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Flashcards in Property Income Deck (17)
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1

After tax rate of return

The after tax rate of return on an investment is a measure of return that takes into account the taxes that the investor must pay. With the sale of capital property, an investor has to report a taxable capital gain as income.

An investor’s opportunity cost has nothing to do with finding the after-tax rate of return on an investment. However, an investor might compare the after tax rate of return to her after-tax opportunity cost in assessing an investment alternative.

The after tax rate of return on an investment in share that did not pay dividends is the rate calculated by (financial calculator!)

N = number of payments per year = 1
xP/YR = number of years of ownership
PV= Present value (-purchase price of shares)
PMT = 0
FV = (proceeds after tax)
Solving for I/YR = nominal interest rate = after tax rate of return

2

Tax on Non-Residents

Tax on Non-Residents
All emigrants who have left Canada after October 1 1996 are deemed to have disposed of all property for deemed proceeds equal to their FMV at the time of emigration, other than:
• Real property situated in Canada, including real estate, Canadian resource properties, and timber resource properties
• Property of a business carried on by the taxpayer at the time of emigration through a permanent establishment in Canada, including capital property, eligible capital property and inventory (not, this does NOT mean that shares in that business are exempt from the deemed disposition)
• Property that is “excluded personal property”, which included many kinds of income rights, such as interest in a RPP, RRSP, or RRIF, as well as other properties that confer right, such as salary deferral arrangements, insurance policies (other than seg funds) or stock options.
• Certain property owned by short term residents
For example, Canada would still be able to tax capital gains that a taxpayer later realizes on the disposition of real estate located in Canada.

This deemed taxable capital gain is fondly referred to as the departure tax.

Post-departure capital losses are allowed to offset pre-departure capital gains, with some restrictions.

The payment of the tax may be deferred until the property is actually sold (or otherwise disposed of) but in some situations, adequate security must be provided.

3

Property Income

Property Income
Property Income includes income from real property, as well as income from financial assets.

Specifically, it includes interest, dividends, rent, and business income earned by a “specified member” of a partnership.

Monies earned by performance of a service and capital gains are not property income.

4

Reporting accrued interest

Reporting accrued interest
The investor must accrue the interest income that has been earned according to the bond year, even if that interest has not been paid.

The bond year ends on the anniversary day of the bond, which is one year after the day immediately preceding the day of issue of the contract.

The interest income is calculated based up the yield to maturity of the strip bond.

At the end of the first bond year, the amount that a strip bond would be worth is calculated by (financial calculator):
P/YR = number of payments per year = 1
N= number of periods
PV = present value
FV = future value
Solving for I/YR
Then…
Entering N (number of years remaining on strip bond 5-1)
Solving for PV

(Then purchase price – calculated PV).

5

Reporting interest income

Reporting interest income
Individuals must report interest income according to the cash/accrual basis for reporting interest income as follows:
• Any interest income received or receivable during the calendar year must be reported as interest income for that fiscal period, except to the extent it was accrued for income tax purposes in a previous fiscal year; and
• Interest income earned as of every anniversary day of an investment contract, or as of every third anniversary day of certain investment contracts, must be reported as interest income for the fiscal period in which the anniversary day falls, except to the extent it was accrued for income tax purposes in a pervious period.

6

Spouse claiming other spouse's dividend income and spousal tax credit

Personal amount in respect of a spouse/common law partner is an amount on which an individual can claim a tax credit, it, at any time in the year, the taxpayer supported a spouse/common law partner. The amount is indexed. The conversion rate it the lowest income tax rate.

A taxpayer can elect to report all of a spouse/common law partner’s taxable dividend income on his own tax return to avoid reducing the spousal tax credit. All of the dividends must be reported; a partial election is not permitted. If he were to make this election, he would be able to claim the dividend tax credit.

7

Foreign Property

Foreign Property
If you owned foreign property with a cost of more than $100,000CDN at any time during the year, you must file a Form T1135, the Foreign Income Verification Statement; and report the foreign investments that you own, the total cost of those investments, along with their geographical locations. You also have to identify the total income that you reported on your tax return from those foreign investments.

Foreign investment property that must be reported:
• Amounts in foreign bank accounts
• Shares in foreign companies
• Interests in non-resident trusts
• Bonds or debentures issued by foreign governments or foreign companies
• Interests or units in offshore mutual funds
• Real estate situated outside Canada
• Other income earning foreign property

However, foreign investment property does not include:
• Personal use property, that is, any property used mainly for personal use and enjoyment, such as a vehicle, vacation property, jewelry, artwork, or any such property
• Assets used only in an active business, such as business inventory or the equipment and building used in the business

8

Foreign Property

Foreign Property
If you owned foreign property with a cost of more than $100,000CDN at any time during the year, you must file a Form T1135, the Foreign Income Verification Statement; and report the foreign investments that you own, the total cost of those investments, along with their geographical locations. You also have to identify the total income that you reported on your tax return from those foreign investments.

