For rental properties, Is principal taxable income?

I am in Canada and I have some rental properties. I want to ask if principal in mortgage payment should be counted as net-income or taxable income? I always think the principal part of mortgage payment is tax free income. I should only pay tax if I have positive cash flow. But my accountant told me that even my property break even with 0 cash-flow after mortgage payment. I still have principal as income, because only Interest is expense. So my principal become net-income and it is taxable. I can only claim depreciation to defer the tax. Is it true? It is against my knowledge that equity & principal is tax free income. Please clarify. Thanks

Public Comments

1. Your accountant is correct. The principal payments on the mortgage is what is referred to as "on account of capital" in the income tax act. As such, those payments are not tax deductible. Only depreciation of the underlying asset is allowed. The interest paid on the mortgage is a deductible expense. The thing is, if you buy a house for $100K, pay off the mortgage then sell the house for $100K, you won't have a tax bill. You will sell the equity tax free. Now, if you've depreciated the building over time then you will likely get a tax bill when you sell the house. Using the above example, if you have claimed $20K of depreciation on the house and you sell it for $100K, you then have to include in income the $20K that you previously expensed. However, in short, your accountant is right. Which is good. That's why you pay him / her!
2. Yes, your accountant is correct. The principal portion is still income. Think about it for a minute: you are taking rental income and directing it to an area (your mortgage payment) that increases your equity in the property, so what rationale would there be for the legislators to make that portion exempt? You don't have to have a mortgage on your property; that is your choice of financing. Interest is deductible, principal is not. You are correct that you don't pay income tax each year on the increased value of the property itself, but if the property increases in value, there will be a capital gain when you sell the property, which is included in your income at 50%, and taxed at your marginal tax rate. Perhaps your confusion is from the use of the word principal; you don't pay tax (capital gains or otherwise) on the sale of your principal residence.