Top tax tips for real estate investors

Incorporating your property business makes sense when...

Just because you can incorporate, doesn’t mean you should — and vice-versa. Weigh the advice of several professionals – a lawyer, an insurance agent, a lender and an accountant. But be forewarned: they will have different opinions and you will have to sort through that advice to make the decision that’s right for you and your business.

Overall, income from passive sources, including rental income, is initially taxed at the highest rate; about 46 per cent depending on the relevant province. This can be reduced to approximately 20 per cent where dividends are paid to shareholders. Due to the tax-favoured treatment of dividends, these dividends may generate little or no personal income tax, but may be subjected to taxes at the rate of approximately 30 per cent, depending on your income and province of residence. This potentially creates double taxation.

Active income is income from businesses such as retail, restaurants, professional practices, developers and rental income in a corporation with more than five full-time employees amongst associated companies. The first $500,000 of taxable income from these businesses is taxed at the low rate of corporate tax (about 16 per cent, depending on your province, although some provincial limits increase at $400,000).

Beyond the general tax rates, a wide assortment of other tax issues will be revealed during your conversations about incorporation with your accountant. The most important thing to remember here is that your situation is unique and demands a unique approach.

There may be tax implications to refinancing an investment property
When you refinance a property you own personally, the interest you paid on the loan may or may not be deductible. It depends on what you used the funds for. If they were used for personal use, the interest is not deductible. On the other hand, if you used the money for qualified investment purposes, the interest will be deductible. The funds received on refinancing will not, however, be taxable.

In a corporation, these mechanics change. Here, if you take funds out of a corporation, they may be taxable regardless of how you use them. Here is an example of how this works, using a property purchased at $1 million as an example.

•     Purchase price: $1 million
•     A partner pays a down payment of $200,000, plus an extra $50,000 for renovations
•     The original mortgage amount: $800,000
•     Your investment: $ 0

Once renovations are complete, you have the property appraised and your numbers look like this

•     Property value $ 1.5 million
•     New mortgage $ 1.2 million
•     Pay out old mortgage $800,000
•     Cash left: $400,000

Let’s say at this point you meet with your partner and decide you will pay back your partner’s original investment of $250,000, with the balance of $150,000 split between you ($75,000 to each). The original $250,000 being paid to the partner is not an issue. It is paid back on a tax-free basis as that was his original shareholder’s loan. The $75,000 becomes a dividend to each of you. Normally, you would pay tax on this amount.

You may be able to get some corporate taxes refunded as a result of paying these dividends, but talk to your accountant first. It is much easier to make adjustments to business decisions before a transaction takes place.

•     Figure out how to make the mortgage on your home tax deductible

You can make the mortgage on your home tax deductible. Sometimes called the Smith Manoeuvre, the strategy actually takes several forms.

In the basic version of a typical plan, you may have, for example, a house with a value of $200,000. Say the outstanding mortgage on the residence is $120,000. In many situations, it will be relatively easy for you to obtain a mortgage of at least $150,000 on this property (75 per cent loan to value). You could also obtain a mortgage product from various institutions, which allows you to effectively place a mortgage and /or line of credit on the property for $150,000. That would be tracked in at least two segments. In one segment, the bad/non-deductible mortgage would equal $120,000. The good/investment line of credit would be available for the difference between $150,000 and the outstanding “bad” debt, initially $30,000 in this example. As you make payments on the “bad” debt, the amount you have available to borrow and invest with increases — although the total is never more than $150,000.

This means you could invest in real estate, mutual funds, your corporation or other qualified investments and receive a tax deduction for the interest related to the “good” debt. These tax deductions then provide you with more cash flow, which, in turn, can be used to pay off more “bad” debt and increase the “good” debt.

•     Documentation is key to deducting interest

The rules related to interest deductibles can be confusing, but a recent Supreme Court of Canada decision offers some clarification. In January 2009, the Supreme Court confirmed in the Lipson case instances where the interest charges on mortgages for a rental property itself are deductible, as is the interest from other loans, provided certain conditions are met.

One of these conditions relates to maintaining the ability to trace the source of the borrowed funds to an eligible investment. Structuring your financial affairs correctly may allow you to deduct more of your interest costs, thus saving more money.

