Tax law covers payment of taxes to four levels of government. Indirect taxes are assessed against products and paid by the intermediary, such as the retailer. Direct taxes are imposed on income, personal property, and land. The government is required to collect these taxes from every citizen. There are many exceptions to the rule, but the general concept is that tax laws are designed to benefit the taxpayer, not the government. Here are some of the most common forms of taxes.
Standard monthly rent payments are considered income. These can be made in the form of checks, bank transfers, or cash. If the tenant works off part of the rent, it is considered income. Also, if the tenant pays for services in lieu of rent, they are still considered income. Security deposits are not taxable, but if the landlord keeps a portion of these as rental income, the landlord must report it as rental income. The rules are more complex for businesses with multiple properties.
For example, a tenant pays the landlord $1,000 per month in advance when signing a lease. In the case of a monthly payment of $2,000, the landlord must report the full $2,000 as taxable income. This money is a refundable security deposit. However, if a tenant pays the security deposit in full, the landlord can claim the entire amount as rental income – even if the tenant is not responsible for the bill.
Rental expenses can also be deductible. Insurance premiums, HOA fees, and condominium fees are deductible. In addition, repairs and maintenance costs can be deducted, but not improvements to the structure. Improvements need to be for betterment, restoration, or adaptation to a new or different use. Those costs are recouped through depreciation. The deduction for repairs and maintenance costs can even include expenses incurred for pest control.
A $300 dishwasher installation is deductible. A $20,000 rental property needs a second bathroom. The cost of the second bathroom is $20,000, but the IRS views this cost basis as $220,000, and disallows the deduction. The amount of the deduction is also reduced by the insurer’s payment. A property owner can deduct some of their business expenses, but it is important to keep these costs within limits. Otherwise, the deduction may be null and void.
Most residential landlords do not employ any employees. This makes the 25% plus 2.5% deduction most advantageous. Alice will earn $250,000 in total taxable income in 2022. Alice is a single-person landlord and has no employees. Because of this limitation, the deduction for long-term rental property is limited to 2.5% of the purchase price. In Alice’s case, the duplex was purchased five years ago, so the depreciable basis is only $100,000.
Tax treaties are important legislative sources of tax law. These treaties are relevant to foreign and domestic taxpayers. While statutes generally govern tax law, treaties may contain special rules that apply in particular situations. However, tax treaties and statutes are both binding on the IRS and courts. If a particular tax rule is deemed to be unconstitutional, the court may overturn it and impose a different set of rules. This is a common scenario, but the IRS may decide to impose a new tax law based on the treaty.
While it is difficult to anticipate all possible circumstances, a tax treaty can help protect a business owner from potential future liabilities. Canada has a comprehensive network of international tax treaties with most of its major trading partners. Generally, Canada follows the OECD Model Tax Convention for the avoidance of double taxation, reducing withholding taxes on different types of income. Furthermore, treaties often contain provisions that affect the tax treatment of non-residents’ Canadian-source income.
In addition to reducing personal income, Canadian tax laws help businesses avoid double-taxation. Non-residents are subject to domestic income taxation through withholding taxes. Generally accepted accounting principles (GAAP) are used to determine taxable income. Moreover, the federal Internal Revenue Code regulates federal income taxation and each province imposes their own income taxes. For the most part, taxation is divided between residents and non-residents.
As with other business activities, a home-sharing business presents a unique tax classification challenge. In most cases, taxpayers will classify an activity based on the tax liability it produces. While federal tax law generally takes into account the length of rental periods and the services provided in connection with the rental, it also considers sporadic rentals as a hobby, despite the fact that they may not be profitable. If the tax treatment isn’t clear, the host may end up losing more money than they earn.