Rent-To-Own Real Estate Accounting: Corporations vs. Individuals

What is rent-to-own?

Rent-to-own (RTO) is a type of rental purchase concept that began in the UK and continental Europe and later got popular in the States.

In this model, the owner gives the tenant the right to buy the house for a certain price (that is agreed upon today), within a certain time frame (usually one to three years). Often a portion of the rent paid will either go towards the purchase price or buyer’s closing costs associated with the purchase in the form of a rent credit. Generally, the tenant will pay a fee, called option money, that will keep the option of buying open.

The income tax relating to such investments are a little complex. It is important to understand how they can affect your taxes so you can plan your investment properly with your accountants.

 

Accounting for an RTO held in a corporation

Accounting for the option money

The option money is a lump sum amount. The accounting depends on the agreement you make, and whether the option money is refundable or not.

  • A non-refundable deposit is recorded as income the year it is received. It is considered an active income – meaning it is a business income – and is taxed at a combined federal and provincial rate of 15.5%.
  • A passive refundable deposit is not recorded as income when it is received. It becomes a liability on the balance sheet until it is either payed back to the tenant when they walk away, or recorded as income if they buy the place. It is taxed at a higher rate in corporations at a combined rate of 46%.

 

Accounting for the rental payments

The regular monthly rent paid by the tenants until they decide to purchase is considered passive income, despite its correlation to the final refund or payment.

 

Accounting for the tax on RTOs

While RTOs are an asset, they are treated like inventory instead of as a capital asset. Capital Cost Allowance (CCA) and depreciation can’t be deducted on the property for major deals.

 

Accounting when the RTO is sold

The sale of an RTO is considered active income.

Your income is: Proceeds of sale (the pre-determined sale price) minus the deposit you took and paid tax on, minus the cost of the property and the cost to sell.

If the business qualifies for the small business rate, this income is taxed at the lower rate of 15.5%.

 

Accounting for an RTO held personally

Accounting for the option money

If the option money is non-refundable, it must be recorded as income the year it is received, and becomes an added tax bill at the end of the year. This means that if your annual income is already reaching the next tax bracket, the added option money can bump you into the next tax level, making you pay a much higher tax.

 

Accounting for the rental payments

It is treated like any other business or employment income.

 

Accounting for the tax on RTOs

This is recorded on your personal tax returns under the statement of Real Estate Rentals. Your net income will be the rent received (minus costs), and you are taxed the rate under the level you fall into.

 

Accounting when the RTO is sold

This sale of the RTO is considered income and not a capital gain. Therefore, it is recorded on your personal tax return as income instead of a capital gain. It can’t be used to off-set net capital losses from previous years.

 

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