More specifically, Canadians are allowed to deduct interest charges where they use a line of credit, second mortgage, or separate loan to pay for a portion of a property’s deposit or various operating expenses related to the property. These expenses can include repairs, utilities and property taxes. The key is being able to trace the payments from the line of credit to the property. Ideally, a separate line of credit is used wholly for investment purposes. Where you require a line of credit for personal use, this should be done with a separate account. This ensures you do not mix amounts spent on your vacation or big-screen TV with those related to your investments.

A variety of financial institutions have debt products which allow you a total amount of debt and then divide this total into multiple accounts you have created. Over time, it may also be possible to restructure your debt so that even otherwise non-deductible interest can be converted into fully deductible interest. To make sure you can take advantage of deductible interest, talk to your tax adviser about what you can do to deduct as much of your interest as possible — and in a method that is acceptable to the CRA.

Don R. Campbell is a bestselling author, investor, researcher, and founding partner of the Real Estate Investment Network. This column is an excerpt from his book, 81 Financial and Tax Tips for the Canadian Real Estate Investor: Expert Money-Saving Advice on Accounting and Tax Planning.

OREA offers help in understanding often confusing real estate terminology

When it comes to real estate, there is no shortage of terminology and plenty of room for confusion. From mortgage types and periods to title searches and conditions, there are countless variables to consider in every real estate transaction.

Ron Abraham, president of the Ontario Real Estate Association says that buyers and sellers needn't be overwhelmed by any of the terms, rather, they should focus on the big picture and let their realtor work through the details.

"For both buyers and sellers, the sheer volume of information and options can be a little overwhelming. However, it's important that both buyers and sellers focus on the larger picture. If you have a clear idea of your needs and go in with realistic expectations, the whole process will be very rewarding."

Here is a cheat sheet of a few common and (commonly misunderstood) real estate terms: 

Fixed-rate Mortgage: A set amount is paid each month. The interest payable is predetermined and fixed at the time of taking the loan, and holds for the entire term. Buyers are protected from any increase in prime lending rates in future.

Variable-rate Mortgage: An adjustable interest rate, which can be altered depending on the market situation. These loans may be beneficial if there is a sudden fall in lending rates, but higher interest rates mean greater monthly payments.

Amortization: The number of years it takes to repay the entire amount of the mortgage.

Title/Title Search: Title is the legal evidence of ownership in a property. A Title Search is a detailed examination of the ownership documents to ensure there are no liens or other encumbrances on the property, and no questions regarding the seller's ownership claim.

Conditions: Sometimes called a "Subject-to" Clause. A statement of a condition to be fulfilled before the contract will become firm and binding, must include a specific deadline for removal.

Multiple Listing Service (MLS): A current and comprehensive listing system for relaying property information. This service offers the widest exposure to properties listed for sale.

Realtors: Real estate professionals licensed by the Real Estate Council of Ontario who are members of the various Real Estate Boards and the Ontario and Canadian Real Estate Associations. 

Abraham adds, "Often people get tripped up when it comes to sifting through information surrounding financing options, as well as the nuts and bolts of the real estate transaction. Talk to your realtor about the best way to get equipped with the information you need to make a buying or selling decision that is right for you and your family."

Submitted by the Ontario Real Estate Association.

Barrie - Revitalization by our friends in Real Estate - Pulis Investment Group

Congrats to our friends, the Pulis' for having this vision and making a difference to our downtown Barrie core! Here's an article in this weeks Barrie Examiner

Property owner breathes life back into downtown building

Kyle Pulis, of Pulis Investment Group, stands near a the Mulcaster Street building that hit the headlines last fall as being captured in a painting by Group of Seven artist Lawren Harris. The Pulis Group ‘rehabilitated’ the building, one of a number of properties that they have worked on in Barrie and Orillia. J.T. MCVEIGH/BARRIE EXAMINER

Something is different on Mulcaster Street.

Ignored for years except for the occasional visit from a police officer or two, the red brick walk up in Barrie’s downtown has pretty well stayed off of the radar.

