In addition to my question in the above post, I wanted to ask whether we should be depreciating our rental properties on our income tax? So far we haven't, instead we've used our RRSP contributions to cancel out any tax we'd owe which kind of sucks because then we don't get any money back. We're just afraid that if we depreciate them we'll owe a lot of money when we sell, although the Canadian housing market is pretty high, so maybe that's not an issue. Do you usually advise depreciating or just paying the taxes? And how does one figure out what the value of the house is without the land?
Also, what are the tax implications of holding US equities in a TFSA? I know an RRSP is better and right now that's where our US stocks are, but we have little contribution room in our RRSP and lots in our TFSA. Would we only be taxed on dividends in the TFSA, or capital gains too?
Thanks in advance for the advice. :)
Sorry for not replying sooner.
For the rental property - you are correct in assuming that the interest on the $185,000 IS deductible on your rental return, and therefore you should continue to do so.
The additional mortgage payment regarding the furnace is also deductible from an interest perspective.
As far as the furnace is concerned, one can make an argument whether to capitalize and amortize this as an asset, or to expense in the year it is installed. This is a judgment call - if it is a SUBSTANTIAL improvement in efficiency over the previous furnace, then you can lean towards capitalizing - if not, then better to expense. Ultimately you can lean to either side, but if you're looking to save taxes this year then I would expense it.
There are no implications as to which account to pay first. You should pay your mortgage first as it is non-deductible, and pay the other components thereafter.
Depreciation - this is a tricky question which is better discussed from an overall perspective.
It seems that you're familiar with the principal residence exemption for properties, and the rental property is no exception. You can elect this as your principal residence for the years inhabited, plus one year. This means that if you owned the property for ten years, and lived in it for two - 30% of the capital gain is covered by principal residence (2+1 years).
That being said - depreciating the property will lead to limited savings in taxes now (depreciation can't trigger a loss on rental income) but will lead to an increased tax bill when you go to sell the property. Considering you're depreciating at your purchase price, but selling on fair market value in the future, this can work against you if the value increases significantly.
For example - the purchase price is $200,000 - you depreciate $20,000 over time, or 10% of the house. This will save, for arguments sake, $6,000 in tax.
The biggest variables to consider is how much you will depreciate (as a % of the house), how long you will hold the house outside of principal residence, and your expected gain on sale. For any amount depreciated today, this % will be added back to the sale at full tax (called recapture), versus a capital gain which is only 50% taxable.
I generally advise clients to avoid depreciating rental properties. The upside is known in terms of tax savings, but the potential downsides are significant and unknown. With a high capital appreciation in value, you could end up paying 3 to 4 times more in tax than what was saved. It becomes a much safer bet as time progresses and real estate prices increase.
Hope this clarifies all of your questions