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January 22, 2018 | The ugly truth

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Like a lot of people in her oily city, Tina can’t sell her condo. Well, not for what she thinks it’s worth. Or what she paid ($380,000). So when she moved into Bryan’s place (a semi) she decided to rent it. The going rate is $1,300 for a one-bedder, which she got.

But, oops, the mortgage costs $1,400 a month, plus $150 for property tax, $100 for insurance and $320 for condo fees. Tina’s negative almost seven hundred bucks a month, since she bought with a lowly 5% down. “Never thought I’d be in this position,” the car dealership (Ford) saleslady says. “But at least I can write all of that off and wait until the market comes back, right?”

It’s a common thing. About to get more so. Right across the country rents have failed to keep pace with house prices. Landlords almost everywhere subsidize their tenants, with most willfully blind to the impact this has on their net worth. Now that the big years of capital appreciation are behind us, just saying, ‘the tenants are paying the mortgage’ means little when cash flow is in the red and the property’s value is stagnant or declining.

There are two things worth remembering: first, rents are considered income and taxed that way. Just like your salary. Worse, rental income is added on top of other income sources (like employment wages), and can easily nudge you into a higher bracket. Sucks. This stands in sharp contrast to the favourable tax treatment accorded to dividends and (especially) capital gains. The highest tax rate anyone pays on a cap gain (on an ETF, for example) is 25%, as opposed to a potential 53% on rent.

Second, Tina may be in for a surprise thinking she can wipe away her bad decision by deducting perpetual losses from her car dealership earnings. Judging by comments posted on this non-deductible blog yesterday, many landlords think all losses are write-offs. Just like in delusional Australia.

So let’s review the law.

First, the good news. Here’s what the CRA says about subtracting negative rental cash flow from the income you receive from other sources (like your job):

Rental losses
You have a rental loss if your rental expenses are more than your gross rental income. If you incur the expenses to earn income, you can deduct your rental loss against your other sources of income.

Now the bad news, part one:

Renting below fair market value
You can deduct your expenses only if you incur them to earn an income. In certain cases, you may ask your son or daughter, or anyone else living with you, to pay a small amount for the upkeep of your house or to cover the cost of groceries. You do not report this amount in your income, and you cannot claim rental expenses. This is a cost-sharing arrangement, so you cannot claim a rental loss. If you lose money because you rent a property to a person you know for less money than you would to a person you do not know, you cannot claim a rental loss

And here’s the rest:

When your rental expenses are consistently more than your rental income, you may not be allowed to claim a rental loss because your rental operation is not considered to be a source of income. You can claim a rental loss if you are renting the property to a relative for the same rate as you would charge other tenants and you expect to make a profit.

The key words here are “source of income” and, of course, “profit.” The logic is simple. If you invest in something to create taxable income (a profit) then the CRA will let you deduct costs which exceed that income for a reasonable time – until profitability is achieved. If there’s no expectation of profit because no tenant will pay enough to carry your condo, ever, then tough. The CRA has every right to (and may eventually) disallow the losses/expenses you wrote off against your salary.

And who decides what a reasonable period of time might be to allow them? Guess. It’s not the taxpayer.

Moisters may think rents are extreme in YVR or the GTA, but it’s still impossible to buy a downtown condo with a small downpayment and be cash-flow positive on rent. The only way the part-time landlord is ever going to break even is if she has paid down most of the financing and has a huge whack of equity. But then it’s just a crappy investment – the equity makes nothing and the rental income’s fully taxable. If the unit’s not appreciating, this was all a bad idea.

Well, during the boom last year stats showed just over 50% of new condo units selling in the GTA were going to people with no intention of living in them. Some were flippers and speckers. Most were likely starry-eyed ‘investors’ who believed they could find tenants to pay down the mortgage, write off monthly losses, and end up with something that would make them rich. When those units are built and available in another year or two – especially now that the CRA’s tracking them – the whining and moaning will be deafening.

Rental math. Say, did Brad Lamb mention any of this?

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January 22nd, 2018

Posted In: The Greater Fool

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