That is until a couple of year’s ago when a 23-year-old named Kyle Pulis, from Brampton, took a look inside and saw promise.

The last time that happened was over a century ago when some artist named Harris stuck an easel across the road and painted a moment in time.

Group of Seven founder Lawren Harris’ A Street in Barrie made it to Sotheby’s Auction House in Toronto a couple of weeks ago, and although the painting wasn’t sold, director of Sotheby’s, David Silcox, estimated that at some point the painting should fetch somewhere between $900,000 and $1.2 million.

Pulis, of Pulis Investment Group, didn’t know about the painting or the auction, but he did know the property.

“Going through these old units really reminded me of the trips to New York where they took the old buildings and were able to turn them into high-end apartments, the same with areas of Toronto,” said Pulis.

And from there a plan was formed.

It wasn’t without its challenges.

Although a great deal of the old trim work, crown moldings, and even solid hardwood floors were in restorable shape, there was still a lot of work to do.

“So when I can into this here, I was 23. When I bought it, and this was my fourth project that year, even my agent thought that I was crazy when I bought this.”

However after conferring with his team of contractors, Pulis got the thumbs up and work began.

Pulis’ founded his investment company with his father David, creating a private investment group whose clients want to invest in real estate in some way, but either don’t have the time or the expertise to tackle a project.

Clients are very much interested in niche investing, and they are looking for profit, but with a conscience.

“They (clients) are really drawn into that idea of revitalizing part of the downtown,” said Pulis, “They are investors that keep a profit in mind, but they also want to be a part of cleaning up the downtown.”

For Hany Kirolos, director of the Economic Development Office for the city of Barrie, this is nothing but good news.

“Any rejuvenation in our city core that is within our zoning requirements, and results in either residential or business traffic, is great for a city centre revitalization,” said Kirolos.

Having private investors take a stake in the city’s downtown can have an enormous impact on the nature of a neighbourhood.

“The best example of this is Yonge and Dundas in Toronto where 20 years ago it was a derelict area with closed shops. Now it has become a mini Times Square changing the focal point to culture, to business and residential space,” Kirolos said.

Transitions aren’t easy, but the rewards are pretty high.

“We have a lot of projects like this in Hamilton and it’s the same thing there; the neighbours come out and say thank you. It is really good to be part of the revitalization of places like downtown Barrie,” said Pulis.

He knows that he is dealing with a niche market, people who want the convenience of modern construction, but enjoy the warmth a century building exudes.

“Here, what I found is that because the tenants are all from pretty much the same demographic, that they create a community, he said “They are all really into the building, excited to hear about the history. Then they fall in love with the story, they fall in love with the neighbours and they really fall in love with the building.”

Pulis believes more opportunities like this are available. He has seen that with his project in both Barrie and Orillia.

Granted they are costly, but with willing investors and a skilled contractor work force, he feels the heritage of a neighbourhood can be saved.

“I know they (Barrie) are doing a lot of work, like cleaning up the waterfront, bringing people back into the downtown, building condos,” Pulis said,

“They are doing their part, so it’s not hard to see business owners and property owners along the strip here, doing our part.”

I borrowed $25,000 from my RRSP to buy a house

I borrowed $25,000 from my RRSP to buy a house

There are generally three ways to deal with paying back the Home Buyer’s Plan.

Last year, I made the decision to use the Home Buyer’s Plan to withdraw money from my Registered Retirement Savings Plan (RRSP) for a down payment on my home in Vancouver. Now comes the difficult task of deciding what strategy to use to repay the money. 

With the Home Buyer’s Plan, you can borrow up to $25,000 from your RRSP without paying tax on the withdrawal. In the second year after the withdrawal, you start paying the money back over 15 years in 15 equal annual sums. 

 I took out the maximum $25,000 and originally planned to pay back the money as soon as possible. But after weighing the pros and cons, I’ve decided to stick with  minimum payments over the 15-year life of the loan.

There are generally three ways to deal with repaying the Home Buyer’s Plan: 

1. Pay the minimum  
The advantage here is that less after tax income goes into the repayment and you can keep contributing new cash each year based on your earnings. The downside is that the longer you take to repay the loan, the slower the RRSP rebuilds and and earns money tax-free.

