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Reporting losses from Rental business? These are the dangers…

deducting losses from rental business

There are many dangers of reporting losses from the rental business… I’ll explain with this story.

A couple of years back, I advised a real estate investor not to take the entire apartment renovation as a one-time deduction.

The renovation was done in between tenancies. He didn’t put much improvement except giving the unit a fresh look.

Technically speaking, he could deduct it as repairs.

I looked at it differently.

He reported multiple years of losses.  His other rental property also had a huge expense creating a bigger overall rental loss of over $50K.

He’s self-employed as well, which means that he was at a higher risk of being audited.

He disagreed with my judgement…

People generally underestimated the amount of work involved in handling an audit and the stress it would add to your life.

This recent court case in Hamilton reminded me of this client. The taxpayer owned a few rental properties in Hamilton and Stoney Creek area.

He reported rental losses from 2005 to 2011 (see below for a summary).

He rented out two properties, detached bungalows, at significantly below market rent.

He rented out these properties for $450 per month for the most part, during the questioned period. He rented one of these properties to his lease for $200 per month.

CRA presented in court that market rent as per CMHC, which we all know as real estate investors are way low, is around $850 per month during the period.

The taxpayer simply argued that his rent was charged on a net basis with the intention that the tenants are responsible for utilities, snow removal and day to day maintenance of the properties.

He stated in court that his objective for these rentals was to “recover property taxes, mortgage interest and insurance”.

As a result, he reported significant losses in multiple years.

CRA audited his tax returns and challenged that he did not intend to carry on the rental with the intention to profit.

If you’re not intending on carrying the rental activities in a commercial manner, this means that you cannot deduct the rental losses incurred.

Losses offset against his income. If these losses are disallowed, that means he must pay back all the taxes he would otherwise be liable if he didn’t have these losses.

Judge didn’t think that he was carrying out his rental activities in a business-like manner.

  • He didn’t have any actual leases signed.
  • He didn’t make any attempt to determine comparable rent being charged in the Hamilton area.
  • He also failed to increase rent even though he’s incurring a loss every year.
  • He rented out one property to his niece for $200, significantly lower than what other tenants are paying, much lower than the fair market value rent.
  • The judge concluded that the taxpayer did not provide any proof that he was conducting his rental activities in a commercial manner.

The judge dismissed the taxpayer’s appeal and sided with CRA.

Next time when you are reporting multiple years of losses – whether it is rental or business, think again.

Next time when you are renting your properties to family members and reporting losses, think again.

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant