Buying a rental property (or not)

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Unlike my previous post, the criteria to decide whether to buy a rental property -or not- are very different. This post may also shed some light if, for example, you already own and have accepted a job in another city/province.

First, understand the tax implications

Although you can deduce some expenses from it, rental income is taxed at your marginal rate, if the property is registered under your name.

In Canada, selling your principal residence for profit does not result in taxes levied. This is definitely not the case with a rental property!

Upon selling, any profit you make is considered a capital gain. In Canada, 50% of the capital gains are taxed at your marginal rate, if the property is registered under your name.

It gets a little bit more complicated if you elected to deduct the Capital Cost Allowance -CCA-from your rental income. CCA is a “wear and tear”amount set by Canada Revenue Agency depending on the type of property, the year it was built etc….

CCA is a tax-deference mechanism. It allows you to lower the amount of taxes levied on the rental income. Note you can’t use the CCA to trigger a loss or if you are already claiming a loss.

Upon selling, the CCA amounts previously claimed become 100% taxable, are added to your income and taxed at your marginal rate. It is called “recapture”.

As an individual, claiming CCA usually does not make much sense, unless you are in the highest tax bracket.

Second, cash flow is king, forget the 1% rule (or almost) 

When you live in your property, land appreciation is important. This is what increases your property value. As an investor, and although this is nothing to sneeze at, this is not what you should be looking for.

As a potential landlord, you need to look at your investment from a business perspective. In other words, will the income generated from the property be enough to cover all its expenses and taxes?

A common principle used is the 1% rule, meaning the rent should be 1% of the purchase price.

Unfortunately, in North America, real-estate has become increasingly expensive. Rents have not necessarily followed that trend. It has become almost impossible to find properties meeting the 1% rule.

Which does not mean you should not consider becoming a landlord.

There is another formula to help you determine if a property has cash flow potential, the Gross Rent Multiplier or GRM:

(gross annual rent/purchase price) X 100

If the number is above 8, the property has potential, if it is under 8, pass. If it is above 10, cash flow is guaranteed. This quick and easy formula takes out all the guesswork and emotions from the search.

Once you have your cash flow number, dig into the details: proposed rent, mortgage payment, property tax, condo fees if applicable, potential repairs, estimated income tax..etc and see if it still adds-up.

As a landlord, you won’t be able to postpone or skip maintenance and repairs. It is best to budget for them. Some utility costs, such as Hydro can be passed on to the tenants.

Third, vacancy rate

The lower, the better for you! It is pointless to buy a rental property if there is little demand for rentals….CMHC provides info on the matter.

Final word

It is crucial to leave your emotions at the door when deciding to purchase a rental property or to rent out your main residence.

There are also lots of other factors that could influence your decision such as how much equity you are able to start-up with or the amortization on your mortgage. In Canada, you need at least 20% down for rental properties.

“Landlord-ing” is not for the faint of hearts. It is actually a lot of work.

 

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