cash. The Reserve is accomplished with a vendor take-back mortgage - - remember the good old days of the 1980s - - which can spread gains over as much as a 5-year period and spread gains into the lower tax brackets in later years. You must declare ALL of the calculated gain received in cash in the year of sale and at least 20% of the calculated gain. You then must declare a minimum of 20% of the gain in each subsequent year until the full gain is declared. The interest on the vendor take-back mortgage is declared annually as income. Be prepared to give a 5-year term at a rate slightly above that of the first mortgage with a low enough interest rate to attract the new owners into agreeing to a vendor take-back mortgage. This approach defers income and drops it into the lower tax brackets. If you declare the full capital gain in the year of sale, you can easily climb up to the highest rate of 46.4%. This is also why spouses should buy rental properties jointly so as to split any capital gain in half on sale so a lower earning-spouse might pay much less tax. A rental property bought by multiple owners is: easier to borrow against; should carry itself; provides more persons to manage; and, legally spreads taxable gains around to those who pay lower taxes on sale. Get back to basics.
If we have anything close to the real estate crash of 1989-1990, we get a ‘tax-driven’ market where investors who bought at the peak might now sell rental properties to `crystallize' tax losses. The "terminal loss" treatment on the sale of rental properties cushions the blow from a sale at a substantial loss. The general rule is that depreciation may only be claimed to the extent it reduces net rental income for all properties owned to zero. This is called the “general limitation on depreciation” (CCA) for rental properties. MURBS in the 1970s to 1980s were an exception to the general rule and sold very well since owners could claim the full brick depreciation amount annually in addition to any operating losses - - tax-driven acquisitions. The second exception is a terminal loss which is a final deduction where a property has depreciated more quickly than foreseen in the prescribed rate of depreciation. Section 20 (16) of the Income Tax Act provides for the deduction of a terminal loss upon the disposition of all of a taxpayer's depreciable property of any prescribed class. This known as “emptying out a class’.
A rental building acquired at a cost of $50,000 or more must be entered in its own class for depreciation purposes [ Regulation 1101 (1 ac) to the Income Tax Act ]. Class 3 brick buildings with a rate of 5% was replaced with Class 1 and a rate of 4% in May of 1988. Frame buildings are Class 6 at a 10% depreciation rate. The rule to put purchases of $50,000 or more in their own class was intended to prevent `pooling' of rental buildings to both delay recapture of depreciation and avoid taxation on net rental cash-flows by maximizing depreciation. The government wanted to accelerate taxation and did not foresee the 1990 dramatic reduction in real estate values. If you sell a rental property for a loss, you can take a full deduction in your tax return. Condominiums are treated entirely as building and a final DEPRECIATION deduction may be claimed in the rental statement in the year of sale. You can thus claim a loss on operating revenues and a fully-deductible TERMINAL LOSS between what you paid including Land Transfer Tax, legal costs and capital improvements and what you net from the sales proceeds less real estate commissions and legal costs. No one wants to see a drop in real estate values anywhere near what happened in 1990.
Properties composed of both land and building allocate the acquisition cost and proceeds from sale between them. E.g., a 70% allocation to building and 30% to land. Since land cannot be depreciated, any loss would be allocated as a 30% capital loss. For the purchase of a parcel of unimproved land, interest and taxes can only be added to the Adjusted Cost Base of the asset so those expenses are capitalized to apply against any gain on sale. The gain is taxed as a taxable gain.
Any rental loss which `washes through’ the T776 “Rental Statement” resulting from the terminal loss treatment is fully deductible against all other income in the year of sale and any excess - - once “Net Income” for the year is NIL - - may be carried back 3 years and forward 10 years. You MUST file your return by your tax deadline to do a T1A “Loss Carry-Back” to any of the three prior years. Regular tax- payers have an April 30th filing deadline while self-employed taxpayers AND their spouses have a June 15th filing deadline. If any loss remains or you miss the filing deadline, losses can carry forward for up to 10 years. NOTE: If you own MORE than one rental unit in a condominium, any terminal loss deduction may be claimed ONLY when the LAST unit is sold. Tax refunds may be used to buy a better property or blunt the pain of a ‘book loss’ of $100,000. Those in the top tax bracket will save 46.4% on the loss.
