March 01, 2021
Rent or buy your vacation property
At Allan Bush Investment Team, we’re always looking for investment opportunities that provide income and help mitigate market volatility. And when we’re thinking about whether or not you should rent or own a vacation property, there are many things to consider that work themselves into our investment philosophy. Here’s a breakdown of both options.
Purchasing real estate with income potential can help diversify your portfolio as this asset class doesn’t move in lockstep with other asset classes, or typically, the overall market. When it comes time to rent your property, the income made off the property has the potential to augment your current investment portfolio cash flow. There are many other non-financial considerations that are significant when it comes to making this type of decision. Here’s a few:
- If we own, will we only go to one spot for every vacation for the rest of our lives?
- If we own, how do we ensure it gets looked after when we aren’t there?
- If it’s ours, will someone end up spending all their time working on the property while the rest of the family has a vacation?
These are just three of a list of common questions that often pop up and it’s a good idea to make a list and go through them carefully as you move forward. In terms of the financial aspects, here’s how we can help:
Finding the right rental
Obviously renting is far less of a financial commitment and sourcing the right vacation property isn’t rocket science. The resources available are abundant and an online search can quickly result in finding the ideal spot for your next vacation. One point of caution would be to be careful of the hidden fees associated with many property rentals. If you are using providers like Airbnb, FlipKey, HomeAway, Vrbo etc., almost always, there are undisclosed items like cleaning fees, service fees, owner’s fees, site fees or something along those lines.The fees can add up and provide you with a bit of an unwelcome surprise if you aren’t aware of them ahead of time. Many providers show you a price before these fees, so when you are searching for the right spot and find one that’s a contender, click through to the final price before making a decision.
If you are looking to buy
A few factors to consider that may impact your decision to purchase.
Where do you want to own? Importantly, are rentals permitted there? There are times they are not, especially in private subdivisions.
What is the real estate market like in the areas you are interested in? Is this a market that looks to be going up or is it already high?
Do you intend to rent it out at all when you’re not using it? Will you be able to generate enough interest to do so during the times that you don’t plan to use it yourself? Or do you need to do some major renovations?
Taxation on vacation properties
The basics of capital gains tax is simple, when investors in Canada sell capital property for more than they paid for it, Canada Revenue Agency (CRA) applies a tax on half (50%) of the capital gain amount. Unlike your principal residence, when a vacation property is sold, there are stipulations applied by CRA as to how the taxation will be levied. Taxation on properties like rental, recreation, vacation, or seasonal fall under a different rule set than that of the principal residence. If you sell a property other than your principal residence for a profit, the difference will be considered business income. The opposite holds true for a loss as well.
If the vacation property is outside of Canada, then foreign-owned property has several tax nuances both during ownership and upon sale. During the time of ownership of a vacation property, a couple of things will change the tax treatment: is the property exclusively used as a vacation property, is it rented out with the intent of simply covering the carrying costs or is it rented out more than 50% of the time with the intent of generating a profit? The first two scenarios do not require disclosure on CRA form T1135, however the last one will. In that case, the property is being rented out more than 50% of the time with the expectation of generating revenue over and above carrying costs, so CRA will not consider it for personal use and if it is valued at more than $100,000 you will need to file the appropriate tax documentation for the property. So, a simple reminder to consider a tax professional, should your property fall under this scenario.
When foreign properties are disposed of, any capital gains are taxable for Canadian purposes. These gains may also be taxable in the country where the property is located. Under certain circumstances, the Canadian personal residence exemption can be applied to a residence outside of Canada, but that would then preclude you from using the exemption on a Canadian residence over that same timeframe.
If you decide to rent out the vacation property while you are not using it to help pay for it or contribute to your wealth accumulation strategy, there are aspects you will need to consider ahead of time. How often the property is rented can have an impact on its tax status. Is this a simple “occasional use” rental income to cover expenses or is this an actual business? Consulting a tax advisor about your specific situation is likely time well spent.
Managing this process can be less than straightforward depending on several factors. Where is the property located? Is it close to home? Is it far away, or better yet, in another country? The answer to the location question may make the decision to hire a management group a very easy one. Property management groups provide many of the needed services you might require to rent your vacation property. From maintenance, to booking, to fee collection and cleaning, a maintenance company can make the rental process doable as opposed to a nightmare.
Rest assured, if you plan to own a property that is a distance from your current residence, you will need to come up with a plan to ensure that it is maintained and if something does go wrong, it isn’t unobserved for a long period of time. In our experience, there are numerous official service providers and then there is often someone in the area that makes their living rendering services like lawn cutting and the like. A quick internet search will point you in the direction of any official property management service providers for any given area and a conversation with any current property owners will point you in the direction of local help.
One financial aspect of owning a vacation property is how it will be transferred to the next generation when the time comes. Priceless family memories can be made at a vacation property and these same memories will impact the emotions or the connections various family members have with the property. It is these same emotions that can make managing a transfer a tricky thing. If you do decide to buy, we would highly recommend that this asset be added to your will and any special instructions for the transfer be clearly defined in the document. Our estate planning specialists are a wonderful resource when weighing these options.
Clients often ask us about gifting assets to their family in the hopes of avoiding the taxation triggered on property upon death. You need to be careful about executing this strategy for several reasons including:
Gifting property means you also lose control over what happens to that property which may not be the outcome you foresaw but has historically led to a few sticky situations in the past for some other well-meaning families.
If you gift capital property, it is deemed to have been sold by you and you are now responsible for the difference in capital value (gain or loss). If you gift an asset to your spouse or minor children (or grandchildren), any income earned by your spouse or child on that asset will be attributed back to you and taxed in your hands. However, capital gains or losses realized by a minor child are not attributed back to you. Additionally, any second-generation income (that is, income on the income) earned by your spouse or child will not be attributed back to you either.
In the end, we can certainly discuss strategies for your estate to deal with the tax bill if you decide to purchase a vacation property and it has appreciated in value. If you’re insurable, often a simple policy can be an effective strategy to deal with this potential CRA tax bill if the value is crystalized and a gain is realized.
Vacation properties can be a wonderful thing and a source for special memories that last for generations to come. Deciding to rent or buy is a big decision and should be entered into with eyes wide open. Weighing the options isn’t always an easy task and we’ve tried to give you a taste of some of the aspects you should be aware of. We’re also always here to chat if we can lend a hand or connect you with one of our experts.
Vacation properties can be a magical place for a family whether rented or owned. They can be a wonderful gathering place as children grow, where cherished family memories and traditions can be built and enjoyed. As with the Chicken and Egg analogy in our investment philosophy, a vacation property can provide actual income and growth or simply provide a venue for your family to build amazing experiences and memories. It’s yours to decide.
Hidden rental fees https://www.checkbook.org/national/renting-a-vacation-home/
Reporting Real Estate Income https://www.canada.ca/en/revenue-agency/campaigns/report-your-real-estate-income.html
Selling your rental property https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/rental-income/capital-cost-allowance-rental-property/determining-capital-cost-property-special-situations/selling-your-rental-property.html
Purchase use and sale of vacation properties https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/gi-025/gst-hst-purchase-use-sale-vacation-properties-individuals.html