Be careful with rental property tax claims

People are often lured into becoming landlords by the promise of collecting monthly rent cheques from hassle-free tenants or by the attractive tax losses rental properties seem to provide, but tenants are often far from hassle-free and tax write-offs don’t always materialize.

The Tax Court is littered with cases about personal rental property schemes in which the anticipated tax write-offs fail to live up to expectations. Take the recent case of home owner and landlord George Leisser.

Leisser is in his late 80s, lives in Westmount, Quebec and went to Tax Court over his 2004 and 2005 tax returns. The returns were reassessed by the Canada Revenue Agency (CRA), substantially reducing the net rental losses he claimed.

The Westmount property has three floors and Leisser lives on the second floor. The top floor is rented to his daughter and the main floor has three smaller rental units, two of which were rented.

In computing his rental income, he attributed one-third of the property’s expenses to his personal apartment and deducted two-thirds of the building’s expenses. The CRA reassessed Leisser, treating the third floor occupied by his daughter along with the vacant unit on the first floor “as not being of a commercial nature,” and disallowed the deduction of that portion of the expenses.

His daughter paid only $570 a month for her five-room apartment, contrasting with the other tenants who paid about $500 per month for one-room apartments. The CRA argued Leisser’s daughter was not paying a fair-market-value rent and therefore, the third floor unit wasn’t a true source of income.

The judge agreed, finding that Leisser, “out of a very understandable wish to assist his daughter, gave the daughter a much lower rent than if he were renting out the unit to an unrelated person.”

The court concluded the unit wasn’t operated in a “sufficiently commercial manner” and therefore was not a source of income — a requirement for deducting expenses. The judge wrote, “Although the daughter has her own dwelling unit, the situation is more akin to the daughter contributing to household expenses than that of a commercial lease.”

The judge ruled the CRA was correct in excluding rent paid by the daughter from Leisser’s income and in excluding from the property expenses the pro-rata share of the expenses related to the daughter’s third-floor unit.

With respect to the vacant unit, Mr. Leisser described how he’d had difficulties with a tenant who left in 2001, after which he decided to take a break from renting the unit. He testified that he was “scared to rent the unit to just anyone and was only prepared to rent the unit by word of mouth.”

While Mr. Leisser appears to have made little effort to rent the unit, he was prepared to do so if he could find a suitable tenant through word of mouth. In addition, there was no evidence that the vacant unit had been reallocated for the personal use of Leisser or his daughter.

The judge therefore concluded the vacant unit was still part of the first-floor rental property and was therefore part of a “source of income.”

This is just one among many examples illustrating why, when you’re considering using a rental property for tax advantages, you need to do so carefully.

Jamie Golombek CA, CPA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.