If you own investment properties or are considering one, it’s worth understanding how such properties are treated when you sell them, whether in a short-time frame (a “flip”) or in a longer-time frame after renting it out to tenants for a length of time.
While primary residences in Ontario are exempt from capital gains (any increase in the value of the property since you bought it), non-primary residences are subject to capital gains tax.
What is this capital gains tax you speak of?
Put simply, capital gains tax is a tax you pay to the government when you make a profit by selling something for more than you originally paid. This applies to all sorts of assets, including stocks, bonds and of particular interest to us, real estate investments.
How is the capital gain calculated?
The good news is that determining your capital gain on an income property is pretty straight forward. You just take the sale price of the property, and you subtract your adjusted cost base (ACB) and you have your capital gain. This of course leads to the next question, what’s an “adjusted cost base”?
Here’s what goes into your adjusted cost base.
You can think of your “adjusted cost base cost” (ACB) as what you paid for the property when you bought it, plus the costs of any improvements you made to the property, plus whatever it costs to sell the property. You can’t add in all your costs (such as a property manager, property taxes and other ongoing costs), but anything you did to improve the property should be recorded separately so you can add it into your ACB.
While using a professional realtor to sell the home helps you get the most amount of money on the sale, the commissions paid on the sale can be significant. The good news is that those sale transaction costs (also including legal fees, bank fees and so forth) are added to your adjusted cost base.
Here’s an example of how it all works.
Let’s go through an example of figuring out your capital gain on an income property.
Here’s the key aspects:
- In July, 2011, you inherited some money and decided to invest in real estate in Toronto. You bought a semi-detached house for just about the average price for one back then, $502,000.
- You had to pay both the Ontario and Toronto land transfer tax (introduced in 2008) and that cost you about $10,000 at that time.
- Over the years, you spent some significant money on some renovations to keep the house in good shape. You redid the roof, you bought a new furnace, updated the bathrooms, had it painted top to bottom a few times and you eventually had the carpet replaced with some hard wood flooring. All in, you spent $82,000 on the home over the ten years you owned it.
- In 2021 you decide to take a year off work, and in July, 2021, you decided the time was right to sell the property. You hired a good agent and managed to get a bit above the average for a semi-detached in Toronto, selling for $1,220,000.
- You paid $61,000 in real estate commissions (5% of the sale price), $1,500 in legal fees and your lender charged a $500 fee for discharging the mortgage.
Take all of this into account and here’s what we see.
When all is said and done, you’re adjusted cost base for the property is $657,000. When we take our sale price of $1,220,000 and subtract your ACB, your capital gain on the property is $536,000.
OK, got it. Now I know my capital gain. So..I have to pay that?
Nope. You only pay tax on 50% of the capital gain you realize on your income property. This means that half of the profit you earned is taxed, but the other half is tax-free. Here’s what that looks like if we continue the above example.
In this case, your taxable profit on the sale is $281,500, which would be added to your income and taxed by the CRA based on your personal circumstances. Given you decided to sell in a year when you had no other income (as you were taking a year off work), your overall tax will be lower than if you did this during a year where you also had other income.
Make no mistake, selling an income property where it has appreciated significantly can result in pretty high taxes. Take comfort in the fact that the other half of your capital gain on the property was tax-free.
Whether it is a long-term rental property or a short-term flip, the bigger the difference in your adjusted cost base and sale price, the more tax you pay. The timing of the sale can have a huge impact on the overall profit you realize and you need to work with agents who understand income properties. If that sounds appealing, don’t hesitate to get in touch!