Rent to Own Taxation (Part 1)

cherry-chan-cpa-ca

The following is a guest post by Cherry Chan, Chartered Professional Accountant. Cherry specializes in real estate taxation and has many great posts on the subject on her blog. For more info visit Cherry’s website at: http://cccpa.ca/

A rent-to-own program is a win-win program for both the investor/landlord and the tenant/buyer.  It allows the investors to generate cash flow from a single family rental and provides the opportunity for otherwise unqualified buyers to purchase their homes over a period of time.

In a typical rent-to-own arrangement, there are (3) three streams of income. 

  1. Firstly, the tenant buyer pays a downpayment in exchange for the option to purchase the property at the end of the contract.  Usually the term of the contract is two to three years. 
  2. Secondly, the tenant buyer also pays rent during this contract.  A portion of the rent is used to contribute to the purchase price at the end.  This is called rent credit. 
  3. Thirdly, at the end of the option contract, the tenant can choose to purchase the property at the preset purchase price.

As investors, how do we report the income from the rent to own arrangement?

This depends on your personal tax situation.  If rent-to-own is considered as a business, all three streams of income are required to be reported as income.  If the rent-to-own investment is capital in nature, these three streams of income are reported differently.

Let’s first look at how Canada Revenue Agency (CRA) determines whether the rent-to-own investment is a business or not.  CRA looks at the following criteria when they consider whether to classify the rent-to-own investment as business or capital in nature.

  1. Is the rent-to-own transaction similar to the landlord’s “normal course of business”
    • If the landlord is a full-time landlord without any other employment income, then the rent-to-own transaction is more likely to be treated as similar to the landlord’s normal course of business.
    • On the other hand, if the landlord has other full-time employment, it is more difficult for CRA to argue that the rent-to-own transaction is similar to the landlord’s normal course of business. 
    • Be cautioned that one single factor can not be relied upon to conclude that the rent-to-own transaction is not to be considered as business income.
  2. How frequently does the landlord invest in rent-to-own deals?
    • The more rent-to-own deals the landlord has, the more likely that the CRA considers it as a business.
  3. Is this rent-to-own transaction an “adventure or concern in the nature of trade”?
    • An adventure or concern in the nature of trade is something a landlord habitually does that is capable of producing a profit, irrespective of the landlord’s own occupation.
    • There are 3 factors that CRA consider when determining whether the rent-to-own transaction is an adventure or concern in the nature of trade:
      • i.     Whether the landlord dealt with the property acquired by him in the same way as a dealer in such property
        • We need to compare the landlord’s conduct with what a dealer’s conduct would be for the rent-to-own deals.  The following factors are usually considered to determine whether the landlord’s conduct consistent with a dealer’s conduct –
          • If there is evidence of efforts, such as advertising, that were made to find or attract purchasers or that a sale took place within a short period of time, it is more likely CRA considers the landlord as a dealer.
          • The more renovations or extra steps that the landlord does to increase the marketability of the rent-to-own property, the more likely CRA considers him as a dealer.
          • If the landlord is a real estate agent or mortgage agent that has a commercial background in a similar business, the more likely CRA considers him as a dealer.
      • ii.     Whether the nature and quantity of the property excludes the possibility of generating income from the property other than selling it.
        • In a rent-to-own transaction, the nature of the property allows the landlord to rent it out to the tenants and hence supports the transaction as being capital in nature.
      • iii.     Whether the landlord’s intention is consistent with other evidence pointing to a trading motivation
        • The landlord’s intention to sell the property at a profit alone cannot be used by itself to determine whether he was involved in the adventure or concern in the nature of trade.  If one of the other above factors clearly shows that the landlord is engaged in the adventure or concern in the nature of trade, his intention can be viewed as corroborative evidence.
        • The investor’s intention can change over the period of time and can have more than one intention.  If the investor’s intention is to hold the rent-to-own investment as an investment (capital in nature), CRA also looks at the secondary intention if the investor is unable to fulfill the first intention.

Admittedly the criteria used by CRA to determine whether your rent-to-own investment is business or capital isn’t black and white.  As investors, you should definitely consult your professional advisor about your personal situation to make a reasonable and supported conclusion.

If you conclude that your rent-to-own investment is considered as a business, you are required to report the downpayment, the rent and rent credit, and the ultimate sale of the building as income the year the proceeds are received for each of these components.

In the next post “Rent to Own Taxation (Part 2)“, I will discuss the tax implication when rent-to-own investment is considered as capital in nature.

The above is a guest post by Cherry Chan, Chartered Professional Accountant. Cherry specializes in real estate taxation and has many great posts on the subject on her blog. For more info or to contact Cherry, visit her website at: http://cccpa.ca/

cherry-chan-cpa-ca

 

FREE Rent to Own Investor Info

Get on the Rent to Own Insiders email list for:

  • Free rent to own content for investors
  • Investor news and updates
  • New opportunities from Ownership Solutions

Speak Your Mind

*