Do you own a second home or vacation property, such as a place in the country? If so, you have a few ways to create income if you ever need it:
* You can sell your vacation property to create some cash.
* You can rent it out when you're not using it. This approach can work very well in a resort area, where demand for rentals is high. You may get more than enough income from renting to pay the costs of carrying the property.
Buying and renting out vacation property in Canada
Here's a quick summary of the benefits and drawbacks to renting out vacation property in Canada:
* You can use the rent to pay your costs, including any mortgage, and improve your property
* If you only rent your property out for part of the year, you can still enjoy it yourself the rest of the time
* You get some tax breaks. The rent you get is business income, so you can deduct many costs against it, such as the interest on your mortgage
* If the property goes up in value, you will have more equity, which you can leave in the property or borrow back out
* It takes time, effort, and money to maintain the property and manage the rentals. If you are providing a furnished home, you will also have those added costs
* The place will be easiest to rent at the times you most want to use it. This may limit your enjoyment of it
* You do have to pay tax on the rental income you get
* If the property is not your main home and it goes up in value, you will pay capital gains when you sell. If the property becomes part of your estate, your heirs will have to pay that tax
Owning and renting out vacation property in the United States
It gets more complex if you own and rent out vacation property in the United States (US). You need to get expert advice, but here are two major tax issues to consider.
1. You will pay US income tax on your rental income
Let's say you buy a condo in Florida and rent it out for part of each winter. You may face a 30% US withholding tax on your gross rental income. You must deduct this amount from all the rent you receive and pay it to the US government each year.
Another option is to report the US income using the net rental income method. This means that you deduct expenses and depreciation from your rental income before you calculate the tax you owe. You can select this method when you file your US tax return. Once you do, you usually can't reverse your choice.
The good news is you don't have to pay tax on your rental income twice. If you pay US tax, you can claim a foreign tax credit on your Canadian tax return.
2. There will be tax on the property after your death
If you own a US vacation property at the time of your death, your estate will have to pay US federal estate tax. This tax ranges from 18% to 55% of the property's value, less a tax credit for non-US citizens or residents.
Can you give the property to a loved one as a gift instead? The short answer is yes, but only up to a certain value. You can gift up to a total of $125,000 (US) per year tax-free to your spouse if he or she is not a US citizen. If your total gifts in the year to anyone else exceed $12,000 (US), US gift tax will apply.
Remember: Renting out a second home or vacation property has pros and cons
Many people like the way it brings extra income into their lives. But before you decide, make sure you also consider the way it will affect your taxes and your estate. You may want to consult an accountant, lawyer, mortgage broker, or other financial expert.
Content in this section is provided in partnership with the Investor Education Fund, a non-profit organization promoting financial literacy to Canadians. To find out more go to GetSmarterAboutMoney.ca.