A caution. Revenue Canada had used the MOLDOWAN case to argue that some properties had no "reasonable expectation of profit". Fortunately, the more recent TONN case decided in December of 1995 favors rental investors. The court said to the CRA in TONN that if a taxpayer buys a rental property to rent and later sell at a gain, it is not the business of the CRA to question the viability of the investment. The above points will reveal `tax-driven’ sales or purchases. Real estate remains a sound investment if intelligent and conservative rules are followed.
Rental properties sold at profit - - other than any recapture of previously claimed depreciation which is fully taxable - - are treated as capital gains with a 50% inclusion rate. Realty agents/brokers and sophisticated investors in real estate with a history of buying multiple rental properties must beware of having their own gains from the sale of rental properties taxed fully as “regular income” and not as capital gains. The test of whether a sale qualifies as a capital disposition and thus eligible for capital gains treatment is: 1) similarity to your ordinary course of business; 2) nature of the property; 3) whether there have been acts of sale such as improvements versus acts or expenditures to increase rents; 4) the number and frequency of transactions; and, 5) the period of ownership called the ‘holding period’ where the rule is the longer, the better. The holding period is what the CRA is focusing on in its new 2013 audit practices. The primary intent on purchase to qualify the eventual sale for capital gains must be the earning of rental income. We recommend that if an agent or investor buys a `bargain’ property that they hold for at least 18 months up to 2 years so that they will not be seen as `flipping’ for fast profits in which case you will be forced to pay full taxes with the CRA concluding that the transaction meets the test of being “an adventure in the nature of trade”. This finding means you will pay tax on the full gain. Get advice.
5. CONVERSIONS OF USAGE
Properties can be converted from personal to rental usage and vice-versa. Properties which are rented out for several years and then used for personal usage for other years are referred to as “mixed-usage properties”. For tax purposes, such conversions are treated as deemed dispositions and subject to taxation. If you move out of a Principal Residence and rent it out, you can file an Election under s. 45 of the ITA to postpone tax consequences for up to 4 years. If you convert a rental property to personal usage, the s. 45 Election defers tax consequences indefinitely or until there is an actual sale. No brick or frame depreciation can be claimed on the converted property during any year of usage. If you move more than 40 kilometers for (self-employment or employment purposes, the s. 45 election is good indefinitely. The s. 45 election is also indefinite if you move into a property previously used as a rental property but, again, you cannot have claimed any brick or frame depreciation while it was used as a rental property as this disqualifies the property from qualifying for the Principal Residence Exemption.
A final point on conversions of usage is that when move into a rental property which has lost substantial value this results in a "deemed disposition" and will crystallize deductible losses including a terminal loss on the building and appliances and a capital loss on the land component. You can sell your home move into a rental condominium where the entire cost is Class 1 “brick” and `crystallize' tax deductions on the rental property. This is the case even if you took depreciation on the rental property during ownership so long as your Undepreciated Capital Cost - - which reduces as you take brick depreciation,is still greater than the market value when you move in. Get a professional appraisal to confirm the loss in the case that the CRA audits the tax treatment on this deemed disposition.
IV. INTERNATIONAL TOPICS
Non-resident owners of personal use or rental properties will pay capital gains tax on sale but there are a grocery list of compliance rules for rental properties. Rental payments to non-residents are subject to with- holding tax. The owner(s) must submit an NR6 asking to be exempt from withholding taxes within 30 days of purchase and request Non-Resident tax numbers to be issued. They must also designate a Canadian resident as their “Authorized Agent”. If they are not waived from withholding 25% of gross rents, then they are required to withhold 25% or any lesser amount designated by the CRA of the gross rent paid and remit it to Receiver General of Canada by the 15th of the month following receipt of rent. Usually an automatic monthly payment from the checking account to the CRA is set up. The non-resident owner(s) must then file, by December 31st of each year, the Form NR6 application with the CRA which includes a projected rental statement showing no or little net rental income - - common where there is a high mortgage - - in which case they will be exempted from withholding tax on the monthly rent. The non-resident must prepare and submit an NR4 slip and NR4 slip summary to the CRA by the end of February each year declaring the gross rents collected in the prior year.The non-resident is not required to file a tax return if they have remitted 25% of the gross rents monthly. So they can opt out of filing a s. 216 tax return enclosing a T776 Rental Statement if 25% of gross rents have been submitted monthly but it is almost always favourable to do the tax filing as they will almost always get a refund on the withholding taxes as the taxes on the net rental income will be lower than the withholding taxes. There is usually a refund as you have off-setting expenses and the first $43,561 in 2013 of income is taxed at the lowest rate of 20.05%. A Section 216 non-resident return must be filed by June 30th and separately for both owners if there is joint ownership.
