Draft Rules Published for Tax “Crackdown” on Non-Compliant Short-Term Rentals

Canada’s Department of Finance has released draft legislation and explanatory notes with the details of the government’s plan to crack down, through the Income Tax Act, on non-compliant short-term rental properties.

In a previous blog post, we discussed the potential GST consequences that may arise from changing the use of a short-term rental property to long-term residential purposes. In this blog post, we will focus on the draft rules intended to crack down on short-term rental properties through the Income Tax Act. The draft legislation answers some questions but leaves other questions unanswered.

Background

Short-term rentals have exploded in Canada in recent years. It is estimated that there are almost 19,000 short-term rental properties in Toronto, Montreal, and Vancouver alone. Municipalities and provinces across Canada have imposed limits on short-term rentals in an effort to keep properties in the long-term residential market. For example, in Toronto, short-term rental operators must comply with various rules, including registering as a short-term rental, renting out only their primary residence, renting the entire unit for a maximum of 180 days a year, and collecting the 6% municipal accommodation tax.

Who is captured by the new rules?

The proposed rules in the draft legislation apply to a person who operates a short-term rental in either of the following circumstances:

1. The short-term rental is in a province or municipality that does not permit the operation of short-term rentals at that location.
2. The short-term rental is in a province or municipality that requires registration, license, or a permit, but the short-term rental does not comply with all registration, licensing, and permit requirements.

What happens if a person operates a non-compliant short-term rental?

The owner of a short-term rental in either of the above scenarios cannot deduct any expenses in respect of the short-term rental.

For example, suppose a person owns a condominium in Toronto where, in a given year, they earn $25,000 in rental income and incur $10,000 in related expenses. Suppose the person is non-compliant with some aspect of Toronto’s short-term rental bylaw.

Under ordinary rules for calculating profit, this person would have a profit of $15,000 from their property. They would pay income tax on that amount.

However, under the new rules, this person cannot deduct the $10,000 of expenses. This results in the person paying tax on $25,000 of income, even though in reality they only earned $15,000. As can be seen, this is a harsh consequence.

What happens if I’m not following local rules now, but I start following the rules?

As long as a taxpayer brings themselves into compliance with all registration, licensing, and permit requirements by December 31, 2024, the new rules will not apply to that taxpayer for 2024. That taxpayer will be able to deduct their expenses. For following years, the same leeway is not granted.

How seriously do I need to break the rules before I am considered non-compliant?

The new rules require taxpayers to be compliant with “all registration, licensing, and permit requirements.” The CRA could potentially interpret the rules to apply even where there was an arguably minor breach of local rules.

For example, Toronto’s bylaw for short-term rentals requires that operators give their guests instructions on how to contact 911 emergency services. In theory, a short-term rental operator that failed to provide their guests with instructions on how to call 911, but complied with all other requirements of the bylaw, could not deduct their expenses. It remains to be seen how stringently CRA will interpret the legislation.

Do I need to be charged or convicted under the local regulation for CRA to consider me to be non-compliant?

Typically, when a person breaches local regulations such as a bylaw, they may be charged with an offence. In Toronto, for example, a person who contravenes the short-term rental bylaw may be charged with an offence and, if convicted, they are liable to a fine of up to $100,000 as well as additional potential penalties. A person charged with a bylaw offence has a right to a trial in the provincial offences court. 

The draft legislation does not address how CRA will determine that short-term rental operators are non-compliant. It remains to be seen how CRA, and the courts, will deal with the situation where the operator of an allegedly non-compliant short-term rental has not been charged (or has been charged but has not been convicted).

When do the new rules come into effect?

If enacted, the draft legislation will come into effect for expenses incurred on or after January 1, 2024.