Much like any other business, owning and managing short-term rental property is subject to provincial and municipal regulatory regimes.
These regimes can impose registration, licensing and permit requirements, collection and remittance of municipal taxes and operational parameters, such as the requirement that any short-term rental must form part of the host's principal residence. Non-compliance with these rules can result in interest and penalty charges, cancellation of registration of the applicable license and outright prohibition of the short-term rental operation.
Additionally, as of January 1, 2024, failing to comply with certain provincial or municipal laws for short-term rentals may also result in the denial of various tax deductions that might otherwise have been available for expenses incurred in operating the short-term rental.
New Deduction Denial Rule
Under the Canadian federal Income Tax Act, a landlord of a short-term rental property can generally deduct several common expenses, such as mortgage interest, insurance costs, third party fees (such as Airbnb fees) and cleaning and maintenance fees, subject to certain limits and requirements under the Act.
However, if a landlord's "short-term rental" (defined in subsection 67.7(1) of the Act as any "residential property" that is rented or offered for rent for a period of less than 90 consecutive days) is located in a province or municipality that does not permit the operation of short-term rentals, the deductions otherwise available under the Act will be denied. Additionally, if the short-term rental is located in a province or municipality that requires registration, licensing or a permit to operate short-term rentals, deductions otherwise available under the Act may be denied if these requirements have not been met.
The deduction denial is contained in recently enacted subsection 67.7(2) of the Act and applies to the portion of expenses for a taxation year that represent the days that the property was non-compliant, out of the days in the taxation year that the property was also a short-term rental.
For example, a C$1,000 expense incurred in a taxation year in which the property was non-compliant for 50 days and was a short-term rental for the full year results in a denial of C$137 of the expense (C$1,000 x 50 days, then divided by 365 days). But if the property was a short-term rental for only 200 days out of that particular year, the deduction denial is C$250 (C$1,000 x 50 days, then divided by 200 days).
Accordingly, the new deduction denial rules can result in significant additional financial consequences for non-compliance with provincial or municipal short-term rental property regimes.
Enforcement Parameters
Generally, the Canada Revenue Agency (CRA) is limited to a specified period during which it can reassess a taxpayer, deny expenses and impose additional taxes, interest and penalties. In the case of an individual or Canadian-controlled private corporation, this reassessment period is normally three years after a notice of assessment for a particular taxation year is sent to the taxpayer, with some exceptions.
Yet under new subsection 67.7(4), the CRA can assess and reassess tax, interest and penalties under the expense denial rule in new subsection 67.7(2) at any time, meaning there is no statutory time limit on the new deduction denial rule so taxpayers' expenses can be denied indefinitely, with the potential for considerable interest and penalties to accrue over time.
The federal Department of Finance also announced the Short-Term Rental Enforcement Fund on December 3, 2024 to provide municipalities with funding to help enforce short-term rental laws. Landlords of short-term rentals should therefore expect more scrutiny from local provinces and municipalities as well as from the CRA.
Exceptions
The new legislation applies starting 2024, subject to limited transitional relief for the 2024 taxation year.
The new deduction denial rule applies only when there is non-compliance with applicable provincial or municipal legislation or by-laws. The rule therefore does not extend to non-compliance with prohibitions of short-term rentals in condominium strata corporations, for example. The new deduction denial rule also does not seem to apply when there has been non-compliance with federal legislation, such as the federal Prohibition on the Purchase of Residential Property by Non-Canadians Act.
To avoid falling afoul of the provincial or federal regulatory regimes, landlords can offer their short-term rental for periods of 90 consecutive days or longer. The property would then cease to be a "short-term rental" and the new deduction denial rule would not apply. That said, changing the rental parameters of a property may cause GST/HST issues. The property might become subject to certain "change of use" rules in the federal Excise Tax Act and attract GST/HST as a result.
It may also be possible to structure certain expenses, such as cleaning fees, to be payable directly by the tenant to the service provider, with the landlord potentially acting as a mere billing or collection agent for this portion of the rental fees. This arrangement would avoid having the landlord include the rental fees in their taxable income in the first place, thereby obviating the need for a deduction. However, such arrangements should be evaluated on a case-by-case basis and may not work in all circumstances. Tax advice should be sought if this type of arrangement is considered.
In light of the punitive tax consequences (on top of the other regulatory consequences), operators of short-term rentals should take extra care and if appropriate seek advice to ensure they comply with applicable regulatory requirements. However, if you suspect that you may face a denial of some or all of your expenses relating to your short-term rental property, it is best to obtain expert tax advice in navigating these rules, as each scenario is unique.
Bennett Jones