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Can rental income be claimed as Active Business Income (ABI)?

Summary of Rental income as Active Income

In most cases, income from the property will be considered passive income and would not qualify for a small business deduction. For example, rental income is considered a passive income (income from property). However, in rare circumstances it can be treated as active Business Income and eligible for a small business deduction limit without hiring more than five full-time employees as described in this article.

A corporation may derive income from holding property in Canada (e.g., income in the form of real estate rentals, interest, or royalties). If such income is received or receivable from an associated company and the amount is or may be deductible in determining the associated company’s income from an active business carried on by it in Canada, then paragraph 129(6)(b) deems the income in the recipient’s hands to be income from an active business carried on by it in Canada.

If subsection 129(6) deems rental income to be active business income and capital cost allowance on the rented building was deducted in calculating active business income, any recapture of capital cost allowance on the disposition of the building would also be considered to be active business income.

Let’s dig deeper into the concept of active income and passive income and the tax treatment of each type of income.

Understanding the Eligibility of Rental Income as Active Business Income (ABI)

Rental income and its classification as Active Business Income (ABI) can significantly impact a company’s tax deductions and overall financial strategies. While rental income is generally considered passive income, there are specific scenarios in which it can qualify as active business income, making the company eligible for small business deductions. In this article, we will delve into the criteria that determine whether rental income can be claimed as active business income and the potential benefits it can offer.

Exploring the Distinction: Passive Income vs. Active Business Income

Passive income is typically derived from investments and property holdings, including rental income and interest income. However, under certain circumstances, rental income can transcend its passive classification and be treated as active business income. This distinction is crucial as it directly impacts a company’s eligibility for small business deductions.

Qualifying for Small Business Deductions through Rental Income

In the majority of cases, rental income is categorized as passive income, rendering it ineligible for small business deductions. For instance, if a company derives rental income without meeting specific criteria, it remains passive income. One such criterion is the employment of at least five full-time employees within the company.

However, there exists a rare and exceptional circumstance in which rental income can be reclassified as active business income, allowing the company to benefit from small business deductions. This reclassification is possible without the mandatory employment of more than five full-time employees.

The Role of Associated Companies and Deductibility

A corporation can generate income from property holdings in Canada, encompassing real estate rentals, interest, and royalties. When this income is received or is receivable from an associated company, and the amount is deductible in calculating the associated company’s income from an active business conducted in Canada, a specific provision comes into play.

Paragraph 129(6)(b) of the tax code deems the income received by the recipient corporation to be derived from an active business carried out in Canada. This provision establishes a connection between the income from property holdings and the active business income, potentially reclassifying rental income.

Implications of Recapture of Capital Cost Allowance

Should subsection 129(6) deem rental income as active business income, the implications extend to capital cost allowance. If the company had previously deducted capital cost allowance on the rented building while calculating active business income, any recapture of this allowance upon the building’s disposition would also be classified as active business income. This underscores the complex interplay between different income streams and deductions.

Mitigating High Tax Rates through Strategic Approaches

For companies grappling with the impact of high tax rates due to passive income, there are strategic approaches to consider. These approaches aim to minimize the tax burden and optimize the company’s financial position. To gain a comprehensive understanding of these strategies and their potential benefits, it is advisable to seek guidance from a Chartered Professional Accountant.

In conclusion, while rental income is commonly categorized as passive income, the possibility of reclassifying it as active business income presents a unique avenue for companies to explore. The determination hinges on specific criteria, including the nature of associated companies and the deductibility of income. By leveraging this reclassification, companies can unlock the potential for small business deductions and make informed financial decisions._

For professional assistance and tailored insights into optimizing your company’s income classification, reach out to your trusted Chartered Professional Accountant today.

Need help with your tax matters, call us today.

Frequently Asked Questions - Active and Passive Rental Income

Active business income refers to earnings generated from a company’s core operations, such as selling products or providing services. Passive income, on the other hand, includes earnings from investments and property holdings, like rental income.

Yes, in specific circumstances, rental income can be reclassified as active business income. This reclassification allows corporations to potentially qualify for small business deductions, even without employing more than five full-time employees.

 The classification of rental income as active business income hinges on factors such as associated company relationships and the deductibility of income. If the income is received from an associated company and is deductible in calculating the associated company’s active business income, it may be considered active business income.

In most cases, rental income is passive unless the corporation employs at least five full-time employees. However, there are exceptions where rental income can be treated as active business income without meeting this employment threshold.

Reclassifying rental income as active business income can make a corporation eligible for small business deductions, which can lead to reduced tax liabilities and enhanced financial flexibility.

Yes, if a corporation deducts capital cost allowance on a rented building while calculating active business income, any recapture of this allowance upon the building’s disposition can also be considered active business income.

Absolutely, corporations can employ various strategic approaches to minimize the tax burden arising from passive rental income. Seeking guidance from a Chartered Professional Accountant can provide valuable insights into effective tax-saving strategies.

A Chartered Professional Accountant possesses the expertise to analyze a corporation’s financial situation, explore opportunities for reclassifying income, and recommend tailored strategies to optimize tax benefits and overall financial health.

Disclaimer: The information provided in this article and other blogs on the website is intended for general informational purposes only and should not be construed as professional financial advice. Individual financial situations vary, and it is recommended that you consult with a qualified professional accountant to address your specific financial needs and circumstances. Always seek the guidance of a professional before making any financial decisions.

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Nafees Chaudhry

Nafees Chaudhry

Nafees Chaudhry is the founder of CNC. Providing accounting, tax, and consulting services to small businesses and individuals for 23+ years.

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