If you are exempted from withholding tax by the CRA, you must file a s. 216 non-resident rental filing by the June 30th deadline. You are taxed on net rental income from at the lowest rate of 20.05% up to $43,561of net rental income. So, if rent is $1,600 a month and you withhold and remit $400 monthly, you will have sent in $4,800 of taxes and need not file. If you DO file and net rental income is $10,000, you will pay $2,005 of taxes based on the 20.05% rate. Thus a $2,795 refund. This is also why non-residents should buy jointly with their spouse as they will split the net rents and the taxable capital gain - - one-half of the actual capital gain - - on sale and keep all or most of the taxable capital gain in the lower tax brackets on sale. A designated agent is required to sign the NR6 and withhold and remit 25% of the gross rents or whatever amount the CRA stipulates - - it can be less than 25% - - if they are not exempted from with-holding taxes based on the NR6 application. If the non-resident fails to file the tax return within the 6 months of the year-end, the agent is liable for any taxes less amounts actually remitted. Most foreign investors have enough equity in their investment that they will get a filing done and the requirement for withholding tax on sale will ‘catch’ any delinquent taxes so an “authorized agent” does not truly face any risk. (SEE BELOW)
2. SALE OF REAL ESTATE BY NON-RESIDENTS
Generally, the Income Tax Act requires prepayment of income tax attributable to sales of Taxable Canadian Property (TCP) by non-residents. Non-residents will pay capital gains tax if there is a gain on the sale of a rental property, a personal use property such as cottage and on a condo bought for usage by one of their children attending local universities. The purchaser of the property from the non-resident must withhold 25% of the purchase price and remit it to the CRA within 30 days from the end of the month of the purchase if the vendor does not provide a Tax Clearance Certificate Form T2068 on close of the sale. The non-resident vendor may make an application to the International Tax Division of the CRA no later than 10 days after the close of the sale using Form T2062 which is an application for a Tax Clearance Certificate (TCC) which will require that the vendor lawyer to send ONLY 25% of the difference between the Adjusted Cost Base - - cost, plus LTT, plus legal fees and any capital improvements - - and Sales Proceeds without deducting real estate commissions or legal fees. On a `differential’ of $100,000, the vendor’s lawyer would remit $25,000 as designated by the CRA in the Tax Clearance Certificate to the CRA within 10 days of the close. With an Adjusted Cost Base of $300,000 and a sale price of $400,000, a non-resident vendor would be required by the purchaser’s lawyer to remit $100,000 - - 25% of the sale price - - to the CRA if no TCC had been obtained and the vendor lawyer does not provide an undertaking to submit a T2062 application within 10 days of the close. If a TCC is obtained, the CRA would require that only $25,000 be remitted, that is one-quarter of the differential.
The Tax Clearance Certificate will have a 'certificate limit' of $25,000 based on the calculation above. Make the T2062 application in a timely fashion or there might not be much money left over once any mortgage is paid off if 25% of the sale price is withheld. Our firm is usually contacted by the vendor’s lawyer once the Agreement of Purchase and Sale is finalized and we do a quick submission of the T2062 application with the hope that the CRA provides a TCC by the date of the close. This is rare as the CRA is now saying that it takes a minimum of 3-4 months to process the application so it only works with a really long,closing date. Usually, the vendor lawyer will hold 25% of the sale price in trust until the Tax Clearance Certificate is received at which point the lawyer will remit the 25% of the ‘book gain” specified in the TCC then pay out the remainder to the vendor client. Unless there is a huge capital gain on sale, there will be a tax refund with or without the Tax Clearance Certificate but if you are forced to send in 25% of the sales price, there will be a massive refund coming and for a sale early in a year, you will wait until the summer of the following year to get the refund. A section 115 return is due by June 30th and is filed for the year of sale calculating the “taxable capital gain” while a s.216 filing for rental income is submitted for the year covering the period from January 1 up to the date of the sale. The s.115 filing is separate and each owner must file if there is more than one owner and required as a non-resident will pay capital gains tax on a gain on both of a rental property or a personal-use property.
