Canada has long been a great market for real estate investors, and renting out a second property or even house hacking by renting out your basement has become common for those looking to start on the property ladder.

With capital gains taxes, mortgages, and rental expenses, tax season can become a little more complicated when you’re renting out your property.

To make things easier, let’s go over how taxes work for investment properties in Canada.

Before we get into it, you might want to check out how real estate taxes in general work in Canada, as well as how investments are taxed.

How are rental properties taxed in Canada?

When we talk about taxes for rental units, we’re dealing with two separate areas. The first are the taxes related to the income you generate from renting out your property. Whether you’re house hacking, or own a multi-unit rental property, rental income is considered taxable income in Canada, which means you need to pay income tax on the money you earn.

With that being said there are a number of ways you can lower this tax burden, by claiming expenses which will be deducted from your income. The other tax to deal with when owning a rental property is the tax on the sale of the property. If you sell a home other than your principal residence in Canada, you will need to pay capital gains tax on the profit from the sale of the property.

How rental income is taxed in Canada

First of all, when calculating how much tax you’ll pay on your rental income, it’s important to determine whether it will be classified as rental income or business income. The Canada Revenue Agency doesn’t provide strict guidelines as to what does and doesn’t classify as running a business, but usually if you aren’t providing services like cooking and cleaning for your tenants, you’ll be safe reporting it as rental income. Most investors renting out a property operate as a sole proprietorship, which means the rental income will be added to your personal income and taxed at your income tax bracket. For example if you’re making an extra $10,000 a year in rental income profit, and $100,000 at your day job, you would have an income of $110,000 to report on your income taxes, which in Ontario would mean you’d need to pay $4,378 of taxes on that extra $10,000 in income.

If you earned rental income you will need to file a Form T776 during tax season. This form will allow you to report your total rental revenue, as well as your expenses which you wish to deduct. Now here comes the important part, there are many expenses which can be deducted from your rental income to reduce your tax burden.

These deductible expenses include:

• Property taxes
• Utilities
• Insurance premiums
• Condo fees
• Professional fees (from your lawyer and realtor)
• Property management fees
• Maintenance & repairs
• Interest 

That last one is very important to remember. The interest portion of your mortgage can be deducted from your rental income, but not the principal portion. To summarize, expenses that you incur from running your rental property can be deducted from your income, but not payments that go towards acquiring assets for you like the principal payment of your mortgage or your down-payment. 

At the end of the day you’ll only end up owing income tax on your rental property if you’re cash-flow positive or close to it, which means you’re making profit on your property while paying off your mortgage. Can’t complain about that.

What tax do I need to pay when I sell an investment property?

The other time you’re taxed in regards to a rental property is when it comes time to sell. If you’re house hacking and renting out a room in your principal residence, this doesn’t apply to you as sale of a principal residence isn’t taxed. However in most cases, a real estate investor selling a second property will need to pay taxes on the profit they made from selling the home.

If you’re in the business of buying and selling properties for a profit, you will be classified as a business by the CRA and will need to pay business income tax on the profit of the sale. In most cases for a real estate investor who purchased a home to rent out and is selling it years later, it will be determined to be capital property. The Canada Revenue Agency defines capital property as property purchased as an investment or to generate income, which includes most real estate investors.

When you sell your investment property for a profit, you are considered to have a capital gain, and you will pay capital gains tax on the profit you made from the sale. If you sold the home for less than you bought it, you would have a capital loss and could deduct it from your other capital gains for the year.

Check out our capital gains tax calculator for a full breakdown on how capital gains tax works, but let’s go through a simple example.

The capital gains tax inclusion rate in Canada is 50%. This means that 50% of the profit becomes personal income and is taxed at your personal income tax bracket. If you purchased a 2 bedroom condo for $250,000 in 2010, and sold it in 2020 for $500,000 you would have a capital gain of $250,000 which means you will add $125,000 to your income tax for the year, if you earned $100,000 from your job, you would pay income tax on a total amount of $225,000 for the year, which would vary depending on the province you live in.

Disclaimer: This article should not be considered tax advice and it’s always a good idea to consult a licensed accountant for guidance specific to your financial situation.

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