2. Repay as fast as possible 
Since you're repaying quickly, this gives you a more money to grow in the tax shelter and so over time the compounding power is greater.  As well, if you pay more than the minimum in a given year, future payments will be reduced based on the remaining amount owing and the number of years left on the loan. 

3. Don’t repay the loan 
If you choose not to, or are unable to pay back the minimum required each year, that one-fifteenth payment will be taxed at your marginal rate for that year. 

This could be an option for those who find themselves in a lower tax bracket for any number of reasons, including becoming unemployed, taking maternity leave, or returning to school. The reason being is that people in a lower tax bracket will take less of a hit when the unpaid 1/15 amount is taxed as income. Then, when their income increases, they can start making their annual minimum payments again. 


There is no advantage for me to repay quickly. By repaying the minimum, I’m still receiving the tax benefit that comes with contributing to my RRSP and maintaining a balance that allows me to manage all my financial needs a little better.

What strategy would you use to pay back the Home Buyer’s Plan? 
Contributor/Guest Blogger: Krystal Yee lives in Vancouver and blogs at Give Me Back My Five Bucks and Frugal Wanderer. You can reach her on Twitter (@krystalatwork)

Difference Between Residential and Commercial Financing

Peter Kinch explains the difference between residential and commercial financing

Call it Commercial Financing 101. I received a call from a client recently who had just put an offer in on a property and needed a mortgage. They had purchased a four-plex only a few months earlier and wanted to know if they could get the same discounted rate for this purchase.

Normally I'd say, no problem, but upon further examination of their deal, I discovered that the property they were buying was an "eight-plex." What's the big deal you might ask? Well, the problem is that the purchase of the four-plex fell under the definition of "residential" financing, whereas an eight-plex is considered a 'commercial mortgage' and the difference between financing the two is quite significant. This simple misunderstanding is probably one of the most common misconceptions in mortgage financing. Many investors do not realize that there is a major difference between residential and commercial financing and as such, enter into purchase agreements with false expectations and often end up disappointed and frustrated.

Different sandbox = different rules

The frustrating part for most borrowers is a misinterpretation of the definition of 'commercial.' Many investors assume that a commercial property is one that includes a retail unit or business component in the building. The problem is that the definition of 'commercial' can vary depending on who you're asking - your Realtor, your banker or your accountant. For our purposes, we are interested in the banker's definition. From a mortgage perspective, a property may be deemed to be commercial as soon as you get beyond a four-plex. Again, we have to realize that we're in a new sandbox. Not only have the rules changed, but so too have the players. Many of the lenders who are happy to lend in the residential sandbox, have opted out of this 'sandbox' completely, whereas some new players have now entered the fray.

Clear definitions

First off, let's define when a mortgage is deemed to be commercial versus residential.

A single unit, duplex or triplex will always be considered a residential property for mortgage purposes. Virtually every bank will treat a four-plex as a residential mortgage as well, however, this is the cut-off point for some lenders and they may only choose to do a four-plex as a residential mortgage on an exception basis (i.e., application must be strong).

A "five-plex" is completely in the grey-zone - most residential lenders opt out at this point and your broker will have to do some digging to find a lender who will treat this as residential.

A "six-plex" is where 99% of the 'residential' players now opt out. Your broker will be extremely limited in finding a lender who will look at this as a residential deal. There is one lender in Canada who is currently treating up to eight units in a multi-family complex as residential, but they are only doing so in Ontario at this point. Beyond that, you will definitely be dealing in the commercial sandbox. The other obvious clue that makes property residential versus commercial is the zoning. Quite often this comes to light when the broker or banker receives the appraisal.

(*Note: Don't confuse an eight-plex, which has eight separate suites, each having its own entrance and each being fully self-contained, with a residential house that has eight rooms rented out and a hot plate in each room for cooking. The latter is considered a 'rooming house' and the banks will scatter quickly if they read this in an appraisal. Simply put - they don't like them. So if you're buying one, expect even more problems. The same is true for 'student housing,' so again, proceed with caution.)

So what's the big deal?

