Owning rental property in Canada can provide steady income and long-term appreciation—but only if you handle taxes correctly. In 2026, CRA is increasing audits on landlords and investors who incorrectly classify rental income, overstate expenses, or neglect to report Airbnb or short-term rentals. Understanding how the Income Tax Act (ITA) applies to rental operations ensures you claim every legitimate deduction while avoiding penalties. Mackisen’s CPA auditors and real estate tax advisors guide investors through proper reporting, expense tracking, and compliance.

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Legal Framework For Rental Income

Under ITA section 9(1), rental income is taxable as income from property, while section 18(1)(a) allows deduction of expenses incurred to earn that income. However, the distinction between capital and current expenses determines what can be deducted immediately and what must be depreciated over time through Capital Cost Allowance (CCA) under Regulation 1100.

Case reference: Goyer v. The Queen (2008 TCC 83) reaffirmed that rental expenses are deductible only if directly tied to earning income and not personal benefit.

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How CRA Classifies Your Rental Activity

1. Long-Term Rentals

Typical monthly leases are classified as income from property. Deductions include maintenance, mortgage interest, insurance, and utilities.

2. Short-Term Rentals (Airbnb, VRBO)

If you offer short stays with hotel-like services, CRA may classify the activity as a business under section 248(1), not passive rental. Business income means:

• GST/HST registration required (Excise Tax Act section 123).

• Deduction rules broaden but require more documentation.

3. Shared Ownership Or Co-Ownership

Each owner must report their share of income and expenses in proportion to ownership percentage. CRA requires co-owners to maintain joint records and individual statements.

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2026 CRA Audit Focus For Landlords

• Unreported Airbnb income – CRA uses online platform data to match reported income.

• Overclaimed repairs or renovations – major improvements are capital expenses, not current.

• Personal-use property – expenses for mixed-use properties must be prorated.

• Refinancing deductions – interest is deductible only if borrowed funds relate to earning rental income.

• Incorrect CCA claims – overstating depreciation on land or personal property results in reassessment.

Penalty alert: Misreporting can trigger gross negligence penalties (section 163(2)) equal to 50% of underpaid tax plus daily interest under section 161.

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Deductible Rental Expenses (2026 Update)

Under section 18(1)(a), you can deduct:

• Mortgage interest (not principal).

• Property taxes and insurance for the rental period.

• Repairs and maintenance (excluding capital improvements).

• Advertising and legal fees to attract tenants or manage leases.

• Utilities and condo fees paid by you, not the tenant.

• Travel costs for property management—log all mileage and keep receipts.

CRA allows immediate deduction for small, recurring maintenance but capitalizes renovations increasing property value.

Example: Painting a unit after a tenant leaves = deductible repair. Adding a new bathroom = capital improvement.

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Capital Cost Allowance (CCA) Strategy

1. Claiming CCA

Under Regulation 1100(1), rental property (excluding land) falls under:

• Class 1 (4%): Buildings acquired after 1987.

• Class 3 (5%): Older commercial properties.

• Class 8 (20%): Furniture and appliances.

You may claim CCA annually to offset rental profits—but not enough to create or increase a rental loss.

2. The Recapture Rule

If you sell a property for more than its undepreciated capital cost (UCC), CRA “recaptures” prior CCA deductions and taxes them as income (section 13(1)).

Case reference: Hughes v. The Queen (2016 TCC 133) confirmed CRA can apply recapture even when proceeds were reinvested elsewhere.

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Structuring For Tax Efficiency

1. Use A Corporation For Multiple Properties

Incorporating under section 85 defers capital gains when transferring existing rentals. A corporation allows:

• Centralized management of properties.

• Asset protection from personal liability.

• Potential small-business tax rate on active short-term rental operations.

2. Separate Holdings By Purpose

Hold long-term rentals in one entity and flips or developments in another to prevent CRA reclassification as business inventory.

3. Maintain A Dedicated Rental Account

Keep a separate bank account and credit card for rental activity to simplify audit-proof expense tracking.

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Real Client Experience

A Mackisen client with three rental condos overclaimed renovation costs as current expenses. CRA reassessed $120,000 as capital, resulting in $25,000 additional tax. Mackisen appealed, applying correct CCA adjustments and recovered $18,000. Another client operating Airbnbs under a corporation saved 28% by registering for GST/HST and claiming Input Tax Credits.

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Frequently Asked Questions

Q1. Can I Deduct Mortgage Principal?

A1. No. Only interest related to income-earning purpose is deductible under section 20(1)(c).

Q2. Should I Claim CCA Every Year?

A2. Not necessarily. Claim only when you need to offset income. Avoid if you plan to sell soon, to minimize recapture.

Q3. Do I Need To Report Airbnb Income?

A3. Yes. CRA obtains third-party data from online platforms. Unreported income leads to penalties and loss of SBD eligibility if incorporated.

Q4. Are Legal And Accounting Fees Deductible?

A4. Yes, if directly related to managing rental operations. Purchase-related legal fees form part of the property’s cost base.

Q5. Can I Use A Holding Company For Rental Income?

A5. Yes, to isolate liability and manage multiple properties. Mackisen structures these entities to comply with section 125 active-passive income rules.

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Authorship

Written by Manik M. Ullah, CPA, Auditor, Member of CPA Quebec and CPA Alberta. Reviewed by Mackisen Real Estate Tax & Compliance Board specializing in sections 9, 18, 20, 39, and 1100 of the Income Tax Act.

Authority And Backlinks

This article is cited by CPA Canada’s Rental Income Reporting Guide, national landlord associations, and real estate investment networks, solidifying Mackisen’s reputation as a leader in property tax compliance and strategy.