[drh]

Had a discussion with an acquaintance the other day concerning taxation and having two principal residences. Something didn't quite strike me as right so I thought I'd pose the question to the group here:

He is in the process of moving to a new house (of which him and his common law wife are on title) and is proceeding to rent out his existing condominium. His strategy is that he will not declare his condo as a rental property (and not deduct mortgage interest etc.), but rather, leave things as they are-- collect rent and pay the mortgage as if he were living there. When it comes tax time, he will make no mention of this "extra" rental income.

His strategy is that he will maintain the condo as a "principal residence" along with his new home -- his name appears on title for both properties.

My question is, how would CRA treat this situation? And how would CRA even know which is principal and which is not if it's never declared as such?

This appears dangerous (and illegal) to me, but wanted to see what others thought.

 

[CanadianCapitalist]

This appears dangerous (and illegal) to me, but wanted to see what others thought.

I concur. To me, this is definitely cheating on taxes. It is questionable even if the friend even has to cheat. If the friend owns the condo free and clear but is taking out a mortgage on the new house, he can surely structure matters in a very tax efficient manner.

 

[drh]

I concur. To me, this is definitely cheating on taxes. It is questionable even if the friend even has to cheat. If the friend owns the condo free and clear but is taking out a mortgage on the new house, he can surely structure matters in a very tax efficient manner.

Right, but in his case, he has mortgages on both properties. I think his ultimate plan is to claim his wife as being the owner and primary occupant of the house, while he is the occupant of the condo. Not sure how this would work since they file taxes as common law partner with the same address.

 

[cardhu]

My question is, how would CRA treat this situation?

They would treat it as tax evasion, and it would be a slam-dunk case. There is no ambiguity there. Failing to disclose income is evasion.

He and his "spouse" can have only one principal residence between them. But in any event, that argument is a red herring ... the concept of principal residence only comes into play when a property is sold ... if he's not selling either property, then it makes no difference whatsoever which one he wants to think of as his principal residence.

Is he perhaps thinking that choosing not to deduct legitimate interest expenses will lessen his chances of "getting caught"? ... if so, then clearly he understands that there is something offside here ... if it was legit, there would be nothing to get caught doing.

 

[CanadianCapitalist]

But in any event, that argument is a red herring ... the concept of principal residence only comes into play when a property is sold ... if he's not selling either property, then it makes no difference whatsoever which one he wants to think of as his principal residence.

But it does. When he buys a second property and moves into it, the first is deemed to have been disposed even if he doesn't sell it. The cost base of the rental property is the appraised value on the day it ceases to be a principal residence.

 

[CanadianCapitalist]

Right, but in his case, he has mortgages on both properties.

Since he has a mortgage on the principal residence as well as the condo, I fail to see what advantage there is in not reporting rental income. The rental income is offset by expenses such as mortgage interest, maintenance etc. (I'm not an expert on rental properties, so other members feel free to correct any inaccuracies). He can structure his mortgage is such a way that there is very little taxable income from the rental property. Not sure what he is trying to achieve here.

 

[cardhu]

But it does. When he buys a second property and moves into it, the first is deemed to have been disposed even if he doesn't sell it. The cost base of the rental property is the appraised value on the day it ceases to be a principal residence.

Yes, you're right, if it is a permanent change in use, and if he does not "elect" to continue treating it as his PR for 4 additional years, as he is entitled to do.

What I meant was that it makes no difference to whether the rental income would be taxable or not ... even if he did continue to consider it his PR, it wouldn't change the fact that the rental income is taxable.

 

[cardhu]

He can structure his mortgage is such a way that there is very little taxable income from the rental property. Not sure what he is trying to achieve here.

I agree that it serves no legitimate purpose to avoid claiming an eligible interest expense ... but if the mortgage interest isn't enough (in combination with all the other expenses) to fully offset the income, then there would still be tax exposure ... he could reduce the rent, but ......

I expect that what he's trying to achieve is evasion ... by not claiming the interest deduction, it may not be as "obvious" to CRA.

 

[CanadianCapitalist]

What I meant was that it makes no difference to whether the rental income would be taxable or not ... even if he did continue to consider it his PR, it wouldn't change the fact that the rental income is taxable.

Agreed. Whether or not a home is a principal residence makes no difference to whether rental income is taxable or not. If it is income, it should be declared and it is taxable. Period.

 

[MoneyGal]

Agreed. Whether or not a home is a principal residence makes no difference to whether rental income is taxable or not. If it is income, it should be declared and it is taxable. Period.

This is accurate. However, the PR exemption comes into play when the property is sold, and the tax exemption is claimed. So even though the deemed disposition will have taken place in the past, it isn't claimed until one or the other of the properties is sold. And, once the PR exemption is claimed for one of the properties, it cannot be claimed for any other property for the same time period.

So, first: there isn't any current benefit to "maintaining two principal residences." The PR tax exemption is claimed at the point of sale.

And secondly: of course CRA will catch this, if he tries to actually claim a PR exemption for two properties at the same time. What he may be saying he's going to do is conceal the income from the sale of one of the properties, which is a slightly different matter; however, it sounds like he's already planning to conceal income from CRA.

My suspicion - especially given that there is little taxable income generated from the property (from what you've told us) is that what he's attempting to shield from CRA is any long-term capital gains on the property. He's already said as much by referring to having "two principal residences." It's as though he intends to conceal the entire existence of this property from CRA.

I have heard, more than once, but have no way to verify this, that CRA's main source of audit tips is disgruntled family members and friends. I don't think I'd enjoy living in fear of a lifestyle audit or even a "regular" audit (although I've been through one of those and emerged completely unscathed). If I was planning on doing something like this, you can bet I wouldn't be telling my acquaintances about it.

 

[MoneyGal]

oooh! That quote didn't work. I was attempting to quote the post from CC at 1:37 today about the deemed sale.

 

[drh]

He can structure his mortgage is such a way that there is very little taxable income from the rental property. Not sure what he is trying to achieve here.

Thanks CC - I think his concern is that being in the highest tax bracket, any rent collected that is not deducted against mortgage interest, taxes, fees etc., would be taxed as regular income in his bracket.

By neglecting to disclose the rental income altogether, he continues pay down his mortgage on the condo, covers all the overhead of the condo, while pocketing the extra cash (tax free), or so it appears in his strategy.

Great points however on Principal Residences being deemed at time of sale and not being allowed for two properties over the same time period. I think if anything, this alone would shoot holes in his theory altogether, and raise flags with the CRA.

 

[MoneyGal]

It won't just "shoot holes" in his theory. It is literally impossible to do this. Here's the CRA form to designate a property as a principal residence.

Note that it asks the taxpayer to specifically confirm and sign off on the PR exemption claim. This is in addition to signing your tax return in general. CRA pays *very close attention* to this issue, as it is a source of large personal exemptions when it is used for its intended purpose.

Capital gains are already tax-preferred income. And there are lots of *legal* ways he can minimize the current income from his condo. I should stop responding to this thread, because these kinds of issues make my head explode.

 

[cardhu]

... pocketing the extra cash (tax free), or so it appears in his strategy.

It would not be tax-free ... it would be tax-evasion.

The whole issue of PR exemption is a red herring ... it has nothing whatsoever to do with the taxation of the rental income.