Real estate investments are an incredible vehicle that can generate substantial returns. However, like other sources of income, taxes can significantly diminish your net profits. For existing or new real estate investors, being tax efficient can help keep more money in your pocket so you can crush those financial goals!
The hottest topic in 2024 in Canada has been the changes in capital gains rules which by all accounts are still being worked through. The new proposed rules have increased complexity, created differences in individuals versus corporate tax treatment, and are punitive.
For those that aren’t familiar a capital gain is the difference between the selling price and the cost you paid to acquire a capital asset in this case real estate. When holding a real estate investment you would pay tax on income generated as well as a tax on the gain from selling the property.
Real estate investors whether new or seasoned need to be aware of the rules and use strategies to minimize taxes to keep more of their profits. The following are three tax strategies that you can incorporate into your real estate investments to help manage your capital gains tax exposure. Please note before implementing a tax strategy it is important you seek professional advice. Our team at Finalyze CFO Services would be pleased to help!
- Maximize your Cost Base – In order to help reduce your capital gains exposure ensure you have reviewed the eligible items you can include in your cost base to ensure costs related to the acquisition of the property are capitalized as well as improvements to the building. All things being equal the higher the cost base the lower your capital gain. Be sure to have someone go through your past records and ensure everything that is eligible is captured!
- Land and Building Allocation – Another consideration is the land and building allocation when setting up your building on your tax books. Land is a non-depreciable asset and isn’t eligible for Capital Cost Allowance (CCA) while a building is. CCA is a tax deduction that lets you write-off a portion of the building’s cost over the life of the property while held. Typically folks will use a recent property tax bill to split their purchase price between land and building. For larger investments we would recommend having your appraiser provide this split based on their expert knowledge of the property. If too much of your purchase price is allocated to the land you will reduce the amount of CCA you can claim over the life of the investment.
- Preserve your Principal Residence Exemption – There are tax complexities with renting out your personal home for income purposes that can impact your principal residence exemption or moving between homes. In Canada, the principal residence exemption allows a a principal residence to not be subject to capital gains under certain conditions allowing you to build wealth in your main home and potentially cash this out at a later date as part of being an empty nester or retirement. Before you take on a strategy please watch out for an impact on your principal residence exemption!
- Utilize Capital Losses– It is important to ensure your tax filings are up to date and that capital losses incurred in the past are tracked and more importantly utilized. You may be able to apply these losses against capital gains generated while savings a considerable amount of tax.
- Minimize CCA to Avoid Recapture – The last few years have had higher interest rates and other costs which likely created minimal taxable rental income for many real estate investors. Capital cost allowance (CCA) is essentially tax deprecation allowing you to write off a portion of the building while it is being held for income. When selling a property with a capital gain the CCA deducted in prior years is actually recaptured into income forcing you to pay tax on it. To avoid this issue make CCA your absolute last deduction to be taken and instead use other related expenses. Working with an experience real estate accounting and tax services provider can help manage this for you.
The above only scratches the surface of tax strategies and considerations that need to be considered when managing the capital gains. They require careful consideration, and the viability of their application is dependent on your personal circumstances.
Instead of trying to do all of this intricate planning yourself be sure to reach out to our team at Finalyze CFO Services for help! We work with real estate investors, land developers, and investment funds to help them with financial advisory, accounting, and tax services. Our specialized expertise in the real estate industry allows our firm to provide tailored solutions to help you crush your financial goals!
To learn more about tax strategies to help you keep more of what you earn, click here for a complimentary consultation with our team.