So you’re interested in getting into real estate, and considering a rental property; either a longer-term rental, short-term AirBnB or VRBO rental. You’ve researched the perks, and with the extra income and additional equity, you’re about ready to take the plunge and invest.
However, what about taxes? Will owning a rental property give you any kind of tax breaks or advantages?
Let’s answer that question by breaking down the facts.
When you initially purchase a rental property and then invest funds into managing it with a tenant, you have quite a few expenses adding up. These include advertising the property, legal costs for the purchase, repairs, renovations and general maintenance fees, and finally, property taxes (which are ongoing). That’s not all! You’ll also need to acquire home insurance.
All these expenses help you out fiscally, by reducing your taxable income. Both the rent you collect, and these collective expenses, are tax-deductible. Let’s say you collect $3000 in rent and spend $2000 on expenses incurred. The difference between the two–$1000–is considered income and will be taxed once it’s declared. So in this way, you’re getting a tax break.
We should talk about another related scenario. You might find yourself in a situation where you’re losing money on your property because the rent you’re pocketing isn’t able to cover your expenses. While this situation would technically help you with your taxes, that’s not an ideal scenario whatsoever. If your rental property isn’t profitable and you can’t cover expenses with your rental income, then it’s time to rethink your investment.
Bottom line? Keep your property profitable and claim all the expenses you can to minimize your taxes.
Just like a car’s value drops as soon as you drive it off the lot, properties are similar. Buying an older property means that with time, you’re going to see increasing maintenance needs. The roof will need replacing, the physical structure will need repairs and will eventually lose value. Even if the property itself increases in value, the structure won’t; and that depreciation will save you money on your taxes.
It’s important to work with a qualified tax accountant to get this balance right. There is also a caveat: if your property goes up in value, which you want from an investment standpoint, you’ll have to pay back part of the taxes you saved when you sell it. In other words, depreciation is an effective tool for deferring taxes indefinitely–you’re merely deferring your taxes to a later date.
So, if you take advantage of the tax deferral, pay less tax today, and reinvest it wisely, it’s a plan that can really pay off in the long run.
Make use of that! What you don’t want to do is take the money you save from property depreciation and spend it on something that isn’t going to make you money and get a decent return on your investment.
Mortgage and Financing
Choosing your financing carefully can be a huge help in lowering taxes.
One of the many expenses on the CRA form T776, here in Canada, is your interest expense; and that comes from a mortgage or a home equity line of credit. If you take a traditional mortgage, you are making a combination of principal and interest payments.
So you’ll need to do some math and figure out how much of your monthly or bi-weekly payment is actually interest. Why? Because the interest amount is an expense that you can deduct, which means it’s going to lower your taxable income.
A Final Thought
When it comes to minimizing your tax load, keep in mind that what you really want in a property is for cash to flow, because the higher the cash flow, the more you can get out of the property (and the more you have leftover to reinvest in another property).
So while there are deductions that you can write off on a rental property that you buy, you need to balance that with the profitability of the investment itself. In a nutshell, don’t buy a property just to show a loss on it for the sake of saving taxes…because your savings and taxes are always going to be less than the loss or gain that you make.
So those are the things that will help you in deciding how to maximize your tax breaks–whether you amortize or depreciate, the type of financing that you choose, etc. Those are critical factors in determining your fiscal outcome.
If you have any questions, or if you’d like a template for analyzing your rental property or analyzing a property that you are about to buy, Grow Your Wealth is here to help! Contact us today, and we can get you set up as well as calculate some of the returns that you can generate from a particular rental property.