Selling a rental property: understanding capital gains and minimizing taxes

By Jean-Guy Ayotte, chartered real estate broker and founder of the Ayotte team

If you sell a rental property that you own personally, you’ll probably make a handsome profit compared to the price you paid for it, especially if you’ve owned it for a long time. You’ll have to pay tax on this capital gain. Do you know how much? And, more importantly, do you know how to pay as little as possible?  

What is a capital gain?

This is the positive difference for an owner between the purchase price of an asset such as shares, land, a cottage or a rental property, and the resale price. For example, for an income property purchased for $300 000 and resold for $700 000, the difference is positive, for a capital gain of $400 000. When the difference is negative, it’s called a capital loss.

How much tax is payable on a capital gain?

For our example of a rental property resold with a capital gain of $400 000, is the entire amount taxable? No, only 50%, and only after certain allowable deductions have been taken. These deductions include all fees paid for the purchase of the property : commission to the real estate broker, welcome tax, building inspection fees and legal fees related to the transfer of ownership. Other deductions allowed : costs of work to increase the value of the building. Amounts paid for normal maintenance, such as replacing worn tiles or leaky faucets, are not eligible. Renovations must result in an improvement to the property, such as adding a garage or extending a balcony into a terrace.

Do you own an income property and want to increase its value? Find out how by reading Income properties: how to increase their value and reduce operating costs.

In our example, if we assume $20 000 in eligible renovation costs and $15 000 in commission to the real estate broker, these two amounts must be subtracted from the $400 000 in realized gains, for a net capital gain of $365 000. Of this amount, 50%, or $182 500, will be taxable, according to the tax rate that applies to the seller’s income for the tax year in which the resale transaction takes place. There is another possible deduction : if one of the dwellings in the income property was the seller’s principal residence, the seller does not have to pay tax on the capital gain for that part of the building he occupied.

To defer payment of tax : balance of sale price

A balance of sale is equivalent to the seller lending money to the new buyer of the rental property, with interest payable by the buyer to the seller. Such a loan, which must be secured by a mortgage and notarized, generally covers the down payment. The buyer must make arrangements with a bank or financial institution for the remainder of the financing. This can be a win-win situation for both parties. A buyer who hasn’t been able to come up with a sufficient down payment has the opportunity to purchase the property. As for the seller, he then has the right to defer taxation of his capital gain for up to 5 years, in addition to collecting interest from the buyer.

Don’t forget the traditional ways of saving taxes

The tax burden of a capital gain can, of course, be alleviated by making larger-than-usual investments in RRSP or TFSA accounts, which will shelter these amounts from tax. The seller of the rental property will be able to increase his investments even more if he has the money he earned from the sale of the property at his disposal. Finally, whenever possible, it’s important to choose the best year from a tax point of view to sell the property. And this best year is always the one in which your income will be as low as possible. This is often the case for owners who want to sell their real estate assets and wait until retirement to do so. When capital gains are added to a low income, the tax rate for these people drops, so they have less tax to pay. However, there are other years when income can be lowered, such as during a prolonged illness, a long vacation or a sabbatical.

Want to know more about capital gains? Or if you’d like profitable advice on buying or selling a rental, commercial or industrial property, contact us at 514 603-7000 or by clicking here.