Recently Erwin and I got to take a tour of our friend Monica’s commercial plaza nearby at Bracebridge. If you are familiar with the real estate investment strategy BRRR (Buy Renovate Refinance Rent), that is what she and her husband are doing in this property.
She’s had this property for over 2 years now. The property was a power of sale and she got it at a really good price.
A great price also came with a lot of work – a collapsed roof, mold issues, asbestos, vacant commercial units, etc.
Needless to say, no bank is interested in financing this property, so they chose the beforementioned BRRR path to make it work.
Except that the numbers aren’t quite what we handle on a daily basis.
Renovation is over $1million and it is still going.
So, what are the tax considerations they need to consider when they use ‘Buy Renovate Refinance Rent’ in a commercial property?
HST impact on substantial renovations
If you are renovating a residential property (even if the residential property is a part of commercial property), you may have an HST impact on the renovation.
If you do the substantial renovation on a residential property (or on the residential unit of the commercial property), you are required to do a self-assessment and pay HST to CRA.
If you simply renovate (not substantial renovation) a residential unit in a commercial unit, make sure you separate the HST related to the residential unit renovation. You cannot claim the HST you pay on the residential renovation as a credit on your HST return.
HST exposure, if converting the commercial unit to residential units
If you are converting a vacant commercial unit to residential units, you are required to do a self-assessment on the fair market value of these residential units.
You have to pay CRA the HST on the fair market value of these residential units.
Make sure you account for these extra costs before doing the conversion.
HST audit
When you are doing a substantial renovation on the property, you can claim the HST you paid to purchase materials and your contractors on your HST returns as Input Tax Credits.
If the HST you paid is greater than the HST you collect, you are claiming a refund.
Sometimes, this amount can help with cash flow.
But more often than not, this also means that you likely will get an audit.
If you’re asking for a refund on your HST return, be prepared for an audit.
Soft costs incurred during the renovation period is not an immediate expense
Major renovation costs are usually not a one-time write-off expense.
Soft costs, including carrying costs, interest expense incurred prior to the property being rented. If you have only a portion of the units ready to rent, then only that portion of the expenses can be deductible.
Cash flow consideration
My friends aren’t extremely wealthy. They made good money with a lot of hard work.
But the amount of money involved in bringing this property from distress to the current stage can break many people’s banks. That was how the previous owner got this property foreclosed as well.
Although this is not a tax consideration, it is worthwhile mentioning that you do need to have the financing ready for the renovation, including the carrying costs of the property.
Doing a month by month budget would help you prepare for the worst case, and plan to get more credit.
Here’s a small video I did at her property.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Real Estate Accountant, Wealth Hacker