Are you a homeowner who is renting out your basement to earn some extra cash? Have you purchased an apartment with the intent of earning rent? In both scenarios, you are a landlord who collects rent from tenants at the market value to earn a profit. The Canada Revenue Agency (CRA) requires you to report all types of income in your tax returns, including rental income that is 100% taxable. A failure to report this income could lead to penalties and interest on taxes owed. In some cases, it could even trigger a CRA audit.
How you report the rental income will determine your tax liability.
What Is Rental Income?
To report rental income, you should establish a landlord-tenant relationship with a proper rent agreement. You can earn rent on the property you own or have the legal right to use and rent out. It means you can manage a property on behalf of the owner or lease a property and sublet it. Depending on what services you offer, the income from property will be classified as:
- Rental income – when you only provide space and basic services, such as heat, light, parking, and laundry facilities
- Business income – when you provide additional services, such as cleaning, security, or meals.
The type of income will determine which form you have to fill out for your tax returns.
- Form T776, Statement of Real Estate Rentals for rental income, and
- Form T2125, Statement of Business or Professional Activities for business income.
Can renting property to spouse, children, or siblings be considered rental income? It depends on the rental arrangement. If you are leasing the apartment to your children at below market rate or the payments are informal and only cover household expenses, you cannot show that as rental income. Remember, the payments should be formal, at market rate, with an intent to earn profit.
How Rental Income Works?
When you rent a property, you form a legal agreement, collect rent, and security deposits. You also incur expenses pre- and post-lease, and bear losses if the property remains vacant or the tenant defaults.
Being a landlord is equivalent to running a business. You advertise your property, pay brokerage, property tax, home insurance, legal costs, file taxes, pay for repair and maintenance, and sometimes incur capital costs to improve the useful life of the property. The CRA gives you the benefit to deduct all the above expenses incurred to earn rent from your rental income.
While some expenses, like property tax and home insurance, are straightforward, others are slightly more complex.
- Interest and bank charges: The CRA allows you to deduct interest on the mortgage you took to purchase a rental property or to fund the capital expenditure to improve it.
- Bad debts: Like a business owner, landlords also incur bad debt if the tenant does not pay rent. To claim the unpaid rent as bad debt, you need documented proof that shows the rent is uncollectible, such as a notice of bankruptcy or your correspondence with the tenant that shows you made reasonable efforts to collect the rent.
- Rental loss: You may incur a loss on rent due to bad debt or rental property remaining vacant despite reasonable efforts to rent it out. You can deduct this loss against your other sources of income.
Like all businesses, you should document and safely keep all receipts for six years after the end of the tax year to validate your rental expenses in case the CRA asks.
How To Report Income and Expenses from Rental Properties?
Once you have established a formal rental agreement, incurred expenses, and collected rent, it is time to report them on your tax returns.
Reporting gross rental income: The CRA requires you to report gross rental income in the year you received it. If you receive the January 2025 rent in December 2024, then you report that rent in your 2024 tax filings. You can collect rent in cash, kind, or services, wherein you must report the fair market value of that service as income.
Deducting allowable expenses: You can deduct the allowable expenses from the gross rental income.
- Current expenses, such as maintenance and repairs, can be deducted as incurred.
- Prepaid expenses, such as home insurance, can be spread over the coverage term. For instance, you purchase $1,200 annual insurance in October 2024. You can claim $300 in the 2024 tax year and the remaining expense in the 2025 tax year.
- Capital expenses, such as renovations or the installation of new heaters or dishwashers, should be added to the property cost and depreciated according to CRA’s capital cost allowance (CCA).
- Renting a portion of your home: If you are renting only the basement of your home, then you can only deduct that portion of expenses from rental income. For instance, if you have a 1,000 sq ft. apartment and you rent a 200 sq ft. space, you can deduct 20% of all the eligible expenses.
Calculating taxes: After deducting rental expenses, you will arrive at net rental income, which is added to your total taxable income for the tax year. The Canada Pension Plan (CPP) is deducted if rent is classified as business income. Otherwise, only tax is deducted from the rental income as per the tax bracket your income falls under.
Things to Consider While Reporting Rental Income
The above scenario is a typical case of a rental property owned by a Canadian resident. However, in real life, different cases could change your rental income reporting.
- Renting Out a Portion of Principal Residence
In Canada, principal residence is exempt from capital gain tax. If you earn rental income from your principal residence, the CRA could consider it a “change of use” for your house, limiting your tax exemption if you sell that house in the future.
You can avoid the “change of use” and preserve the principal residence exemption by renting only a small part of the house without making any structural changes and not claiming the CCA portion of the rental unit. However, you can still deduct current expenses such as maintenance and utilities.
- Co-owned Property
If you own the rental property jointly with another person, you can divide the income and expenses in proportion to your ownership. If Amy and Anna own 60:40 of the property, they will divide the rental income and expenses in the same proportion. If the co-ownership is with a spouse or common-law partner, the proportion is likely to be 50:50.
- Non-Resident Canadian
If you are a non-resident Canadian earning rental income from Canadian properties, your tenant will withhold 25% tax on the rental income. To claim rental expense deductions, you must file a Section 216 return by June. You could also consider filing Form NR6 to reduce the withholding tax rate on the net rental income after expense deduction. In this case, you must file Form T1159 before June, irrespective of tax liability.
Contact Black and Gill LLP in Etobicoke, Toronto to Help Landlords File Their Income Tax Returns
A professional accountant can help you with the paperwork and tax filing, ensuring multiple sources of income are reported accurately. At Black and Gill LLP, our accountants and bookkeepers can provide services such as tax filing and tax planning. To learn more about how Black and Gill LLP can provide you with the best accounting and bookkeeping expertise, contact us online or call us at 416-477-7681.