Rent to Own Taxation (Part 2)

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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/

In my previous blog post “Rent to Own Taxation (Part 1)“, I shared with you the (3) three streams of income from a typical rent-to-own arrangement and the criteria to determine whether the rent-to-own investment strategy is considered as business or capital in nature.  I also shared with you that if the rent-to-own investment strategy is considered as business, the investor is required to report all three streams of income as income.

In this blog post, I will continue to explain to you the tax implication if the rent-to-own arrangement is instead considered to be capital in nature.

Stream 1. Non-refundable downpayment

In a typical rent-to-own arrangement, the tenant buyer puts a non-refundable deposit down (a minimum of 5% of the purchase price at Ownership Solutions) in exchange for the option to purchase the house at an agreed price at the end of the term, usually 2 to 3 years (most commonly 3 years at Ownership Solutions).

If the agreement does not specify that such downpayment is used for the purchase of the option right, the investor is required to report it as income as the amount is non-refundable.

However, if the agreement specifies that the non-refundable deposit is to be used towards the purchase of the property at the end of the term, the Income Tax Act (ITA) allows the investor to report it as capital gain in the year he receives the money.

In most rent-to-own option agreements I have worked with, they clearly specify that the down payment is to be used to pay for the purchase. Therefore it’s most likely the investor can report it as a capital gain in the year he receives this downpayment.

Stream 2: Rent and rent credit

During the term of the rent-to-own arrangement, the tenant buyer is required to pay rent.  A portion of this rent is then credited toward the ultimate purchase price as agreed on in the option agreement. 

For the regular portion of the rent payment, the investor is required to report it as rental income. 

As for the amount of rent credit, if the agreement specifies that it is used to maintain the option right and credited towards the future purchase, similar to the non-refundable deposit, the amount can be reported as a capital gain.  Otherwise, the rent credit should be reported as income in the same year.

The investor should be careful with respect of drafting up the agreement specifically to the rent credit.  One rent-to-own expert had expressed his concern that if the rent credit was not part of the lease agreement, the landlord investor may not be able to go after this amount in case of tenant default. 

Stream 3: Purchase option at the end

If the tenant buyer decides not to exercise his option, all the reporting has been completed the year the money is received.  Nothing further is required.

If the tenant buyer proceeds with the purchase, the investor is required to do the following:

  1. For the years the investor has reported the non-refundable deposit and rent credit as capital gains, the investor is required to file an amended return to reduce the capital gain to zero.
  2. In the year the tenant buyer exercises the option to purchase the house, the investor is required to report the sum of non-refundable downpayment, the rent credit, together with the actual cash proceeds from the sale as the sale price, less the cost of the acquisition of the house as capital gain.

That’s all you really need to know about rent-to-own taxation. You should be able to determine whether your rent-to-own transactions are a business or capital in nature, and understand how to report each of the three types of income received during the transaction.

If you have any questions about rent-to-own taxation or require further clarification, please contact me (Cherry) directly.

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/

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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/

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October 9th Event: The Secrets of Win-Win Rent to Own Investing

Andrew C. MacDonald will be speaking for Michelle Read‘s investor workshop on October 9th, 2014 at 7pm. We’d like to invite you to see Andrew’s presentation and learn more about Rent to Own investing.

Presentation Overview

In this presentation Andrew will be covering the following:

  • What rent to own is
  • The 3 major types of rent to own
  • The benefits and drawbacks of rent to own investing
  • How you can safely earn double digit returns while helping Canadian families
  • Keys to structuring “WIN-WIN” deals
  • Real life rent to own examples

On top of Andrew’s presentation, there will be an interactive Q&A period and the opportunity to network with other likeminded investors.

How to RSVP

To learn more about this workshop being held on the evening of Thursday, October 9th, 2014 at a downtown Toronto location, please contact Michelle Read at (416) 879-7323 or by e-mail: mx.mr@sympatico.ca

We hope to see you there!

June 23rd Event: Private Mortgage Lending 101

kwc-real-estate-investorsAndrew C. MacDonald, will be speaking for the KWC Real Estate Investors Group on June 23rd, 2014 at 7pm. We’d like to invite you to see Andrew’s presentation and learn more about Private Mortgage lending.

Presentation Overview

In this 30 minute presentation Andrew will be covering the following:

  • Overview & Private Private Mortgage Basics 
  • Private Mortgage Fundamentals  
  • Private Mortgage Due Diligence & Structuring 
  • RRSP & Registered Account Basics 
  • The Complete Process 
  • Avoiding Pitfalls, Other Options & Comparison to Traditional RRSP Investments 
  • Bonus Resources

On top of Andrew’s presentation, there will be a 15 minute interactive Q&A, another keynote speaker with experience in the same field. Finally, the evening will finish up with some time to network with other investors.

How to RSVP

You can see more details about the meeting and RSVP online at MeetUp.com.

We hope to see you there!

