For individuals who are currently renting out or considering renting out a portion of their home, navigating the tax implications can be intricate and the consequences can be expensive if proper precautions are not taken. Generating income through renting out a part of your home may entail diverse rules and reporting obligations to the Canada Revenue Agency. As you delve into the various considerations, even minor rentals can become complex. The subsequent are fundamental recommendations for those renting out a unit within their own home.
Essential Steps for Renting Out a Unit in Your Canadian Home
Before renting out a portion of your Canadian home, it is crucial to adhere to certain guidelines.
Step 1: Set up a legal rental.
While it may appear straightforward to rent out a basement or room, there are specific regulations to consider. Residential leasing is highly regulated, necessitating a separate living space with a bathroom, kitchen, and adherence to municipal and fire codes. For instance, in a basement rental, windows must be large enough for a person to exit.
Rentals require a lease agreement detailing rent and basic services such as heat, light, parking, and laundry facilities. It is essential to avoid creating a lease agreement yourself as the government requires standard forms to be utilized. Failure to comply may result in breaking landlord and tenant regulations, leading to issues with the CRA.
If the potential tenant is a student, it’s wise to add parents as guarantors on the lease agreement.
Key Considerations for Handling Rental Income in Your Canadian Home
Step 2: Understand the details of rental income.
It’s crucial to determine if the income generated from renting out a space in your home should be reported as rental or business income on your personal tax return. This classification will impact how you claim expenses and other tax considerations, as each requires different tax treatment and filings.
If the homeowner is offering additional services, such as cleaning, security, or meals, the income may be classified as business income. This is more likely to be an issue if the property is offered on a short-term basis, similar to a bed and breakfast.
Understanding Change in Use Rules for Renting Out a Unit in Your Canadian Home
Step 3: Familiarize Yourself with Change in Use Rules.
Renting out a space in your Canadian home may trigger a change in use of that area, resulting in a deemed sale. This can be problematic in terms of cash flow, as unlike a regular sale, there are no cash proceeds to pay tax liability.
You must pay tax on a gain for which you have received no cash proceeds. The government usually does not consider it a change in use if three conditions are met: the space is small compared to your home, no structural changes are made, and you are not claiming tax depreciation called Capital Cost Allowance (CCA) on your rental income, renting out a unit.
If you meet these criteria, there will be no deemed disposition, and no sale needs to be reported on your T1 form. Moving forward, you must report rental income and expenses on Form T776 of your T1 Personal Tax Return. Moreover, when you eventually sell your home and meet these three conditions, the entire property generally qualifies for the principal residence exemption.
Step 4: Claiming Rental Income and Expenses on Your T1
When reporting rental income on your tax return, you must include all rent payments received and deductions for allowable expenses. However, it’s important to ensure that the expenses you claim are reasonable and incurred specifically to generate rental income.
You will also need to determine whether an expense is a current or capital expense. Repairs and maintenance are usually considered current expenses, while improvements that have a lasting benefit, such as structural renovations, are considered capital expenses and must be claimed over time by using the capital cost allowance (CCA).
It’s important to avoid claiming CCA if you want to avoid a deemed disposition of the space you’re renting, which could impact your ability to claim the principal residence exemption when you eventually sell your home.
Furthermore, GST/HST is not charged on long-term residential rentals, but it will need to be collected on short-term or occasional rentals lasting less than 30 continuous days.
Ensuring that you have accurate documentation for rental income and expenses is crucial when renting space in your home, as the rules surrounding it can be complex. It’s easy to overlook important details when filing your tax returns, so it’s recommended to review everything with a qualified tax professional before submitting to avoid claiming unwarranted expenses.
Renting out space in your home can become even more complicated during a potential change of use or when selling the property. It’s advisable to seek guidance from a qualified professional who can provide detailed guidance on all tax-related matters.
It’s worth noting that this article provides a general overview of tax rules, and if you require specific tax advice, it’s recommended to hire a professional accountant to ensure you’re getting the best possible assistance.