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Government Imposes Restrictions on Short-Term Rental Expenses

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Urvesh Patel

Corporate and International Tax Manager

Canada’s persistent housing crisis has led the federal government to implement measures aimed at discouraging short-term rentals (STRs) to increase the availability of long-term rentals. The 2023 Federal Economic Statement (FES) indicated that in three major cities—Toronto, Montreal, and Vancouver—approximately 18,900 homes were used as STRs in 2020, a likely underestimation. For instance, a study suggested that more than half of Toronto’s STRs in 2023 were unregistered.

In response, the federal government has proposed new rules to deny expense claims for STRs that do not adhere to local regulations. These measures complement other housing affordability initiatives like the Underused Housing Tax Act and the First Home Savings Account.

Defining STRs

STR units are properties rented out for short periods, typically days or weeks. In 2023, Canada had an estimated 235,000 active STRs. Various provincial and municipal laws already restrict the use of STRs by prohibiting such rentals under specific conditions.

Existing Municipal and Provincial Regulations

Many municipalities, including Toronto, Montreal, Ottawa, and Calgary, have bylaws restricting STRs. British Columbia has enacted similar legislation, especially stringent in areas with populations over 10,000. Typically, operators can rent out an STR only if it is their primary residence, limiting them to one STR property. There are also restrictions on the number of bedrooms that can be rented, the rental duration, and the number of tenants per room.

Municipal and provincial rules also require licenses, permits, or registration, insurance, and detailed record-keeping and disclosure of rental details. These requirements extend to STR rental platforms like Airbnb and VRBO. Similar regulations exist in other jurisdictions, such as New York City, Florence in Italy, and Byron Bay in Australia.

Proposed Federal Tax Rules

In December 2023, the Department of Finance proposed legislation that would deny income tax deductions for expenses incurred by non-compliant STRs starting January 1, 2024. These rules apply to STRs not permitted to operate due to local regulations. The denied expenses are calculated based on the proportion of days the STR operated non-compliantly.

For example, if an operator’s STR was non-compliant for a quarter of the year, the Canada Revenue Agency (CRA) would deny a quarter of the claimed expenses for that unit.

Tax Implications for Operators

Typically, rental income is taxed on a net basis to apply taxes to profits, not business costs. Thus, rental property operators find expenses attractive for offsetting revenue and reducing tax bills. However, the new federal legislation prevents this offset for non-compliant operators, resulting in higher taxable income and increased taxes.

An FES example illustrates this: a fictional operator earns $120,000 annually from three STRs and spends $120,000 on operating expenses. If these STRs are non-compliant year-round, the operator cannot deduct these expenses, resulting in an additional $33,100 in federal taxes, not including increased provincial taxes.

Taxpayers with month-to-month leases transitioning to short-term rentals (less than 90 days) should be aware of these changes to avoid classification issues.

Enforcement and Effectiveness

Enforcement of the proposed legislation relies on identifying non-compliance with provincial and municipal regulations. Local governments typically require STR operators or platforms to maintain rental records and provide them upon request. Some cities, like Toronto and Calgary, have registries of licensed STR units.

Local regulations may require platforms to remove non-compliant STR listings and impose fines and penalties on non-compliant operators. For instance, Toronto identified over 3,500 STR complaints between January 2021 and November 2023.

Despite local efforts, some commentators believe federal goals could be thwarted by savvy operators attributing STR income to their primary residence, skirting local rules. Federal enforcement depends on local compliance efforts, which can vary.

The measure’s success in reducing STR numbers depends on the strictness of provincial and municipal rules. Since rules are not uniform, some areas are more lenient than others. For example, Montreal does not require STRs to be an operator’s primary residence. Consequently, local compliance stringency will determine the extent of disincentive for STR operators.

If you have any questions or need further assistance navigating these new regulations, please do not hesitate to contact our firm. Our team of experts is here to help you understand the impact on your tax obligations and ensure compliance with all applicable rules

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