3. INVESTORS IN U.S. REAL ESTATE
Recent Canadian legislation, effective as of 1996, requires Canadians to disclose specified foreign assets held outside Canada, if the total fair market value exceeds $100,000. This is called the “Foreign Asset Declaration” and is discussed as No. 4 under “Tax Planning” below. The purpose of the declaration is to track assets outside Canada to ensure that worldwide income on property is being reported and for capturing all assets for departure tax upon emigration or tax on deemed dispositions upon death. Foreign rental properties worth more than $100,000 alone or combined must be reported. Assets not included are those used in active business of the reporting person and personal use assets of the reporting person including personal homes.
Many Canadians have rental properties in the U.S. as well as personal homes. All rental income and gains on the sale of realty in the U.S. must be reported in Canadian tax returns. This income is reportable in a U.S. federal tax return - - some states require state filings where tax will be levied - - and is taxed first in the U.S. since the U.S. is the `source' country. You are required to file a 1040NR U.S. federal income tax return and, since the 1996 filing, obtain a Taxpayer Identification Number (TIN) from the IRS even if you have used a U.S. Social Security Number for previous filings. You must discontinue using the SSN.
The rules for depreciation of rental buildings differ. In Canada you cannot use depreciation to create or increase a loss. In the U.S. you must take the prescribed depreciation in the annual rental filing and carry forward any losses to apply against gains on sale. The U.S. has draconian non-compliance provisions for non-residents and U.S. citizens who do not file. Failure to file can result in being taxed on the gross rents during ownership on an annual basis with no right to reduce tax based on operating expenses or depreciation. On sale, you will be imputed to have claimed the prescribed depreciation annually, then taxed on the recapture as ordinary income to the extent this imputed depreciation reduces your cost base of the property below original cost. You will also pay capital gains tax to the extent the proceeds of sale exceed your original cost. Any federal and state taxes paid in the U.S. can be used to offset Canadian taxes through the Foreign Tax Credit Schedule on Capital Gains in the Canadian return. The US requires purchasers to withhold a portion of the purchase price which is remitted to the I.R.S. when buying real estate from non-residents of the U.S. Note that in the event of death, you are subject to estate taxes in the U.S. but under the U.S.- Canada Tax Treaty the exempt amount is rising to $600,000 (U.S.) pro-rated based on the proportion that your U.S. holdings represent of your world assets.
4. EMIGRANTS/IMMIGRANTS & AMERICAN CITIZENS
Canadian residents emigrating have to consider the tax impact of retaining a Canadian residential property. The Principal Residence Election is an annual election and upon emigration, by definition is not available to non-residents. Therefore, for each year the emigrant owns the Canadian residence, a larger percentage of the gain on the sale will be a taxable capital gain because of the averaging effect of the Principal Residence Designation Form T2091.
They need to consider the consequences of selling the Canadian residence versus changing its use to rental property. You can file a s. 45 election under the ITA to postpone taxes for Canadian purposes on the deemed disposition. But as per U.S. taxes, if the immigrant to the U.S. rents out the Canadian property, the property is classed as an investment property and will not qualify for the U.S. residential tax exemption. Under U.S. rules, the cost basis for calculating gain on sale is the original cost not FMV at the date of the conversion of use to rental usage. Upon sale, all of the gain will be taxable in the U.S. tax return. This also true for rental properties as their cost base for U.S. tax purposes is their original cost. You will also be taxed in the U.S. for capital gains purposes on the original cost of any homes or cottages in Canada if you sell them after becoming a U.S. resident. So sell ALL of your Canadian real estate, stocks and mutual funds before moving to the U.S. and buy a new home, a second home and invest in rental properties, stocks and mutual funds in the U.S.[ Show this material to your real estate agent.]
