Here’s the first half of the two-part series on the best practice Real estate investors can use to set up their back office to audit shield against CRA
But before I get into this, here’s a side note.
I saw this post a while ago on my FB feed. A friend of mine wanted to “stop” Doug Ford to cut OSAP. It’s old news now, cutting teachers is the new news.
Most of us only read the news from its title/headline. If you see the title of Doug Ford cutting OSAP, I personally would be offended.
Doug is not really cutting entire OSAP, he’s only cutting grants that are made to kids who come from the wealthy background. Hence, the title probably isn’t sexy enough, so cutting OSAP as the title works, and that’s what everyone saw.
For the record, I don’t agree with all his cuts, some are necessary as this one, some are controversial.
While our government is constantly under attack to make cuts and be more financially responsible, we as real estate investors have to earn every single deduction that we take.
1. Understanding the general deduction rule
In the Income Tax Act, it specifies that you can deduct expenses that you incur to earn business income or property income, subject to a bunch of exceptions.
This means that if you incur the expenses, such as mortgage interest, property taxes, utilities, etc. to earn property income, you are eligible to deduct the expenses.
Some expenses are not so obvious, such as buying your real estate agent lunch, connecting with other real estate investors via coffee, etc.
I always tell my clients to keep all your receipts and discuss with us at the end of the year when we file your taxes.
In CRA’s eyes, you need documentation to support your deductions. No receipts, no deduction for sure. That’s low hanging fruit from them.
The minimum standard for deduction is that you need to keep the receipts, credit card statements and bank transactions don’t count.
Now that you have your receipts, have the conversation at year-end with your accountant to see if you can deduct the expenses or not. ?
2. Paper system vs. electronic system
Let’s face it. Some receipts are printed on thin glossy paper. They fade over time. When I say they “fade over time”, it’s an understatement.
They fade pretty much immediately after they’re printed from the cash register.
CRA does allow storing receipts electronically, but the storage of your electronic receipts must be in Canada.
If you save it in your back-up drive in your Miami vacation home, that probably won’t work.
A cloud-based system such as Dropbox may work, provided that the server must be in Canada. Cloud technologies may be a beneficial addition to businesses for a multitude of reasons. In the case of its implementation in Office software, visit here to see how it can extend your business’s SharePoint environment for the better.
If you’re not sure, a backup drive in your Canadian home would count.
If you opted for the paper system, no worries.
3. Folder system
Whether you are using paper or electronic system, I would suggest that real estate investors set up a folder for each property each year.
Keep all the receipts/invoices occurred during the year, such as insurance, property tax bills, mortgage statements, repairs & maintenance receipts, etc. in the folder.
If you claimed meals & entertainment expenses, make sure you keep them in this folder as well.
If you claimed home office expense, you can set up a separate folder for your home office. Keep a copy of your floor plan there.
The more documentation you have, the easier it is in the future to audit shield against CRA.
In addition to the annual folder system, I would also set up a “permanent folder” for each property.
The permanent folder would have the following documentation:
- Closing documents when you purchase the property
- Refinancing documents
- Any capitalized expenses that are used to increase the building cost
- History of the work done to the house in a summarized format, such as:
- Year of roof, contractor, warranty date, contact info of the contractor
- Year of appliances, make and model, warranty information
- Year of plumbing, contractor’s name, all related permit
- Year of electrical last updated, contractor’s name, all related permit
- Year of windows, contractor’s name, warranty, etc.
- The list goes on…
This permanent folder helps keep the important documents to manage your property and potentially refinance your property, all at the same place.
4. One bank account for one property, if feasible
I prefer one bank account for one property.
This bank account already does part of the bookkeeping for me.
- All rent related to this property goes in this account
- All expenses related to this property comes out from the same account
At the end of each quarter, all I need to do is to go through all the transactions in the bank account to see if I am making money or not.
Half of the bookkeeping is already done for me.
I can easily see how much money I am making or lack thereof.
I can make sure I take every single deduction that went through my bank account.
It’s getting long. Let’s break it down to two posts and we will share with you the remaining in the next post.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant