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Is real estate a tax-effective investment?

24 November 2016 by National Bank
Is real estate a tax-effective investment?

There’s no doubt about it, purchasing a home is a major financial decision. Many factors come into play when assessing the benefits of an investment. Often, the buyer neglects to weigh the tax consequences of buying a home against other investment options.

Good news: there are considerable tax benefits to purchasing a home.

“Taxes should never be the prime consideration when making a financial decision, however, it is essential to understand their overall impact,” explains Daniel Laverdière, Senior Manager Financial Planning and Advisory Services with National Bank.

He believes that the tax benefit of a property investment can be summed up as follows: the capital gains are tax exempt. Let’s take a look at this largely unknown and often misunderstood fact.

Capital gains taxes

“Capital gains are taxable, as a general rule,” continues Daniel Laverdière. “Up to 50% of the profit is taxable, according to your personal tax rate.”

Say you purchase $5,000 worth of shares and sell them for $10,000 a few years later. You will owe taxes on a $2,500 profit. If you are at the maximum tax rate, you will have to pay $1,307.75. Imagine the financial impact if these amounts multiplied by 10, or 100, as is the case with a real estate asset!

Fortunately, capital gains on primary residences are exempt from that tax obligation: the seller gets to keep all of the profits. This only applies to primary residences, so it’s important to properly define them.

Choose your primary residence carefully

If you own only one home, it goes without saying that it is, de facto, considered to be your primary residence. What about people who own a home, condo, cottage or rental property?

The primary residence isn’t necessarily the house where we spend most of our time, nor the one used on government paperwork,” explains Daniel Laverdière. The primary residence is the one we designate as such in our income tax return, and it can change from one year to the next. You must, however, “live there during the year.”

If the cottage has greatly increased in value in the past decade, unlike the house, it might be financially beneficial to designate it as the primary residence after it is sold. This avoids having to pay potentially higher capital gains taxes, and leaves more money in the bank.

Daniel Laverdière adds the following cautionary note: “Remember, there can be only one primary residence per couple. So, if they both own a home, or if one of them also owns a cottage or condo, they must sit down and decide which of them would benefit the most from the capital gains tax exemption.”

Generous tax deductions

Should you decide to invest in home improvements, you’re entitled to tax deductions and tax credits through a number of provincial or municipal programs.

Even though the program benefits may vary from region to region, they are usually generous if the renovations are aimed at boosting a home’s energy efficiency. Replacing windows can increase your living comfort, cut the electricity bill, increase your home’s market value and provide you with a bigger tax refund. A solid investment!

“Of course, it’s important to make sure that taking advantage of these programs makes good financial sense: can you afford it? Does your home need the upgrade? If so, you could save hundreds or thousands in tax dollars,” says Daniel Laverdière.

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