Wednesday, April 25, 2012

Paying the rent... (paying YOU the rent)

It's tax time people...  I know it's ugly for some of you.  Mountains of shoe boxes, hundreds of receipts and no clear plan of attack. If you're an employee and get a T-4 from your employer then chances are you have no freakin' clue as to what I'm talking about. 

So what do you mean it's more complicated than the T4 from my work, the T3 from my brokerage and the T5 from my savings?

Well, to you worker bees out there, this year I didn't make much money and I have 18 T-slips (of various types) for 2011.  Not to mention the hundreds of travel (gas, parking, repairs, lease, insurance, hotel, meals, flights, taxis, buses) receipts as well as hundreds of office related expenses.  (Equipment leases, repairs, supplies, consumables).  Why can I deduct all of this stuff?  Well, I'm self-employed that's why.

However I digress...  I went to my accountant, and wound up owing some money to the HST department but nothing to the Federal Coffers.  (You really don't want to know how ugly it looks on paper... But I'm not homeless, I eat well almost every day.)

Now it's time to switch over to the real topic of this blog post: REITS and why they are AWESOME for people in low income tax brackets.

REITs (Real Estate Investment Trusts) are "flow-through" companies that do not have to pay corporate taxes since they have to distribute nearly all the profits to the share holders.  Why is this good?  This means the dividend tax credit does NOT apply since they are not paying a dividend.  They are paying a DISTRIBUTION of profits, which may or may not be taxable depending on how they run their business.

Yes, this means the distributions may be taxed like income, but that's OK!  As I generally don't have sufficient enough income to pay income taxes then it's a non-issue.

REITs have the opportunity to depreciate their assets and use that to offset the taxes that you might pay on your distributions.  Since they are showing the value of their properties/buildings depreciate over time then any "profits" actually just balance out the depreciation.  Thus rendering the distribution a ROC (Return of Capital).

This means they are in essence "giving" you your money back. How this this change things?

It means that effectively it's decreasing the amount of money you paid for your holding.  So when you go to sell it means you have a larger capital gain.  And will be responsible paying the tax on that gain.

AGAIN, since I'm more often in the lowest of the low or the non-taxed bracket it means that I don't care!  It's essentially tax free.  If I do have to pay tax on the gain, then I'm most likely going to be in the lowest income tax bracket.  And since in Canada we only have to pay tax (at our income bracket rate) on HALF of the gain, it's a steal.

It's at this time of year that your brokerage (iTrade does) adjusts your average cost (in taxable accounts only) per unit to reflect this accounting tactic.  (Call it book-cookery if you will.  Just because you don't understand how depreciating assets work doesn't mean it's wrong or illegal.)

This is why I'm very happy with my REITs and will continue to hold them as a major component of my portfolio.

YTD: I'm up about 14%  (It was 25% at one point in early March, but markets have cooled off since then.  I'm in a good position to sit back and relax and watch my money come in at a slow agonizing rate.)

Total family budget covered by dividends/distribution income 15%.

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