Rental Income vs. Business Income in Canada: Tax Implications and Deductibility of Losses (2025 Update)
With the increasing popularity of real estate investing in Canada, many individuals are entering the rental market to generate supplemental income or build long-term wealth. However, whether rental income is classified as property income or business income under the Income Tax Act (ITA) can significantly affect how it is taxed, what expenses are deductible, and which tax forms and elections apply.
Classification of Rental Income: Property vs. Business
Under subsection 9(1) of the ITA, taxpayers must compute income from a business or property based on profit. In most cases, rental income is treated as property income. However, it may be reclassified as business income when the rental activity involves more than passive ownership—particularly where substantial or ongoing services are provided to tenants.
This distinction is important because it affects the availability of deductions, reporting obligations, and the ability to claim losses or apply tax credits.
Key Criteria for Classification
CriteriaProperty IncomeBusiness IncomeType of Services ProvidedBasic only (e.g., heat, utilities, maintenance)Significant (e.g., daily cleaning, meals, on-site staff)Reporting FormT776 – Statement of Real Estate RentalsT2125 – Statement of Business or Professional ActivitiesCCA ApplicationCannot create or increase a loss (Reg. 1100(11))May create or increase a lossCPP ContributionsNot requiredRequiredGST/HST ObligationsUsually not applicableApplicable if taxable supplies exceed $30,000 annually
Rental Losses: Deductibility and Restrictions
According to subsection 18(1)(a) of the ITA, expenses are only deductible if incurred for the purpose of earning income. This means rental losses can be claimed against other income sources only when the taxpayer demonstrates a reasonable expectation of profit.
Losses May Be Disallowed If:
The rental is provided below market value (e.g., to family or friends)
The property continuously operates at a loss without a viable business model
The arrangement is effectively a cost-sharing agreement rather than a commercial lease
Losses Are Generally Allowed If:
The rent is charged at fair market value
The taxpayer intends to generate a profit and operates the rental accordingly
Expenses are reasonable and directly related to income generation
Deductible Expenses Under the ITA
Under the ITA, rental expenses are categorized as either current expenses (deductible in the year incurred) or capital expenses (deductible over time via Capital Cost Allowance).
Current Expenses (ITA s. 18):
Property taxes
Mortgage interest (principal is not deductible)
Utilities, if the landlord is contractually obligated to pay
Insurance premiums
Repairs and maintenance
Advertising and accounting/legal services
Management fees and related administrative costs
Capital Expenses (Reg. 1100 and Schedule II):
Building acquisition costs (excluding land, which is not depreciable)
Major renovations and structural improvements
Equipment, furniture, and appliances used in the rental property
Note: Under Regulation 1100(11), Capital Cost Allowance (CCA) cannot be used to create or increase a rental loss when income is reported on Form T776.
Mixed-Use Properties
Where a property is used both personally and for rental purposes (e.g., renting out a basement suite), only the portion of expenses that reasonably relate to the rental use are deductible. This allocation should be based on either square footage or the number of rooms used for rental versus personal use.
Expenses exclusive to the rental area (e.g., repairs to a rental unit) are fully deductible, while shared expenses (e.g., property taxes or utilities) must be prorated.
Change in Use and Principal Residence Designation
A change in use occurs under subsections 45(1) and 45(2) of the ITA when a property is converted from a principal residence to a rental property, or vice versa. In such cases, the taxpayer is deemed to have disposed of and reacquired the property at fair market value, which can trigger capital gains.
However, taxpayers may elect under subsection 45(2) to defer this deemed disposition and continue designating the property as their principal residence for up to four additional years—provided no CCA is claimed during the rental period. This strategy may preserve eligibility for the principal residence exemption under paragraph 40(2)(b).
Rental Income Through a Corporation
When rental income is earned through a corporation, it is typically classified as income from a specified investment business (SIB) under subsection 125(7) of the ITA. In most cases, such income does not qualify for the Small Business Deduction (SBD) unless the corporation employs more than five full-time employees throughout the year or the rental activity qualifies as an active business.
Considerations for Corporate Ownership:
Passive rental income is subject to higher tax rates
Losses and capital gains remain trapped inside the corporation
Additional compliance requirements (e.g., filing T2 returns, preparing financial statements)
Shareholder benefits may arise if the property is used personally without market-rate compensation
Final Thoughts
Correctly determining whether your rental activities constitute property income or business income is essential under the Income Tax Act. The classification impacts:
Which tax forms you file (T776 vs. T2125)
The ability to deduct current and capital expenses
Your CPP and GST/HST obligations
Your eligibility for certain elections, including the principal residence exemption
Failing to classify your rental income correctly can result in denied deductions, CRA reassessments, or penalties. Working with a knowledgeable professional ensures compliance and optimal tax outcomes.
📩 Need Help Navigating the Tax Treatment of Your Rental Property?
FalconSight Accounting Inc. provides specialized tax support for real estate investors and landlords across Canada. Let us help you determine the most tax-efficient structure for your rental income.
📧 Email: Help@falconsightaccountinginc.ca
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