Canadian tax rules are based on residency which requires living in Canada for at least 183 days a year with a "settled intention" to remain here. U.S. tax rules, in contrast, are based on citizenship AND on residency if you take up residency in the U.S. although both jurisdictions tax based on worldwide income with the source country taxing first and foreign tax credits provisions to offset or reduce double taxation in the other country.
Immigrants to Canada are deemed to have acquired capital assets owned at the date of immigration at FMV at that date. This is much fairer than the U.S. rule. The FMV on arrival in Canada will be the basis against which gains will be subsequently calculated for Canadian capital gains tax purposes. Excepted from this rule is Taxable Canadian Property owned by the immigrant on the date of immigration which includes: 1) real property situate in Canada; 2) capital property used to carry on a business in Canada; 3) certain shares in public corporations; and 4) any Canadian resource property
The Canadian and U.S. governments are freely exchanging information as part of reciprocal assistance to enforce the tax laws of the countries. The U.S. has built up a huge computer database of real property transactions in the U.S. Revenue Canada has access to this information. Conversely, there are an estimated 250,000 residents of Ontario who have U.S. citizenship OR are deemed to be U.S. citizens if born in the U.S. The I.R.S. now has access to Canadian data. The I.R.S. has been recently mandating that these U.S. citizens - - ‘Overseas Filers’ of U.S. taxes - - satisfy U.S. tax compliance rules and file the current U.S. return along with the prior 6 years’ worth of filings. Only a small fraction of U.S. citizens in Canada have been complying. Under the Canada/U.S. Tax Treaty, each country will exchange full information and will act reciprocally in collecting tax balances for the other country.
A recent controversy has arisen over those Americans living outside the U.S. who, aside from the Overseas Tax Filings to the IRS, have not done the informational filing of the “Foreign Bank Account Report” (FBAR) filed annually in the U.S.,The FBAR requires an annual filing declaring all accounts including RRSP, TFSA, RESP, trust, investment, pension and bank accounts. You must identify the institution, the account number, type of account and provide the highest balance in the year. Even though this is a mere informational filing purportedly intended to track tax evaders - - as though they would include secret accounts in the filing???? - - Americans in Canada and around the world who are delinquent in filing FBARs are facing a 25% penalty on the highest balance in EACH account since the year 2003. Again, that is a 25% penalty on the HIGHEST BALANCE in every account since 2003 for the simple failure to file FBARs. An amnesty on late filers expired on September 8th of 2011. The vast majority of U.S. citizens in Canada are delinquent.
Jim Flaherty, our Minister of Finance, had the courage to fire off a strong letter to the U.S. government that this would be a draconian practice and catch honest tax-filing American citizens living in Canada. He correctly pointed out that the intention of this compliance requirement was to track tax evaders, the bad guys such as those caught in the Swiss UBS scandal with millions stashed away in that bank with the active assistance of UBS. It was never intended to target honest, tax-compliant American citizens living outside the U.S. Good on you Flaherty!
The U.S. Ambassador to Canada made an announcement that some relief might be made available. He announced that U.S. citizens who are “tax-compliant” in Canada - - which means filing accurate Canadian returns and declaring their world income - - could be allowed to get current on their Overseas filings which declare world income in their U.S. 1040 personal tax filings and pay any outstanding taxes and interest and who also complete the FBAR filings back to 2003 MIGHT be waived from the 25% penalties on delinquent FBAR filings. By 2013, the IRS has moved to a position of requiring only the last 6 years of tax returns and FBARs but has not set out what relief will be given on the 25% penalties. Americans filing the 1040 Overseas filings get an employment exemption if working and can use Canadian taxes paid for the purposes of a foreign tax credit on employment, pension, investment and other income. High earners will still face a tax bite as, beyond a certain level of taxable income, they can use foreign tax credits to offset only the first 90% of Alternative Minimum Tax (AMT). AMT is a 26% tax on income beyond a certain threshold. Once over the threshold, Canadian taxes paid eliminate only 90% of the 26% AMT rate leaving a 2.6% AMT liability for high earners. That is $260 (U.S.) of tax for each $10,000 (U.S.) of income above the threshold. The AMT threshold cuts in at a much lower point for retirees. Yes, it is complicated but our firm does U.S. 1040 returns, U.S. 1040 NR (Non-Resident) returns and the FBAR informational filings. Call us and we can explain it to you.
