How To Get The Most Out Of Your Rental Property

The most recent federal census found that 33.5 per cent of Canadians were renters. Those rental properties are owned by individual landlords, as well as corporate and institutional investors like Real Estate Investment Trusts (REITs) and pension plans.

REITs offer a simple way for an investor to invest in rental real estate without the responsibility of managing a property on their own. There are publicly traded REITs that trade as stocks on public stock exchanges, as well as private REITs that are less liquid and may offer a different risk-return profile.

Many real estate investors opt for direct ownership, and for those who do, there are several considerations to get the most out of your investment.

What Do Tenants Want?

According to Canadian Apartment Properties REIT, the largest residential REIT in Canada, beyond location, the next three most important amenities for apartments are security features like controlled access entry points, parking options like covered parking, and laundry facilities on site.

According to Zolo, Canada’s largest independent real estate marketplace, the top three must-have features for a rental are a pet-friendly unit, an updated kitchen, and a primary bedroom with an ensuite.

So, whether you are looking to buy a new rental property, or are considering renovations, keep these factors in mind for rentability, and to command top rental dollars.

Increasing Your Rent

You can increase your rent from year to year for an existing tenant, subject to the applicable provincial rules. British Columbia, Manitoba, Ontario, Nova Scotia, and Prince Edward Island all have rent controls that limit the annual increases, subject to provincial guidelines.

A landlord may be able to apply to increase rent beyond the guidelines, subject to extraordinary circumstances like a major capital expenditure. There may be specific forms to use, and notice periods can apply to increase rent and stay compliant.

If a landlord chooses not to increase rent for their tenant, it may be harder to keep pace with market rents and expense inflation in the future for a long-term tenant.

Expenses You Should Not Be Paying

Mortgage insurance is an expensive addition to many mortgages that borrowers should think twice about. This coverage may make ongoing mortgage payments for you if you become disabled, or pay off your mortgage balance if you die, both of which seem like good protections.

However, the cost of this disability and life insurance compared to buying the same level of protection separately can be expensive. It may also duplicate coverage you already have in place through your employer’s group plan or private insurance coverage.

Old appliances can use a lot of extra power compared to newer, more energy-efficient options. So, if your tenant is not paying the electricity costs for your rental and you are, consider replacing your old appliances. This will make your tenants happy and may also improve your bottom line in the long run.

Depending on where you live, you might be taking a different approach to your water heater. In Alberta, it is common to buy your water heater outright. By comparison, in Ontario, most people rent their water heaters. Over the long run, buying is generally the better financial choice, especially if you intend to own your property for the long term.

Increasing Your Mortgage Amortization

If you want to improve your cash flow, you can consider pushing out your mortgage amortization to as many as 35 years. Some lenders offer 30- or even 35-year repayment options, but there may be incremental costs like additional fees, or a higher interest rate compared to a traditional 25-year mortgage.

Regardless, if your amortization is under 25 years, you may be able to increase it back to 25 years, and still maintain a competitive interest rate.

Deducting Capital Cost Allowance

If your rental property is cash flow positive for tax purposes, you can deduct depreciation, called capital cost allowance. You can generally claim 2 per cent of the building portion of the property’s cost in the first year and 4 per cent on a declining balance basis thereafter.

If you buy appliances or other equipment, they may have different depreciation rates that apply.

You can use capital cost allowance to decrease your rental income to zero, but not to create or increase a net rental loss. The caveat is that you must recapture this historic depreciation when you sell and add it to your income in that year. If you are in a low tax bracket now, but will be in a high tax bracket when you sell, this could lead to a short-term gain (tax savings) for long-term pain (tax owing). So, capital cost allowance is better suited for a high-income landlord, or someone who does not expect to sell for many years.

Keep in mind if you plan to move into your rental property at a future date, you may be able to do this without triggering capital gains tax, deferring the tax bill before it becomes your principal residence until the property is sold. However, if you have claimed capital cost allowance, this negates your ability to move into the property without incurring tax at that time.

Refinancing Your Property

Some landlords opt to borrow against their property value as the equity in the property—value minus mortgage—increases. This can be a way to access cash to buy another property, invest in Registered Retirement Savings Plans (RRSPs) or Tax-Free Savings Accounts (TFSAs), or simply free up cash for personal expenses.

When you do this, the use of the funds determines if the interest is tax deductible. If you use the funds for another rental property purchase, or to buy taxable investments in a non-registered investment account, the interest may be tax deductible. However, if you use the funds for RRSP or TFSA contributions, or personal expenses, the interest is not tax deductible. It is a misnomer that all rental property interest is deductible, simply because the mortgage or line of credit is on a rental property.

Refinancing can sometimes be more appealing than selling, either because market conditions are not ideal, or because of a large, deferred tax liability to sell. Borrowed funds are tax-free, unlike the sale proceeds of a rental property whose value has appreciated.

Selling Your Property

Landlords sell their properties for different reasons. It may be that they no longer wish to own it, or the value has appreciated, and they want to take some chips off the table, or they may need the funds for other purposes.

Regardless of the reason, selling can lead to a significant tax liability. The good news is when you sell, you have a cash inflow that can be used to pay the tax. If you want to mitigate the tax, there are only a couple of simple solutions.

One is to sell the property in a year when your income is relatively low, like after you have retired. If you are an incorporated business owner with control over your income, and you are selling a personally held rental property, you can reduce your salary or dividends to minimize other income sources.

If you have RRSP room, an RRSP contribution using the sale proceeds will generate an RRSP deduction that can reduce your taxable income in the year.

Although less common, there may be an option to claim a capital gains reserve on the sale of a rental property. This situation is most likely to arise if you strategically structure the sale, gift of the property, or some combination thereof to a family member.

This reserve can allow you to bring 20 per cent of the capital gain into income each year over five years, but only to the extent you do not receive the proceeds upfront. This approach would be uncommon when selling to an arm’s length stranger.

Summary

Getting the most out of your rental property is influenced by a variety of factors, ranging from property features to rental increases, expense management, mortgage strategy, and tax planning.

Seek advice from your contractor, realtor, mortgage broker, and accountant. If you are playing any of these roles on your own, make sure you are taking the time to consider the resulting implications of your decisions.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.