In Canada, many couples choose to split rental income between spouses as a way to optimize their tax liability. By doing so, they can take advantage of lower tax rates and maximize their overall income. However, it is important to understand the rules and guidelines set by the Canada Revenue Agency (CRA) to ensure compliance with tax laws. In this article, we will explain how to split rental income between spouses in Canada.
First and foremost, it is essential to establish a legal basis for splitting rental income. This can be done through a written agreement, such as a partnership agreement or a co-ownership agreement. This agreement should clearly outline the respective ownership shares and responsibilities of each spouse in the rental property. By having a legally binding agreement in place, the spouses can justify the income-splitting arrangement to the CRA.
Once the legal basis is established, the rental income can be split in a couple of different ways, depending on the specific situation. The most common approach is to allocate the rental income based on the ownership shares specified in the agreement. For example, if one spouse owns 70% of the property and the other owns 30%, the rental income can be split accordingly.
It is important to note that the rental income must be split in a manner that reflects the actual sharing of risks and rewards associated with owning the property. This means that the spouses should contribute to the expenses and management of the rental property in a proportionate manner as well. The CRA may scrutinize the income-splitting arrangement to ensure that it is not being used solely for tax avoidance purposes.
In addition to splitting the rental income, spouses can also allocate the related expenses in a similar manner. This includes deductible expenses such as mortgage interest, property taxes, insurance, maintenance and repairs, utilities, and advertising costs. Again, the allocation should be based on the ownership shares specified in the agreement.
By properly splitting rental income and expenses, spouses can take advantage of the progressive tax system in Canada. Since each spouse is taxed individually, the portion of income that is allocated to the spouse with the lower income can be taxed at a lower rate. This can result in significant tax savings for the couple.
However, it is important to note that the CRA has specific rules regarding the tax treatment of rental income. For example, rental losses can only be used to offset rental income and cannot be used to offset other types of income. Furthermore, the CRA may apply the attribution rules, which can deem certain income to be attributed back to the original owner, if the income-splitting arrangement is not deemed to be genuine.
To ensure compliance with tax laws and minimize the risk of a CRA audit, it is recommended to seek professional advice from a tax specialist or accountant. They can provide guidance on structuring the income-splitting arrangement, preparing the necessary documentation, and filing the appropriate tax returns.
In summary, splitting rental income between spouses in Canada can be an effective tax planning strategy to optimize tax liability. It requires a legal basis, such as a partnership or co-ownership agreement, as well as a proportional allocation of income and expenses. By following the guidelines set by the CRA and seeking professional advice, couples can minimize their overall tax burden and maximize their rental income.