This ‘scandal’ is still to be resolved so watch the press and other media for developments from the U.S. end If the I.R.S. does start levying the FBAR accounts with a 25% penalty, there will be hell to pay with American citizens living in Canada, with the Canadian government, with the media and a lot of U.S. Senators and Congressional members will get angry demands from Americans in Canada demanding relief. A 25% penalty would put a big hole in investment accounts and amount to the U.S. taxing Canadian pension, RRSP. RRIF and even bank accounts and, in the long run, there would be a big decrease in Canadian taxes collected from Americans living in Canada as their wealth and income generated therefrom would drop.
V. TAX PLANNING
Taxpayers may come forward and correct inaccurate returns or declare amounts previously undeclared and avoid penalties and prosecution. This relates to both personal tax and HST filings. A disclosure is only valid if 4 conditions are met:
- The disclosure is voluntary;
- The disclosure is complete;
- That it involve the potential application of a penalty; and,
- That it involve information more than one year overdue.
A fifth related condition is that the disclosure must be made before the CRA has started any review of the relevant tax filings or issued any demands for filing of the tax or HST returns in question, If the disclosure is accepted, the taxpayer must pay the taxes calculated plus interest but avoids penalties and prosecution. Lawyers at our firm do VDP applications and we know that there is virtually no risk of the application triggering prosecution, fines and jail as some law firms are stating COULD happen. This is a tactic to scare a taxpayer seeking VDP relief into paying exorbitant and unjustified fees. The CRA is happy to get taxes plus interest but you will be in serious trouble if you do not give full disclosure or falsify information which defeats the entire VDP process.
A disclosure is made using the RC199 E “Taxpayer Agreement Voluntary Disclosures Program” by completing it and submitting supporting documentation. You can do a “No-Name” disclosure through a lawyer who can obtain the relief without naming the client based on solicitor-client privilege. If you use an accountant, who lacks solicitor-client privilege, the CRA can then compel the disclosure of the name of the applicant and compel the accountant to give evidence as to any discussions with the taxpayer/ applicant.
You can request a review of a rejected application to the Director of your local Tax Services Office (TSO). If done as a “No-Name” disclosure and relief is refused, you can continue to hide under your bed and hope that the CRA does not identify false information in a return or undeclared revenue.
Defer income and accumulate tax-free. The `lag' formula is 18% of the prior year's EARNED INCOME to a maximum of $22,990 by 2012 and then pegged to the Consumer Price Index thereafter. Unused RRSP eligibility may accumulate since 1991 and be carried forward indefinitely. Hope for an inheritance. Those who turn 71 in 2013 will have to convert RRSPs to RRIFs or annuities by the end of the year. The 2009 federal budget raised the amount that can be drawn from an RRSP under the Home Buyers Plan for first- time buyers from $20,000 to $25,000 for each purchaser.
Between spouses, the taxpayer in the higher bracket should use their RRSP eligibility room first. The lower earner should make RRSP contributions only after the higher earner has used up all of their RRSP eligibility. To equalize, the higher earner can make spousal contributions with the higher earner named as the “contributor” and the lower-earning spouse into whose RRSP account the RRSP contribution is made is the “annuitant”. When spousal contributions are made - - say $10,000 - - the money must remain in the recipient’s RRSP account for the year of contribution and the subsequent 2 years. If the taxpayer who received the $10,000 spousal contribution withdraws $12,500 the next year after the contribution, the first $10,000 would be deemed RRSP income to the original higher-earning contributor under the “attribution rules”. The lesson is to leave the money in for the 3 years and then any withdrawal is not attributed back to the original contributor.
RRSP loans are not deductible. Emphasize repayments of non-deductible loans first while leaving deductible loans intact. Sell stocks/mutual funds to buy a larger home or invest in real estate then borrow to buy stocks/mutual funds at a later date which creates a situation where interest costs are fully deductible.
