Renting out investment properties has become a fairly common way for Canadians to supplement their income. To declare their income from that rental business, taxpayers with such real-estate investments must include a T776 form as part of their T1 income tax return.
Of course, responsible landlords must pay for the proper upkeep of the properties they rent out. That means repair costs for normal wear and tear as well as the occasional significant incident of damage. While it’s possible to get a tax deduction for such expenses, not all are deductible in the year they are incurred.
“[S]ome of these kinds of outlays will be considered current expenses while others will more properly characterized as capital acquisitions to be depreciated in future years,” explained tax lawyer David Rotfleisch in a recent commentary.
According to Rotfleisch, current expenses are deemed currently deductible, thus reducing taxable income within the year. Capital spending, on the other hand, has two tax consequences. First, the property will be classified in a certain category of depreciable category, entitling the taxpayer to a claim of capital cost allowance for each year they own the property. Second, when the property is sold, the outlay will have an impact on the final measure of capital gain or loss experienced on the disposition; this applies irrespective of whether the property is of a depreciable nature or not.
The CRA provides some guide questions to determine whether a repair or maintenance expense is current or capital in nature:
- Does it provide a lasting benefit?
- Does it maintain or improve the property?
- Is it for a part of a property or for a separate asset?
- What is the value of the expense?
- For those who acquired a used property, were the repairs done to put it in a suitable condition for use?
- Were the repairs done in order to sell the asset?
More simply, a capital expense creates a lasting benefit, improves the property beyond its initial value, or extends the property beyond its initial capacity or purpose. In contrast, a current expense creates a benefit that is “used up” within the tax year, maintains the property’s value, or replaces a damaged portion of the property to restore it to its original state.
“If after these first three considerations it remains unclear whether the outlays are capital or current in nature, one should consider the relative magnitude of the repair costs to the value of the asset,” Rotfleisch said. If a repair costs almost as much as the entire value of the asset, or makes the property suitable for use, it is more likely to be regarded as a capital acquisition. Repairs made to sell the property are likely to be improvements, which means they’re likely to be characterized as capital as well.
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