Cracking Down on Non-Compliant Short-Term Rentals: What You Need to Know

In the 2023 Fall Economic Statement, the Canadian federal government announced a significant move to deny the deductions for owners of non-compliant short-term rentals. The pretext of these changes is that these rentals have been keeping homes intended for Canadian residents off the market. At Achen Henderson, we believe it is dangerous for the federal government to deny business owners deductions based on their compliance with local laws and bylaws for several reasons, not the least of which is the dangerous precedent that it sets.

What are the changes for short-term rental owners?

Starting from January 1, 2024, the government of Canada plans to deny income tax deductions for expenses incurred by taxpayers in earning short-term rental income on residential properties. However, this denial applies only to those who do not comply with provincial or municipal rules and restrictions related to short-term rentals.

What Constitutes a Non-Compliant Short-Term Rental?

To fall under the category of a non-compliant short-term rental, three conditions must be met:

1. Residential Property: The property must be residential, including houses, apartments, condominium units, cottages, mobile homes, trailers, houseboats, or any other property used for residential purposes under applicable law.
2. Short-Term Rental: The property must be actively offered as a short-term rental; long-term rentals are exempt from the proposed legislation.
3. Non-Compliance with local laws / bylaws: The property must be non-compliant with provincial or municipal laws or regulations related to short-term rentals. Specifically, if the province or municipality:
   1. Doesn’t permit the operation of a short-term rental at the property.
   2. Requires registration, a license of a permit to operate the short-term rental and the rental doesn’t comply with these requirements.

What is the 2023 Fall Economic Statement and draft legislation?

The fall economic statement specifies that expenses incurred to earn income from non-compliant short-term rentals will not be deductible for income tax purposes. This will include various expenses like interest, property taxes, insurance, repairs and maintenance, condo fees, and any other expenses incurred for the purposes of earning short-term rental income.

The draft legislation provides a calculation mechanism for the taxpayer to become compliant during the year and claim deductions for the portion of the year when they were compliant.

The legislation specifies how to calculate the non-compliant amount, as A X B / C

A: The amount of expenses incurred for the short-term rental

B: The number of days the property was a non-compliant short-term rental

C: The number of days the property was a short-term rental.

What are the financial implications for impacted short-term rental owners?

Deducting expenses incurred to earn income from a business or property is crucial for measuring net income accurately. It ensures that taxpayers pay the appropriate taxes based on their actual financial situation and earnings.

For example, let’s assume that an Alberta-based property owner earns $50,000 in short-term rental income for a property they own in Golden, BC, and that they incur $30,000 in related expenses for a net profit (before tax and mortgage principal payments) of $20,000.

Let’s assume that Golden, BC’s municipal government has recently passed a municipal bylaw that stipulates that only residents of Golden may operate an Airbnb. Since the owner is resident in Alberta, they are not in compliance with this new bylaw.

• Under the old rules, and assuming a top-marginal tax rate of 48%, the owner would pay $9,600 in income tax, and be left with $10,400 in after tax profits. Let’s assume that the property owner must then pay $800/mo. (or $9,600/year) in principal payments on their mortgage, which are not tax-deductible, leaving the owner with $800 in positive cash flow from the property during the year.
• Under the new rules, the owner would pay 48% on the full $50,000, or $24,000 in taxes. This on the before tax profit of $20,000, resulting in an effective tax rate of 120%, and putting the owner at a loss of $4,000. The owner still has to make the $9,600 in principal repayments on their mortgage meaning that they lose $13,600 in cash by operating their short-term rental. This is certainly not the result they expected when they purchased their rental property prior to the municipality introducing their bylaw restricting short-term rentals.

What options do owners of impacted short-term rental properties have?

There are only a few options for impacted short-term rental owners:

1. Become compliant with local laws. In our example, this would require the individual to relocate from AB to Golden, BC which may not be practical.
2. Convert the property to a long-term rental property. This option has a variety of challenges including the fact that many short-term rental owners use the rental income to help finance their vacation properties, so a shift to long-term may negate their purpose for buying it in the first place. In addition to this challenge, there can be significant GST/HST issues relating when converting a property from short-term to long-term.
3. Sell the property.

What tools to the CRA must find offside short-term rental properties?

The CRA have a variety of tools in their arsenal to enforce the government’s new rules denying expenses of non-compliant short-term rentals. For starters, the CRA are known to watch land title transfers which list both the location of the property and the individual purchasing it. This can easily be married to tax return data.

Both schedule T2125 Statement of Business income and T776 Statement of Rental income have an address field that is required to be completed, showing the location of the properties on which the income is earned. It would take the CRA no-time at all to generate a list of rental properties that are being reported on T1 personal tax returns in specific locations in Canada.

Rental platforms like VRBO and Airbnb are already required to provide host data to the CRA with relation to GST/HST reporting requirements, and it is a matter of time before they use their powers to compel rental platforms to provide data to enforce the governments rules, once they become law.

Our thoughts

The government of Canada’s crackdown on non-compliant short-term rentals is unfortunate as it introduces unrealistic financial burdens on operators of Airbnb’s for not complying with local laws and bylaws. We find the measures to be heavy handed, considering that an estimated 189,000 houses in the short-term rental pool, many of which are very likely the principal residence of their owners, is a very small drop in the bucket in easing Canada’s housing crisis. We find these numbers hard to marry with the fact that the government concurrently intends to bring in nearly a million immigrants over the next two years with virtually no solid plan on where to house the inflow.

For people considering purchasing a vacation property and using a short-term rental strategy to offset the high cost of ownership that has come about since the Liberal government took office in 2015, the decision just got trickier. Now not only do they have to consider purchasing a property in a jurisdiction that doesn’t have restrictions against short-term rentals, but they also run the risk that the local rules of ownership may change, as is happening in many municipalities in the interior of BC. If the goal posts move at some point after they’ve purchased the property, its ownership may become financially impossible due to the government’s new deduction limitations on short-term rentals.

Questions?

If you own a short-term rental, ensure you understand and adhere to local regulations to avoid losing out on deductions.