Foreign investment property that must be reported:
• Amounts in foreign bank accounts
• Shares in foreign companies
• Interests in non-resident trusts
• Bonds or debentures issued by foreign governments or foreign companies
• Interests or units in offshore mutual funds
• Real estate situated outside Canada
• Other income earning foreign property

However, foreign investment property does not include:
• Personal use property, that is, any property used mainly for personal use and enjoyment, such as a vehicle, vacation property, jewelry, artwork, or any such property
• Assets used only in an active business, such as business inventory or the equipment and building used in the business.

9

Rental property: what can and cannot be deducted

premiums for property insurance
rent collector
legal fees
property taxes
mortgage interest

Cannot deduct mortgage principal, materials to build (would be added to ACB) or time spent to build.

10

Can rental losses be used to offset employment income?


Can rental losses be used to offset taxable capital gains?

Yes, if the taxpayer had the expectation of profit from the rental income

Yes

11

Calculating UCC when capital is disposed and new capital is purchased

(UCC at beginning of year + (net additions + 50%)

12

50% rule pertaining to acquiring capital property

The 50% rule is a rule such that if you were to acquire depreciable property during the taxation year, you could usually claim only one half of the et additions to a CCA class for the year.

13

What is a corporation's taxation year is shorter than a calendar year

UCC is prorated

14

Calculating UCC at dispostion

Whenever a taxpayer disposes of depreciable property i a class, the UCC of that class after disposition is calculated as:
UCC - (lesser of proceeds of disposition and capital cost)

---If a taxpayer disposes of the last asset in a CCA and the taxpayer's UCC after disposition is a positive amount, the taxpayer can deduct the balance as a terminal loss

--If a taxpayer disposes of the last asset in a CCA and taxpayer's UCC after disposition is a negative amount, the taxpayer must report the balance as a recapture of CCA.

A terminal loss is 100% deductible, unlike a capital loss, of which only 50% is an allowable capital loss.

15

Change in use of property

Change in use of property
When income producing property begins to be used for a non-income producing property, the Income Tax Act deems the property to have been disposed of at that time for it’s FMV and immediately reacquired for the same amount.

This deemed disposition has the potential to result in a recapture or terminal loss, depending on the situation.

Where a taxpayer, having acquired property for some other purpose, has begun at a later time to use if for the purpose of gaining or producing income,
1. the taxpayer shall be deemed to have disposed of it at that later time for proceeds of disposition equal to it FMV and to have reacquired it immediately thereafter at a coast equal to the FMV; and
2. the taxpayer shall be deemed to have acquired it at that later time at a capital cost to the taxpayer equal to (the lesser of (FMV at that later time and (the original cost +any taxable capital gain at deemed disposition – any capital gains exemption claimed.)

While a capital gain on disposal of personal property is taxable, a capital loss on a personal use property is not deductible, even to offset the capital gain on disposal of persona use property. Instead, a capital gain on disposal of personal use property is deemed to be nil.

Where a taxpayer, having acquired property for some other purpose, has begun at a later time to use it for the purpose of gaining or producing income, the taxpayer can elect not to have begun to use the property for the purpose of gaining/producing income. This no-change-of-use election would:
1. permit the taxpayer to defer the taxation of any capital appreciation
2. prevent the taxpayer from recognizing a capital loss; and
3. prevent the taxpayer from claiming CCA on the property if it is a depreciable capital property.

16

Deducting Interest Expense


A taxpayer cannot deduct the interest expense on money borrowed for the purpose of contributing to a registered plan, including RRSP, RPPs and RESPs.

A taxpayer can deduct the interest expense on money borrowed to earn property income, including interest, dividends, rents or income earned as a specified member of a partnership. Capital gains are excluded from the definition of property income, so the potential for capital appreciation cannot be used to support the deduction of interest expense. However, as long as the investment has the potential to earn property income, the deduction will be allowed.

A taxpayer can deduct the interest expense on money borrowed to earn business income. It is not the collateral for the loan, but the use of the funds that determines if the loan interest is deductible.

17

Carrying charges

if not incurred for registered plan:
-fees for the management or safe custody of investments
-accounting fees for recording investment income (but not tax return preparation services)
-investment counseling fees with regards to specific investments, but not brokerage or general financial planning fees.

Interest expense is not a carrying charge.