February 4th - 2010

First-time buyers may want rental income but beware restrictions

Many homebuyers consider purchasing a property with an existing or potential for a second suite.

Many homebuyers consider purchasing a property with an existing or potential for a second suite. First-time homebuyers in particular often hope to take advantage of the extra income a second suite, often a basement apartment, can generate. Financial advantages can be great, but the buyer needs to know the legal implications.

Your client or customer may have many questions regarding the legalities and financial implications of creating or operating a rental unit. REALTORS® should refer them to their lawyers or accountants for legal or financial advice, but REALTORS® still have an obligation to disclose material facts.

Whether a suite is a legal second suite will depend on building code and fire code issues and municipal zoning bylaws. Although bylaws across Ontario are generally similar, each municipality has its own variations.

For example, while the town of Bolton encourages basement apartments, in neighbouring Brampton, only basement apartments built before November 16, 1995 are legal, and these units must be registered with the city. Basement apartments in Brampton built after that date are illegal. Any landlord that violates this bylaw faces fines of up to $50,000 and one year in prison. REALTORS® should encourage their clients to visit a municipality’s website, or to speak to a lawyer located in the area.

If a buyer intends to create a second suite, he needs to determine whether the home qualifies under the bylaws of the specific municipality. If the home does not meet these requirements, the potential buyer must determine whether he is willing to make the necessary changes to create a legal apartment. A building permit is always needed, even in cases where construction will not be taking place.

Any construction plans are approved based on zoning requirements, safety systems and building issues. Once a second suite is introduced into a home, a General Inspection for Fire Code Compliance must be completed by the Electrical Safety Authority. The inspection reviews both the owner’s unit and the rental unit for fire code compliance.

If a home currently has a second suite, it is important to determine whether the existing unit meets the municipality’s requirements. The municipality will inspect the unit to determine whether it is fit for habitation and whether it meets established standards. Both new and existing units require a General Inspection for Fire Code Compliance.

Return on investment
The cost of retrofitting a home depends on the home’s condition. Assuming a renovation expense of $25,000 and net rental income of $500 a month, the return on investment will be 24 per cent. The investment will pay itself back in just over four years.

Rent collected from a second suite must be declared as income. However, landlords can deduct direct expenses (directly related to operating the rental unit, e.g. replacing appliances) and indirect expenses (costs shared with the entire house, e.g. utilities and mortgage interest) needed to operate the suite. Direct expenses are 100 per cent deductible; indirect expenses are deducted on the portion of the home assigned to the rental unit.

Landlords can also deduct capital cost allowance (CCA), commonly known as depreciation, from their income. CCA is permitted on any long-term purchase, such as renovations or appliances. The consequences of claiming CCA must be considered carefully. The equity earned when selling a principal residence is not taxed. However, once CCA is claimed, the area dedicated to the second suite is no longer considered personal residence. Therefore, a homeowner would forego any tax benefits from the sale of the property on the second suite portion of the home.

A second suite can increase a property’s value between two to five per cent. Property taxes are based on a Current Value Assessment (CVA), which usually does not increase unless the home’s value increases by at least $10,000 or five per cent. So, most second suites do not add enough value to increase taxes. The exception is a second suite created by an addition, which can add significant value to a property, and can increase property taxes.

As in any transaction, REALTORS® need to be sure to provide their clients with information that is accurate and not misleading. In the Ontario Superior Court case Malpass v Morrison (2004 ONSC 12542), the judge found that the agent had failed in his duty of care to his buyer clients. The buyers were looking for a home with four bedrooms or space that could be converted to a bedroom. They made an offer on a bungalow that was accepted. They later discovered the fourth bedroom was illegal and decided not to proceed with the purchase, which cost them over $60,000. They sued their agent for the losses, alleging their agent failed to advise them with respect to a municipal by-law prohibiting a basement bedroom.

The judge found that it was a material fact known to the agent that the basement “fourth bedroom” was not compliant, and that the buyers considered this room to be a bedroom and he did not correct their impression. He found that in this case, the breach of fiduciary responsibility amounted to a breach of duty of care. When listing a property or showing a home to buyer clients, the best policy is to always disclose any material facts, including whether a suite is legal or not.

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For more information contact

Ontario Real Estate Association

Jean-Adrien Delicano

Manager, Media Relations

JeanAdrienD@orea.com

416-445-9910 ext. 246

Ontario Real Estate Association
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