What difference does it make if a property is considered commercial or residential?

First of all, the entire underwriting process now changes - as you might have guessed, new sandbox, new rules. The simple explanation is that in the residential sandbox, you the borrower, were the main focus and the property was secondary. In the commercial box, the property becomes the focal point and you (the covenant) become secondary - which may come as welcome news for some.

The biggest difference between the two is the cost of doing business. In the residential sandbox, the interest rate was very predictable, there was no lender fee, the appraisal costs were low and the legal fees were standard. All of those change when you buy a multi-family/commercial property. The rates could be higher; the bank charges a fee - as does your broker, the appraisal costs start at $1,200 and can go much higher. The legal and accounting fees will be higher. Your residential home inspector is not the same person you will use for a commercial property inspection (and yes, you guessed it, they don't charge the same) and lastly, the lender will likely ask for a Phase 1 Environmental on the property. Other than that, there's no difference.

Source: Peter Kinch, Mortgage Expert

Why Canada trumps the U.S.

As the world goes through its continuing economic turmoil, Canada has quietly become one of the world's economic safe havens. A haven where international money is being parked for safety and ROI, a haven that is poised to provide the world what it needs for at least the next decade and probably a lot longer. 

However, most Canadians are the last to truly believe what we are sitting on. We have been so programmed over our history to look elsewhere for opportunity - always playing small. Well, 2011 - 2020 will be the exact wrong time to be doing so, in fact, we are in the first year of what will prove to be Canada's Economic Decade - one of the best times in history to invest in this country.

Unfortunately, due to a misdirected attitude that cheap equals good when investing in real estate, many Canadian investors have turned their eyes south as real estate prices in the United States continue to plummet. 

Investors with their eyes solely on the cheap price of U.S. real estate have flooded Canadian media with their tales of deals and steals. One can only hope that these investors understand the real life metrics involved in analyzing a market's potential (currency risk, taxation, record jobless numbers, massive debt, property supply and demand) and have decided to take the 'buy cheap' risk anyway despite the reality. 

This is the equivalent of buying a $1,000 suit for $500 and ignoring the fact that the pants are torn in nine places.

Replacement cost means absolutely nothing if you don't have demand - however it is a wonderful way to sell properties. Investors looking for long-term sustainable wealth for themselves and their families need long-term sustainable economic fundamentals. Using housing stats and prices to predict a real estate market is like driving at full speed and only looking in your rearview mirror - you will crash. 

In our 21 years of analyzing and investing real estate markets, our research team has uncovered a predictable long-term pattern for real estate markets across the globe. In fact, the tool we've developed is now used by investors, media and investment firms to dramatically reduce the risks in their real estate portfolios.

Titled The Momentum Formula, it shows the progression of an economy and how it will eventually impact the real estate market. You will note that housing stats are very late in the formula: meaning many commentators and speculators are at least 18+ months behind professional investors. 

This analysis tool states: No job growth = high risk real estate market. 

GDP growth leads to job growth. These jobs attract population growth, which leads to increased rental demand (12 months later). This demand drives rents up, pushing more to buy properties (18 months later), which eventually leads to property price increases. 

Right now, Canada is creating jobs by becoming the world's safe supplier of four key commodities entering supply/ demand super-cycles (food, fuel, fertilizer and forestry). 

From this fact, investors will witness select Canadian real estate markets experiencing amazing sustainable growth over the next 10 years. For instance, Alberta, a province of only 3.5 million created more jobs in a month than the total jobs created in the whole U.S. (population over 311 million). Following the formula, this job growth will be reflected in the Alberta real estate market 18 - 24 months from now. 

The world's economic outlook will continue to be cloudy for many years to come, risks will seem to be everywhere but so will long-term opportunities. No matter what occurs, the fact that jobs and population growth drive long-term demand will not change. 

The other fact that won't change is that Canada has what the world needs to survive and it will be willing to pay for it. Although it will occur in cycles, what you have is an opportunity to be a professional investor (not speculator) who reduces risk and positions yourself for long-term results based not on today's price, but on tomorrow's demand.

Source: Don R. Campbell - Real Estate Investment Network