Capital Gains on Rental Investment Property
Real estate investors have to take care of many expenses – one such expense is capital gains tax. Besides the income, payroll, excise, sales, and property taxes, investors must also pay some tax on their capital gains when they sell the property.
Capital gains tax applies when the initial sale price of your property exceeds your buying price. In Canada, only fifty percent of capital gains are taxable. Let’s try to understand this with an easy example.
Understanding Capital Gains Tax with A Simple Example
If you bought a property for $500,000 and later on sold it for $600,00, your capital gain will be $100,000. Only 50% of this gain is your taxable income, which amounts to $50,000. If you owned the property, you would have to add this taxable income to your other incomes and apply the marginal tax rate.
We will consider Ontario’s example and take its highest marginal rate of 53.53%. Apply this rate to your capital gains taxable income, your tax liability on capital gains will be $26,765.
To simplify it even more, you can just multiply your capital gains with 25% to calculate your capital gains tax liability.
The tax is payable on the difference between how much you paid for the investment property while buying it and the amount which you are selling it for. However, there are certain exemptions for this tax under certain conditions.
Real estate owners who are looking to sell their rental properties must understand that the capital gains on rental properties are calculated very differently than the gains on any house that you personally live in.
It is crucial to study this process thoroughly; otherwise, you might end up paying more than you should. You should also keep a strict check on all expenses and investments that are associated with the rental property as they need to be accounted for to calculate your capital gains accurately. You should also keep all receipts and documents related to these expenses so that you have proof.
Assessing Your Capital Gains
To assess your capital gains, calculate the price you purchased the property on. Then you can augment this basis of the rental property by incorporating all expenditures you have made for improving the quality of the rental property. It will help you significantly reduce the amount of capital gains that will make you liable for tax payments.
For example, if you have remodeled the kitchen in the house, all the costs that were incurred can be factored in directly.
You must also account for the depreciation that may have occurred over the years of owning the property. Previous tax returns can be consulted to evaluate how much depreciation has been accumulated and needs to be accounted for. Similarly, you must also deduct any tax credits that you received, such as energy-saving credits. These must be subtracted from the adjusted basis to calculate the gain on your rental property accurately.
During the process of acquiring the rental property, you also face other expenses like legal fees and land transfer taxes. These costs are also added to adjust the cost base for determining the capital gains.
After selling the property in question, you will find the difference between the adjusted purchase price and the price you sold the property for. It will be the total capital gain on the property, which will now be taxed. All these financial details are provided to the tax office in their tax return forms. If you have previously claimed any depreciation on the property, this must also be declared.
Lower adjusted prices often create higher capital gains if the property has gained value over the years of ownership. On the contrary, if your property is sold for less than the price
you purchased it for, you will face a capital loss. In this case, you won’t have to worry about paying any such tax. During the process of selling the property, additional expenses like legal fees and real estate commissions are faced by the seller. These are also deductible expenses and can decrease your capital gains.
Another tax that you might face when selling a rental investment property is the depreciation recapture. Owners are entitled to claim depreciation deductions every year to help them reduce their taxable rental incomes. However, when the property is sold, these deductions are captured back by the government through a tax. Generally, depreciation recaptures can be taxed at rates of up to 25%.
If you are looking to sell your rental property, it is important to be aware of all the legal obligations you must fulfill. You must also know when to pay these taxes. The capital gains tax is assessed in the year in which you incur the capital gain. They are payable for the year in which the sale of the rental investment property has been finalized.