March 20th Event: The Secrets of Win-Win Rent to Own Investing

yrreig-logoAndrew C. MacDonald, will be speaking for the York Region Real Estate Investors Group on March 20th, 2014 at 7pm. We’d like to invite you to see Andrew’s presentation and learn more about Rent to Own investing.

Presentation Overview

In this 30 minute presentation Andrew will be covering the following:

  • What rent to own is
  • The 3 major types of rent to own
  • The benefits and drawbacks of rent to own investing
  • How you can safely earn double digit returns while helping Canadian families
  • Keys to structuring “WIN-WIN” deals
  • Real life rent to own examples

On top of Andrew’s presentation, there will be a 15 minute interactive Q&A, another keynote speaker with a sizeable portfolio who has some great tips on real estate joint venture investing, and then some time to finish up the evening with some time to network with other investors.

How to RSVP

You can see more details about the meeting and RSVP online at MeetUp.com.

We hope to see you there!

January 8th Event: The Secrets of Win-Win Rent to Own Investing

durhamrei

Andrew C. MacDonald, President of Ownership Solutions will be speaking for the Durham Real Estate Investors group on January 8th, 2014 at 7pm. We’d like to invite you to see Andrew’s presentation and learn more about Rent to Own investing.

Presentation Overview

In this 45 minute presentation Andrew will be covering the following:

  • What Rent to Own Is
  • The 3 Major Types of Rent to Own
  • The Benefits and Drawbacks of Rent to Own Investing
  • How You Can Safely Earn Double Digit Returns
  • Real Life Rent to Own Examples
  • How to Attract and Qualify Rent to Own Tenant-Buyers
  • Planning for a Successful Exit Strategy
  • How to Properly Structure the Legal Agreements
  • The Importance of the “Win-Win” Philosophy
  • 2 Ways and 2 Resources You Can Use to Get Started Today

On top of the presentation, there will be a 15 minute interactive Q&A, another keynote speaker, and some time to finish up the evening with by networking with other investors.

How to RSVP

You can see more details about the meeting and RSVP online at:

Please note there is a cost of $30 to attend a Durham REI meeting as a guest.

Get Off to the Right Start in 2014

What better way to kick start your investment efforts in the New Year than an opportunity to learn and network with other successful investors?

Speaking of making the most of 2014, here is a great presentation by Quentin D’Souza, a successful real estate investor who heads up the Durham REI group:
Top Tips to Propel You Forward in Real Estate Investing in 2014

We hope you find Quentin’s presentation helpful and that we’ll see you on January 8th!

September 24th Event: The Secrets of Win-Win Rent to Own Investing

gtawreinIn case you missed last week’s presentation in Cambridge, you have a chance to catch Andrew’s presentation again here in the GTA.

Andrew C. MacDonald, President of Ownership Solutions will be speaking for the GTA West Real Estate Investing Network Group on September 24th, 2013. We’d like to invite you to see Andrew’s presentation and learn more about Rent to Own.

In this condensed 40minute presentation he will be covering the following:

  • What Rent to Own Is
  • The 3 Major Types of Rent to Own
  • The Benefits and Drawbacks of Rent to Own Investing
  • How You Can Safely Earn Double Digit Returns
  • Real Life Rent to Own Examples
  • How to Attract and Qualify Rent to Own Tenant-Buyers
  • Planning for a Successful Exit Strategy
  • How to Properly Structure the Legal Agreements
  • The Importance of the “Win-Win” Philosophy
  • 2 Ways and 2 Resources You Can Use to Get Started Today

If you are interested in boosting your cash flow or making your real estate investments more passive, you won’t want to miss this meeting.

On top of the presentation & interactive Q&A, there will be some time to finish up the evening with by networking with other investors. What better than a an opportunity to learn and network… for free?

You can see more details about the meeting and RSVP online at: http://www.meetup.com/GTA-West-Real-Estate-Investing-Network/events/134811352/

Hope to see you there!

September 16th Event: The Secrets of Win-Win Rent to Own Investing

kwc-real-estate-investorsAndrew C. MacDonald, President of Ownership Solutions will be speaking for the KWC Real Estate Investors Meetup Group on September 16th, 2013. We’d like to invite you to see Andrew’s presentation and learn more about Rent to Own. In this presentation he will be covering the following:

  • What Rent to Own Is
  • The 3 Major Types of Rent to Own
  • The Benefits and Drawbacks of Rent to Own Investing
  • How You Can Safely Earn Double Digit Returns
  • Real Life Rent to Own Examples
  • How to Attract and Qualify Rent to Own Tenant-Buyers
  • Planning for a Successful Exit Strategy
  • How to Properly Structure the Legal Agreements
  • The Importance of the “Win-Win” Philosophy
  • 2 Ways and 2 Resources You Can Use to Get Started Today

If you are interested in boosting your cash flow or making your real estate investments more passive, you won’t want to miss this meeting.

On top of the presentation & interactive Q&A, the last half of the night will be for networking. You definitely do not want to miss this opportunity to learn and network.

