Introduction
Short-term rental properties have grown in popularity across Canada, thanks to platforms like Airbnb. While this has created lucrative opportunities for homeowners, the government has introduced new tax regulations that impact short-term rental owners, particularly those operating as a business.
New Tax Rules
and Compliance Requirements
Federal Tax Changes: 2023 Fall Economic Statement
As part of the 2023 Fall Economic Statement, the federal government introduced measures to enforce compliance in the short-term rental market. Effective January 1, 2024, tax deductions for short-term rentals will be denied if the property does not meet provincial or municipal regulations.
What Defines a Non-Compliant Short-Term Rental?
A rental property is considered non-compliant if it fails to meet municipal or provincial licensing, registration, and permit requirements. This non-compliance can lead to financial consequences, including denied tax deductions and potential reassessments by the Canada Revenue Agency (CRA).
GST/HST Implications for Short-Term Rentals
When Does HST Apply?
HST applies to rental periods of less than 28 consecutive days if the property is primarily used for short-term. If over 90% of a property’s usage is for short-term rentals, it may be classified as a commercial asset, triggering HST on its sale.
A recent Tax Court of Canada case highlighted this issue when an Ottawa condo owner transitioned from long-term to short-term rentals before selling the property. The court ruled that the property was a commercial asset, making the entire sale subject to HST. This unexpected tax liability resulted in a costly reassessment for the owner. The case underscores how changes in rental use can shift a property from residential to commercial classification, leading to significant tax consequences.
Small Supplier Threshold
Short-term rental operators generating over $30,000 in revenue (gross income) within four consecutive calendar quarters (per year) must register for GST/HST, as they exceed the small supplier threshold.
Municipal Regulations and Compliance
Local Bylaws and Registration
Municipal rules vary widely across Canada. Cities like Toronto, Hamilton, and Huntsville require registration and licensing for short-term rentals. For example, Toronto mandates that the rental property must be the owner’s principal residence, while Huntsville applies a Municipal Accommodation Tax (MAT). Non-compliance with these regulations can lead to denied tax deductions and financial penalties.
Transitional Relief for 2024
To help owners adapt to the new rules, a transitional provision allows property owners until December 31, 2024, to obtain the necessary local licenses and registrations to be considered compliant for the entire year.
Financial Impact of Non-Compliance
How Denied Deductions Affect Tax Liabilities
Non-compliant short-term rental owners risk losing deductions on expenses like mortgage interest, property taxes, and maintenance costs. For example, a rental generating $50,000 in revenue with $30,000 in deductible expenses could face a much higher taxable income if those deductions are denied.
Case Study
Consider an Ontario homeowner earning $100,000 annually from short-term rentals, with $40,000 in deductible expenses. If they fail to comply with municipal regulations halfway through the year, $20,000 in deductions could be disallowed, increasing taxable income. At a 40% marginal tax rate, this results in an additional $8,000 in taxes owed, significantly impacting cash flow.
Additionally, non-compliance may trigger CRA audits or retroactive reassessments, further increasing financial burdens. Without deductible expenses, short-term rental profitability can quickly decline, making it crucial for owners to maintain compliance.
Strategies for Compliance
Key Steps to Stay Compliant
- Understand Local Regulations: Each municipality has its own rules. For instance, Toronto requires short-term rentals to be a principal residence. Keeping up with local updates is essential.
- Obtain Proper Licensing: Registering your property and securing the necessary permits ensures compliance and protects tax deductions.
- Follow Federal Tax Requirements: If your rental income exceeds $30,000 in four consecutive quarters, you must register for GST/HST.
- Track Principal Residence Status: If required, document your property’s principal residence status to ensure eligibility for short-term rental operations.
- Maintain Detailed Records: Keep financial records of rental income, expenses, and compliance documents to avoid issues during CRA audits.
- Monitor Regulatory Changes: Municipal and federal rules evolve frequently. Staying informed through newsletters and industry groups can help prevent compliance issues.
- Consult a Tax Professional: Tax experts can provide guidance to ensure compliance and optimize deductions.
The Consequences of Non-Compliance
Financial Penalties and Tax Liabilities
As mentioned earlier, non-compliance can lead to the denial of expense deductions and increased tax liabilities. Additionally, CRA reassessments may impose penalties, interest, and retroactive tax bills.
In Addition to that, HST on the Sale of Short-Term Rental Properties
When a property has been used at least 90% of the time for short-term rentals, the CRA requires a 13% Harmonized Sales Tax (HST) to be applied upon its sale. This tax is calculated on the full sale price, creating a substantial financial impact for sellers. For instance, on a property sold for $1 million, the HST liability would amount to $130,000. Property owners should carefully assess their rental usage and consult a tax professional to mitigate unexpected costs. In an extreme example: A person purchases a house for $900,000 with no HST on the purchase. That person lives in it for a year, then decides to switch the unit to a short term rental unit. The increase in value for the time they lived in the house is not taxable due to being covered under the primary residence exemption. Then there is a change of use for the property to short term rental. that makes more than $30,000 for the following year, so they are forced to register for a HST number. The following year, they do the same, and decide to sell the unit for $1,000,000. They are obligated to collect 13% tax on the $1,000,000, so they ask the buyer for $1,130,000. The buyer sees that this is $130,000 over market value and stays firm at $1,000,000. The seller accepts since they want out of the property, so the sale price is $884,955.75 + $115,044.25 (13% HST ). The seller would lose $15,044.25 on the sale of the property, which can be deducted from the rental income. There is some more nuance in this area, but stands outside the scope of this article. My main point is that it may not have been advantageous to operate this property as a short term rental in the first place.
Conclusion
With evolving tax regulations, compliance in the short-term rental market is more important than ever. Property owners must stay informed and proactive to avoid penalties and unexpected tax liabilities.
Need Assistance?
If you’re uncertain about how these tax changes affect your rental property, contact us for expert guidance. Our team can help you navigate the new regulations and ensure full compliance.