If emigrating, timing is important. If you leave on January 15th your income could be very low although you would only get a pro-rated personal non-refundable tax credit. Nevertheless, you could fall within the low taxes in the first bracket which is to $43,561 for 2013 at a tax rate of only 20.05%. You could make a withdrawal before emigrating to top up your income to the $43,561 figure. Any remaining RRSPs must be designated as “Non-Resident” RRSP accounts and can be left intact. In the next full year after emigrating, RRSP withdrawals are taxed at a flat rate of 25% - - you net 75% as a non-resident withdrawing from your Canadian RRSP. You do not have to file a return on such withdrawals which means you will not face paying taxes at the higher rates of 33.33%, 43.1% and 46.4%. DO NOT withdraw RRSPs if emigrating which would take your income above $43,561. Be patient and after the first full year of emigration you will pay only 25% on RRSP withdrawals and do not have to file a non-resident return.
3. TAX-FREE SAVINGS ACCOUNTS
(TFSAs) could be opened starting January 1, 2009. The income from any of the annual maximum of $5,000 which went to $5,500 in 2013 put into a TFSA ,the account is not taxed. Withdrawals are not taxed. These are only suitable for those with a mortgage-free home or who have used up their entire RRSP contribution eligibility room bur are preferable to an investment account where any income is taxed. That is, use your cash to pay down your mortgage first and to make RRSP contributions as the interest on money borrowed to make RRSP contributions is not deductible. Many taxpayers setting up TFSA accounts are buying stocks with high growth potential for tax-free capital gains. Speak to your expert money manager about under-valued stocks. A 3% GIC in a TFSA will give you only about a 1% ,to 1 1/2% real growth after inflation ,while a nice capital gain is tax-free. You can eventually roll all of your TFSA money by cashing stocks or mutual funds to make RRSP contributions or contributing “in kind” which means the actual stocks or mutual fund units are put into your RRSP and you get a contribution receipt for the FMV of the stocks or mutual funds at the time of transfer or ‘rolling over’ to a TFSA and they can continue to grow tax-free inside your RRSP. This approach is limited by the amount of your regular RRSP contribution limit.
4. THE FOREIGN ASSET DECLARATION
This is purportedly to track tax evaders. Unfortunately, those truly determined to hide income off-shore are far more sophisticated than the CRA. It amounts to an extra level of penalties if you fail to disclose or falsify your Foreign Asset Declaration on top of the regular penalties for tax evasion. The threat to tax evaders comes from the new computer system at the CRA. The new computer system at the CRA is efficient at spotting those who ‘flip’ real estate properties and the like or investors who claim the personal usage HST rebate on new homes when they should be filing for the Tenant Home Buyer Rebate. ,Those hiding income off-shore are ,in trouble since Canada is busy signing new tax treaties with ,other ,countries with major banking systems to disclose the names of Canadians with foreign accounts.
The Foreign Asset Declaration (FAD) requires a “Yes” or “No” on page 2 of the T1 personal tax return as to whether a taxpayer has over $100,000 Canadian of cash, stocks, rental properties, foreign pensions and other assets outside Canada. Personal usage homes outside Canada are excluded from being declared in the declaration. Taxpayers must then complete the T1135 form showing the allocation in dollar terms for these types of assets and the amount of related income declared in their Canadian ,tax return. It is proving to be a money-maker for the CRA. Late filers who have over $100,000 outside Canada and are required to complete the T1135 form are subject to a $100 per month late filing fee for filing after their tax deadline. We have had a few angry clients who are making full disclosure, file late and are informed of this provision. File on time.
Since 1985, net capital losses are only deductible against capital gains except in the year of death. You can do a net capital loss carry-back to the prior 3 years against taxable capital gains in those years. Business losses and rental losses are deducted against all other income in the year incurred to reduce “Net Income” in the year to NIL and, since 2004, may be carried back 3 years and forward 10 years. You must file by your tax deadline to complete the required T1A form and do a net capital loss or business loss carry-back against taxable capital gains in the 3 prior years for net capital losses and against any income in the case of business losses. This is advantageous if you were in the highest 43.1% or 46.4% bracket in the 3 prior years.
