Know your tax bracket and maximize your income
Real Estate Investors know that when they make income from their property, the taxman will come knocking. Do you know how much you owe? Depending on your level of income and real estate value, you may be in for a surprise come tax time. Look at the two examples below and you’ll see how generating income and selling property can have separate effects on your taxes – or compound to create a complicated situation.
First, if you own a ‘Buy and Hold’ property and you’re collecting rent, every year you need to declare the income that you generate as rent on your tax return. You do get to write off several expenses and some of those include your mortgage interest, property taxes, property maintenance, any utilities that you pay and any depreciation. You want to be reasonable; there are many line items that the CRA will let you use and you need to make sure that your expenses are legitimate.
What remains after you take your rent and you subtract all your expenses is your taxable income. Your taxable income is then added to your income from work, business or other sources and you now have to pay tax on that at the full tax rate, your full marginal tax rate. In Canada, there is a graduated tax system and the more money you make the higher percentage of tax you’ll be asked to pay. For example, if you have salaried income of $60,000 from your job and you add on another $10,000 of rental income, now you have $70,000 of income in that calendar year. The extra $10,000 may raise you to another tax bracket – so often it’s more prudent to make less rental income from your income property to stay in a lower tax bracket. Remember that tax is also an expense because income tax continues yearly.
Second, there will be taxes related to your real estate investments when sell a property. If you purchase a property for $100,000 and you sell it for $200,000, it means you’ve made $100,000 in capital gains. So how is this reflected on your tax return? Include half of the capital gains in your tax return! In Canada, there’s a 50% inclusion rate; take the $100,000, halve it, and add the remaining $50,000 to your taxable income. To summarize, in this example year, you had $60,000 of salaried income and $10,000 of rental income net of expenses. Since you sold the property for a $100,000 net gain, you would now add that $50,000 to the $70,000 of income that you already have. Now you have $120,000 of income for the year and that’s what you’re going to pay tax on. Since your income has now jumped from $60,000 or $70,000 all the way to $120,000, this means that that additional $50,000 will be taxed at a higher marginal tax rate than your regular income.
It’s never too late to learn the ins and outs of the Canadian tax system and put your knowledge to good use. If you’d like to chat about how to plan for your investment home purchase, please fill out the questionnaire below, and we’ll be happy to connect with you about your long-term goals.
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