Getting the most out of tax deductions re real estate

Judge Denning of the British House of Lords said it, our own Judge Bora Laskin said it and US Judge Learned Hand said it a very long time ago:

"Anyone may so arrange his affairs that his taxes shall be as low as possible. He is not bound to choose the pattern which best pays the Treasury. Everyone does it, rich and poor alike, and all do right; for nobody owes any public duty to pay more than the law demands."

Let's face it: Revenue Canada is a profit sharing entity in your earnings. Every dollar that you miss as a deduction will cost you an extra 22 to 44 per cent in income taxes. So, you have a duty to look up and claim legal deductions. There is also the question of whether you should carry your real estate as an individual investor or in a proprietorship/partnership of a limited company.

David Ingram (taxman@centa.com) feels that there is no real benefit in carrying property in a company unless you have multiple employees. You will be held personally liable whether you hold property inside or outside a company anyway. But, holding properties outside of a company gives you control of the money. A proprietorship/ partnership gives you flexibility, you can break up the mortgages to pay down non-tax deductible mortgages faster (by using your rental income first) and you can make your own personal mortgage tax deductible as well. But ask your lawyer and he will tell you that you should always set up a company. The decision is yours, but if you prefer to incorporate do not hold your investment property inside your operating company, keep it in a separate company.

For the smaller investor it is also important to remember ALL of your possible deductions:

Apart from writing off and claiming your direct property expenses, remember that you can likely write off gifts for your tenants, bankers, lawyer, real estate brokers, mentors, mortgage brokers and other such advisors. Also if you entertained some of your advisors (realtors, lawyers, etc) keep the receipts.

You claimed your insurance, but did you remember the investment condo rider on your home insurance policy?

You can pay your children to do minor repairs to your rental property such as cutting the lawn, painting or cleaning up...or even pay them if they helped with record keeping or making phone calls to your tenants or centres of influence or used the net to search out opportunities.

All your stationery, internet connection, home office, computer, cell phone, etc. is likely deductible as well. Even mundane charges such as parking meters, monthly or other parking charges are.

Remember whether this year you traveled to your meetings, schussed out buying opportunities. Remember the payments you made while attending seminars or other events that helped you earn income as a real estate investor.

Of course, your accountant or other advisors fees are deductible. Did you get professional tax advice, legal advice, etc?

It really is important that you spend the time to use all of your deductions. Then there is the fact that it is possible to write of the interest you pay on your home mortgage (using the Smith maneuver) and that for different ownership situation you may need a specific tax structure ( like in a mixed used residential/commercial building)

Most expenses missed commonly are those that are not directly linked to the property. The more properties (three and up) you own the more likely it becomes for you getting the deductions allowed. Then you are considered to be running a business.

There is also the question: "What if I lose money on my highly-leveraged condominiums?" It is true that in the past Revenue Canada ruled that you had to have 'a reasonable expectation of profit'. However there is a new test for allowable business loss income tax deductions. In a 2003 case (Stewart) a real estate investor bought four highly-leveraged condominium rental units in a managed rental pool real estate development. The projections (10-year projections) were for negative cash flow and income tax deductions and a profit in the future. However, the rental income, vacancy rates were miscalculated or otherwise not achieved. The tax department disallowed the losses on the basis that, when the taxpayer made the investment, he had 'no reasonable expectation of profit'.

Originally the investor was unsuccessful in his appeal to the Tax Court of Canada and the Federal Court of Canada. However he did succeed in the Supreme Court of Canada. The court decided that the tax department's test 'second guessed' bona fide commercial decisions of a taxpayer and resulted in "the unfair and arbitrary treatment of taxpayers."

As a result, the Court substituted a two-step test to first decide whether the activity was commercial or personal. If it was commercial, the next step was to determine if the expenses for which a loss is claimed fall within the Income Tax Act. There was no evidence of personal use by the taxpayer. The Court allowed the taxpayer's claim for losses by applying this new test to the investment.

So, there you are -. even if you did not have that dreaded 'reasonable expectation of profit' you are able to deduct 'them thar' business loss income tax deductions for commercial ventures.

In all our dealings it always is important to get good solid personal tax advice. In this new time we live in it becomes much more important to keep what we have. Every tax dollar saved, took you two to earn. So, remember the old Morgan Stanley ad: "You must pay taxes. But there's no law that says you gotta leave a tip!"

(prepared by Ozzie Jurock/Vancouver Sun)