Admission is $5 at the door to pay for snacks and beverages. You can see more details about the meeting and RSVP online at: http://www.meetup.com/KWC-Real-Estate-Investors/events/126813612/

5 Considerations for Your First Investment Property

This past week The Hudsucker published a guest article written by our President Andrew C. MacDonald which we wanted to share with our own readers.

The article offers some food for thought to aspiring investors in the form of 5 important considerations before making that sometimes scary first investment property purchase:

  1. Your Objectives
  2. Your Desired Level of Involvement
  3. Your Available Capital
  4. Your Intended Strategy
  5. Your Education Plan

To read more including 2 tips for getting started with real estate investing, visit:

Guest Writer Andrew MacDonald: 5 Things to Consider With Your First Investment Property

Photo Credit: Getty Images

How New Mortgage Changes Would Impact Investors

changes-next-exitApril 19th, 2010… a day that will live in infamy. Well not quite, but it did introduce some pretty punitive mortgage changes (at least as far as investors were concerned). 

Key Changes Over the Past 3 Years 

Back in April 2010 investors lost the ability to purchase non-owner occupied properties at with 95% 1st mortgages. It’s still possible to finance investment purchase with less than 20% down, but generally not at the type of rates we were able to get back then (eg. Prime -0.7%). With leverage being one of the primary advantages to investing in real estate, this change really slowed down the acquisition rate for many small investors, myself included.

Another key change at this time was the drop from 95% loan-to-value refinancing on your primary residence to 90% LTV. This has since been restricted further and limits the amount of equity available for investors to put towards their investment portfolio. Using a HELOC is a very popular strategy for rent to own investors who earn great cash flow which is able to easily offset the minimal interest paid to unlock home equity for investment purposes.

The final important change back in April 2010 was that borrowers would have to qualify at the 5 year fixed rate regardless of the term they chose which made it a little tougher to qualify for a mortgage. 

Since these major changes in 2010 there have been a few more rounds of mortgage rule changes, each more restrictive than the last. 

Potential Changes in 2013

The Office of the Superintendent of Financial Institutions (OSFI) is now looking at the issue of limiting amortizations on conventional mortgages. Currently on a conventional mortgage (those with 20% or more as a down payment) amortizations of up to 35 years are permitted, but proposed changes would see the maximum amortization period reduced to 25 years. 

OSFI is still examining this and it could take a little while to trickle down (if it happens at all) but it’s best to know about these sorts of changes early on so you can plan accordingly. Personally, I wish I had more of a heads-up about the April 19th, 2010 round of mortgage changes but they were really a catalyst that got me take action on a couple of deals which have made me great returns over the past 3 years, so I can’t complain too much. 

What Will the Impact Be for the Rent to Own Investor? 

There are a couple of impacts to the rent to own investor that should be considered, and to illustrate these I will use our latest rent to own opportunity as an example to put things into perspective.

The first impact would be cash flow. The longer the amortization, the lower the mortgage payment, and the higher the cash flow on any given investment opportunity. As an example, here is the estimated cash flow on this $50K investment assuming 3 different amortization periods:

  • 35 year = $921/mth cash flow (+$105/mth)
  • 30 year = $838/mth cash flow
  • 25 year = $733/mth cash flow (-$105/mth) 

 We normally aim for a 30 year amortization period which is quite attainable these days for most investors. As you can see, reducing the amortization period by 5yrs eats up $105/mth of your cash flow on a $250K home. The difference between 25 and 35 year amortizations is $210/mth which is fairly significant. On the flip side there is more mortgage paydown so the total ROI stays the same but would you rather have that cash flow in your pocket or going towards principal paydown? 

The second impact would be mortgage qualifying ability. Right now with a conventional mortgage you can use higher amortization periods which boost your cash flow and make it easier to qualify for mortgages and purchase more rental properties. If you plan to build a portfolio of cash flowing properties these rule changes could make it tougher to qualify for the mortgage financing you need. 

What’s the Point of All of This? 

These changes may come into effect, or they may not, but there is a clear trend of mortgage rules tightening.  The tougher the mortgage rules get, the tougher it is for you to build a portfolio of cash flowing real estate. 

The point is that if you’ve been sitting on the fence as I was leading up to the April 19th, 2010 round of mortgage rule changes, maybe now is the time for you to take action. 

If you’ve been considering investing in real estate but aren’t sure how to get started, need some great professional contacts to help you evaluate your options, or are sick of being stuck sitting on the fence for any other reason, I’d like to figure out how I can help you get off that fence and start achieving your financial goals in 2013. 

Connect with us on social media using the links on the right sidebar if you haven’t already. More importantly get on our RTO Insiders list to make sure you don’t miss out when we release our next great deal. Finally, contact us to setup a time to chat with Andrew by phone or over a cup of coffee.  You’ve got nothing to lose, and the seats at Starbucks are far more comfortable than sitting on the fence.

Photo Credit: http://tothepointwithbozic.com/wp-content/uploads/2012/06/new-mortgage-rules-canada.jpg