6. LEGAL AND ACCOUNTING FEES
You can claim accounting costs related to tracking investments as a “Carrying Charge” in Schedule 4 of your personal tax return. You can also claim “Investment Counselling Fees” and interest on loans or ‘margin trading’ as a “Carrying Charge” in Schedule 4. Self-employed taxpayers and commission employees can claim accounting/legal costs of a tax preparation in the self-employed statement or Form T777 for employees. The rules on legal costs are stricter. Legal and accounting costs relating to CRA audits and appeals are fully deductible. If you are self-employed, claim the cost in your business statement - - the T2125 statement - - to recoup the 13% HST paid. Legal fees incurred to collect salary owed to you or in action for severance, a retirement allowance or to pension income where your legal fees are not ordered to be paid by the defendant to the action are deductible but only to the limit of the amount that would be treated as employment income or pension income. In a bad result in such a lawsuit, your legal fees could exceed the severance awarded and would be limited to the amount of the severance. The deduction of legal fees is also reduced to the extent that you roll over any retirement allowance or pension benefit to an RRSP so there are many restrictions.
You may also deduct against employment income legal fees related to an action to establish a right to collect insurance benefits for sickness or accident under a policy provided by an employer. You need not win the action to deduct the legal expenses which was set out in the Federal Tax Court decision of Fortin v. The Queen. The Loo decision of the Federal Court of Appeal concluded that legal costs were deductible where the taxpayer failed in a lawsuit claiming higher wages for work performed.
Legal costs to obtain taxable alimony or maintenance payments - - “spousal support” - - are deductible as are fees in actions to increase support. As of December 5, 2000, legal fees incurred to obtain child support payments under the Divorce Act are deductible even though child supports payments became non-taxable from May 1, 1997 and, further, since 1996, legal fees for the enforcement or defense of child support payments are deductible. This area is somewhat gray and the possibility remains that the CRA will fight the deduction of legal fees attributable to issues of child support. There is yet to be a definitive case. The bad news is that legal fees for taxpayers defending against an action for alimony/ support or for increased support and fees related to child support are non-deductible. This seems unfair but clear.
7. GENERAL ANTI-AVOIDANCE RULE (GAAR)
Every transaction may be challenged by CRA as done PRIMARILY for tax reasons and not for business purposes and disallowed under the General Anti-Avoidance Rule (GAAR). Get advice before getting too clever in your tax planning. There is a famous Supreme Court of Canada decision which states: “It is the right of every taxpayer to aggressively attempt to minimize their taxes.” Go aggressive on the vehicle and home-office deduction as discussed in our bulletin. Put spouses and children on payroll according to the rules for income-splitting. You can see a discussion of this under the “Salaries, Payroll/Casual Labour” expense heading for self-employed real estate agents.
8. PENSION-SPLITTING & OAS CLAW-BACK
An important recent change which started with the 2007 personal tax return was the right of spousal couples - - married, common-law or same-sex - - to PENSION-SPLIT. This can be an extremely generous provision. Private pensions, foreign pensions and RRIF withdrawals may be split up to 50-50 between spouses. This is of critical importance where the higher earner is in the top two brackets at 43.1% and 46.4% tax and they can split pension income down to a spouse in the lower tax brackets. The tax savings can amount to almost $10,000. The claw-back zone on Old Age Security payments for 2012 started at $68,562 with benefits clawed back at a 15% rate or $150 for each $1,000 of income over the threshold and the full Old Age Security Benefits are clawed back at $111,667of net income. The maximum OAS benefits in 2012 was $6,511. Your “effective tax rate” for those receiving OAS with high income is $33.3% + 15% or 48.3% for income from $69,562 to $87,123 and on income from $87,123 to $111,667 the total is 43.1% + 15% or 58.1%. THE OAS CLAW-BACK IS A DISGUISED TAX. The pension spilt can thus take half of the pension income to the lower earner at 20.05% or 33.3% taxation and reduce or eliminate the OAS claw-back for the higher earner. So, lower taxes AND up to $150 saved for each thousand dollars of OAS claw-back where applicable. This is a great provision for pensioners.