If you have a vacation property — or are thinking of buying one to rent out — make sure you understand all the pros and cons, especially if the property is outside Canada. Talk to an accountant, lawyer, mortgage broker or other financial expert about how it may affect your taxes and your estate.
- Rental income – Use it to pay your costs, including any mortgage, and to improve your property.
- Enjoy your property – If you only rent it out for part of the year, you can still enjoy it as a vacation home.
- Get tax deductions – The rent you get is business income, so you can deduct costs against it. Example: mortgage interest.
- Increase your equity – You have ownership in an asset that may go up in value and add to your estate. if the property goes up in value.
- Pay to maintain it – It takes time, effort and money to maintain the property and manage rentals.
- Enjoy it only at off-peak times – It will be easiest to rent at peak times – when you may want to use it.
- Pay tax – You have to pay tax on rental income.
- Pay capital gains – If it goes up in value, you have to pay capital gains tax when you sell a property that is not your main home. If it becomes part of your estate, your heirs will have to pay the tax.
You must have a down payment of at least 20% of the purchase price when buying a property that is not your main home.
Renting out a U.S. property
Under U.S. tax rules, non-residents who own U.S. property and rent it out must file a U.S. income tax return and pay tax on the rental income. If you pay U.S. income tax, you can claim a foreign tax credit on your Canadian tax return.
Consider these 3 factors before you decide:
1. You have 2 options for paying U.S. tax
- Pay tax on your gross rental income – You’ll pay a 30% U.S. withholding taxWithholding tax Tax that comes off your pay or other income and goes to the government before you get any money.+ read full definition on your gross rental income. You must deduct this amount from all the rent you receive and pay it to the U.S. government each year.
- Pay taxTax A fee the government charges on income, property, and sales. The money goes to finance government programs and other costs.+ read full definition on your net rental income – You deduct certain expenses and depreciationDepreciation The amount that something drops in value over time. Example: A home may go down in value if you don’t maintain it well. A car or a piece of business equipment will go down in value as it wears out.+ read full definition from your rental income before you calculate the tax you owe. Your net rental income will be taxed at rates ranging from 10 to 35%. If you own the real estateEstate The total sum of money and property you leave behind when you die.+ read full definition jointly with someone else, such as your spouse, each of you must file. Once you choose this option, you usually can’t change your mind.
2. You must file a U.S. tax return when you sell your U.S. property
You have to file a U.S. tax return whether you rent out your home or not, and whether you have a gain or loss when you sell the home. In some cases, you must also file a state income taxIncome tax A charge you pay based on your total income from all sources. The Canadian government and your province set the rate.+ read full definition return. In 2011, the maximum federal tax rateTax rate The rate at which you or a business pays tax on income. Often stated as a percentage, such as 25%.+ read full definition on these capital gains was 20%.
In most cases, the buyer of your property must withhold 10% of the purchase price and pay this amount to the Internal Revenue Service (IRS). But you may reduce or eliminate this withholding tax by filing the appropriate form with the IRS before you close the sale. If you own the real estate jointly with someone else, such as your spouse, each of you must file this form.
You must also report any capital gains to the Canadian Revenue Agency (CRA). You may claim a foreign tax credit for any U.S. tax you paid.
3. There may be tax on the property after your death
If you own a U.S. vacation property at the time of your death, your estate may have to pay U.S. federal estate tax. But in most cases, this tax only applies if your worldwide estate is worth more than $5 million (or $10 million as a couple).
Talk to an expert about how renting out a vacation home may affect your taxes and your estate — especially if the home is outside Canada.