In late 2023, the Federal government announced its intention to deny income tax deductions for expenses by non-compliant operators of short-term rental properties (such as Airbnb or VRBO properties rented for periods of less than 90 days). These rules would apply to individuals, corporations and trusts with non-compliant short-term rentals. These rules are proposed to come into effect on January 1, 2024.

A short-term rental would be non-compliant if, at any time, either:

• the province or municipality does not permit the short-term rental operation at the location of the residential property; or
• the short-term rental operation is not compliant with all applicable registration, licensing and permit requirements.

Many municipalities require a business license or permit for short-term rental operations. Where short-term rental activities are carried on without such a permit, the operator would be subject to these proposals and taxable on gross rental revenues with no deductions in 2024 and later years.

Residential property would include a house, apartment, condominium unit, cottage, mobile home, trailer, houseboat and any other property legally permitted to be used for residential purposes.

No expenses incurred with respect to the non-compliant short-term rental would be deductible. For example, consider a short-term rental that incurred $100,000 in expenses to generate $20,000 in profit. If non-compliant, all expenses would be denied, resulting in a profit for tax purposes of $120,000. Assuming the individual owner was in the top tax bracket (53.53% in Ontario), they would pay tax of $64,236. As the actual profit was only $20,000, the effective tax rate would be 321% ($64,236/$20,000). In absolute dollars, the individual would have to pay $53,530 in additional taxes due to the denied expenses.

Where the short-term rental was non-compliant for part of the year and compliant for another part of the year, the total expenses incurred for all short-term rental activity would be pro-rated over the period of that activity to determine the non-deductible portion.

For example, assume that a property was used for long-term rental from January 1 to June 30, then converted to short-term rental on July 1. However, the owner did not obtain a business permit as required until September 1 (62 days non-compliant). Expenses for July 1 to December 31 (the short-term rental period, 184 days) would be 62/184 non-deductible. Expenses related to the long-term rental period would not be part of the calculation of non-deductible expenses.

Transitional rule

For the 2024 taxation year, if the taxpayer is compliant with all applicable registration, licensing and permit requirements on December 31, 2024, they would be deemed compliant for the entire 2024 year and, as such, would be able to deduct all relevant expenses for 2024.

Short-Term Rentals: Sale of Property – GST/HST Issues

Due to the proposal to deny deducting expenses related to non-compliant short-term rentals, some owners may consider selling their short-term rental property. While it is widely discussed that gains on the sale of a short-term rental property are generally taxable, the GST/HST implications of such a sale may be a surprise.

A March 15, 2024 Tax Court of Canada case considered whether the sale by a corporation of a condominium unit used for short-term rentals attracted GST/HST. The condo was originally acquired in 2008 and used for long-term residential leases. In 2017, the property began to be used solely for short-term rentals (all less than 60 days). The corporation sold the property in 2018 to an arm’s length purchaser; no GST/HST was charged or remitted on the sale. The taxpayer was registered for GST/HST.

The taxpayer was assessed $77,079 of GST/HST that was collectable on the property sale as CRA asserted that it was a taxable supply.

Taxpayer loses

For the sale of the condo to not be subject to GST/HST (that is, an exempt supply), the following three conditions must be met:

• the taxpayer was not a builder of the condo;
• the taxpayer did not claim an input tax credit (ITC) with respect to the last acquisition of the condo by them or with respect to an improvement to the condo; and
• the condo was a residential complex.

All parties agreed that the taxpayer was not a builder, and no ITCs were claimed on the condo or its improvements.

As such, the Court examined whether the condo was a residential complex. The Court stated that if all of the following conditions applied, it would not be a residential complex:

1. the condo was part of a building that was a hotel, a motel, an inn, a boarding house, a lodging house or other similar premises;
2. the condo was not owned by an individual who used the property primarily as a place of residence for themself or a related person; and
3. all or substantially all of the leases, licences or similar arrangements of the condo were provided (or expected to be provided) for continuous periods of use of less than 60 days.

The Court opined that point (a) was met as the furnished condo with utilities included in the short-term rental was akin to these accommodations. In addition, neither the vendor nor purchaser was an individual and therefore point (b) was satisfied.

Regarding point (c), CRA argued that the all or substantially all tests should be determined at the time of the sale rather than over the period of ownership, as argued by the taxpayer. The Court found that, at the time of sale, all or substantially all of the leases were for less than 60 days. The Court further stated that, even if it were to accept the taxpayer’s argument, the relevant period of ownership would span from the change in use (long-term rental to short-term rental) to the sale. Both would lead to the same result; point (c) being met.

As all three points were satisfied, the condo was not a residential complex, and therefore, the sale attracted GST/HST as it did not constitute an exempt supply.

The Court also opined that the taxpayer acquired the property in 2008 to provide the exempt supply of long-term residential rent and, therefore, did not pay GST/HST on the acquisition of the condo. The Court then found that the taxpayer was deemed to have essentially acquired the condo when they began to use the condo in commercial activities (short-term rentals) in 2017. As the taxpayer did not pay GST/HST on the acquisition in 2008, the taxpayer could not claim any input tax credits on the deemed acquisition in 2017.