Avoid unexpected tax consequences and reach out to a BDO tax advisor to stay on top of income tax developments that may impact your short-term rental operations.
Published: April 18, 2024
Updated: April 18, 2024
As part of the federal government’s efforts to address the housing challenges in many parts of Canada, a proposal to deny the deduction of expenses incurred in the year on non-compliant short-term rentals was announced in the 2023 Fall Economic Statement.
Since then, draft legislation was released with an effective date of Jan. 1, 2024. The purpose of this proposal is to discourage the use of residential properties as short-term rentals instead of long-term rentals. The reasoning is that long-term rentals provide greater relief to the current housing crisis.
In this article, we discuss which short-term rentals are affected by the proposal, how you may benefit from the transitional relief that is only available for 2024, and uncertainties that exist as we await further guidance from the government.
Is my rental property affected by the proposal?
If you rent out a residential property for short periods of time through platforms like Airbnb or Vrbo, you may be wondering if and how the proposal impacts you. As a first step, you should know that a residential property includes all or any part of a house, apartment, condo unit, cottage, mobile home, trailer, houseboat, or other property that is legally permitted to be used for residential purposes.
To determine if the proposal to deny expense deductions applies to your rental property, you need to understand the definition of a non-compliant short-term rental, which is, at any time, a residential property that is offered for rent for a period of less than 90 consecutive days that:
- is located in a province or municipality that does not permit the operation of a short-term rental; or
- is non-compliant with any of the registration, licensing, and permit requirements in the locality in which the property is located.
Based on the above definition, it is important to ensure that all regulatory obligations are understood and complied with so that your property isn’t considered a non-compliant short-term rental.
Based on the draft legislation, owners who lease their residential property for at least 90 days may still be caught under the rules in situations where the property is subleased by a tenant for a period of less than 90 days.
How is the amount of non-deductible expenses calculated?
Where the proposal applies, a non-compliant amount is determined by taking the total of all outlays made, or expenses incurred, in respect of the short-term rental in the taxation year.
Where the short-term rental was non-compliant for part of the year, the total amount of rental expenses would be pro-rated based on the number of days of non-compliance over the number of days that the residential property was a short-term rental to determine the portion of expenses that would be non-deductible.
Currently, there is some uncertainty as to how certain expenses, such as prepaid expenses, capital cost allowance, financing fees, and bad debts expense, should be treated in determining the non-compliant amount based on the proposal. This is because these expenses are usually deducted for income tax purposes in a year or over a number of years after the year in which the outlay was incurred.
What is the transitional relief available in 2024?
For the 2024 taxation year, if you are compliant with all the local registration, licensing, and permit requirements on Dec. 31, 2024, you will be deemed to be compliant for all of 2024.
This transitional relief means that you have until Dec. 31, 2024 to ensure compliance with all the registration, licensing, and permit requirements, permitting you to deduct expenses incurred on your short-term rental to reduce your income tax liability for 2024.
Based on the draft legislation, this transitional relief may operate differently for taxpayers (such as corporations) with a non-calendar year-end.
What is the impact on my personal income tax if the proposal applies?
If you have a non-compliant short-term rental, the non-compliant amount would be non-deductible for income tax purposes.
Let’s explore an example:
Joe owns an investment property, a condo unit in Guelph, Ont., and was renting it out long-term to a university student. The university student is now graduating and will not be renewing the lease at the end of the semester.
Joe decides to rent out his condo on Airbnb starting May 1 for the rest of the year. He earns $12,000 in rent and incurs $8,000 on reasonable expenses to operate the short-term rental, resulting in $4,000 in net income.
Unfortunately, since May 1, Joe failed to comply with all registration, licensing, and permit requirements locally and remained non-compliant on Dec. 31, 2024.
Joe may be under the impression that he only needs to pay income tax on his $4,000 net income, but the proposed legislation would apply on his non-compliant short-term rental. In this case, the non-compliant amount would be $8,000 (i.e., $8,000 in reasonable expenses multiplied by 245 non-compliant days and divided by 245 days the condo was a short-term rental). This means Joe’s taxable income would be increased to $12,000 (i.e., $4,000 in profit plus 8,000 of non-deductible expenses) as a result of the proposed legislation.
Assuming the top marginal tax rate in Ontario of 53.53%, Joe would be liable for personal income tax of $6,424 on his non-compliant short-term rental for 2024, which is $4,282 higher than he anticipated.
How BDO can help
The information in this publication is current as of March 1, 2024.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.