Tax implications of purchase structures

Apportioning Value on Different Price Components. The manner by which you structure the purchase of rental property has tax implications. The price being offered for a property can actually be a composite of several elements included in the purchase such as land, the building itself and chattels (e.g. appliances), inventory (e.g. supplies), and goodwill, if any. Goodwill is intangible, but the reputation of a rental property could affect its appeal to future tenants and, therefore, can impact its tenancy rate on a regular basis.

It is important to make sure your offer to purchase covers the proposed allocation of the purchase price to each component mentioned above and, for this reason, to receive competent tax advice whilst formulating your offer. Some points to consider are described below.

· When purchasing a revenue property, you may want to apportion to the land the highest value possible. If you eventually sell the property, the higher land value will result in a lesser capital gain than if the land valuation is lower. It is important to get the value fixed at the outset to avoid problems with Revenue Canada later on.

· This also affects the values apportioned for building and chattels, which are to be depreciated over the economic life of the assets. A higher value implies a higher amount of depreciation to be claimed.

· When you are selling revenue property, your preferred value allocation may differ from the buyer's. The negotiation between buyer and seller will include the tax impact to both, and they will need to agree on a value allocation package that mutually benefits them.

Purchasing from corporate vendor. The purchase of revenue property from a corporation could involve either its shares or assets. Some of the implications might be the following.

· By buying shares you buy into ownership of the corporation. This means you are also exposed to the risk of its liabilities such as debts owing and pending lawsuits. By buying only assets, you do not assume such liabilities.

· By buying shares, you could benefit from any losses incurred in previous years that are still available for offset against future rental income. This would naturally depend on whether such losses are allowed for offset. By buying only assets, you receive no possible benefit from such losses.

· There is no change of title on the property if you buy shares of the corporation, because the corporation remains as the owner. This means there will be no purchase property tax (if such a tax exists in your province) to be paid. There will be a change in ownership from the corporation to you if you buy the assets, which means the tax will have to be paid.

· You may not benefit from deductible depreciation if the corporation has already used up most of the depreciation credits on its depreciable assets such as buildings and chattels. If you buy assets, you can claim depreciation on the value allocated for buildings and chattels in your purchase price.

· In cases where the corporation's land valuation has been set artificially low, there may be a larger capital gain tax to pay in the event of a future sale from you to another purchaser.

Purchasing in Personal or Corporation's Name. There are different tax implications on purchase of a property by a person, several persons, or a limited company (corporation).You may want to ask your accountant to structure the purchase in a manner that will best meet your needs.

Soft Costs. These outlays are part of activities intended to make a building rentable. The soft costs refer to expenses such as interest on borrowed money, legal services, accounting fees and property taxes. They do not include the cost of construction, renovation or alteration on the building.

Soft costs may be expended during the period of construction or alteration or outside that period, but the outlays are attributable to that activity. For instance, you may incur expenses in borrowing money which, when released, will allow you to start the construction. Soft costs are treated as capital expenditure, which may later on be amortized as part of CCA.

Vacant Land. The interest on money borrowed to purchase vacant land and property taxes on the land will be subject to different tax rules depending on how the vacant land is used.

If the land is idle and not earning rental income, these costs (interest and property taxes) may be treated as capital expenditures and added to the original acquisition cost when you sell it. Upon sale, the total accumulated cost will thus be higher and the capital gain on it is lower.

If the land is earning rental income (e.g., you lease it to a farmer), you may deduct interest on money borrowed to purchase it, property taxes and related land assessments - but only to a limited degree. The allowable deduction is limited to the net amount of rental income minus rental-related expenses. You are not allowed to create or increase a rental loss. You cannot use the above expenses as a deduction to reduce other income sources. But if the limitation restrains you from deducting a portion of the expenses, you are allowed to add this portion to the cost of the land.

Your tax accountant should be consulted for more specific tax advice that conforms to current rules.

Importance of records

It is extremely important to keep detailed records when you invest in real estate and are earning income from the investment. All documents that help prove monies received and paid out should be kept - contracts, invoices, receipts, etc. The absence of such documents during an audit (if one is conducted) can cause your claims to be disallowed.

Your accountant should be able to help you with this all-important task.