A primary objective for landlords is to maximize the rent they can earn on the properties that their tenants occupy.
However, another significant benefit for landlords is the tax deduction they can claim on the rental income they earn.
In Canada, the Canada Revenue Agency (CRA) allows businesses to claim tax deductions on specific business expenses they incur over the course of operating their rental property.
It is important to remember though that only expenses incurred for business purposes can be claimed as deductions.
Any costs for personal use such as items you buy for your personal place of residence may not be claimed.
Additionally, if you rent out a part of your house, you can only claim expenses incurred for the rented portion of the property.
How does CCA work?
Before we go into the specifics of CCA calculations, it is pertinent to go over how its mechanism work for the taxpayer.
The amount of CCA you can claim boils down to two factors:
- The capital cost allowance class
- When you purchased the property
The first factor relates to the CRA’s methodology for dividing depreciable assets into different classes.
The classification is available on the Government of Canada’s website.
Each of these classes has a specific rate prescribed to it that should be used for all assets in that class.
For example, a Class 6 property has a prescribed rate of 10%.
For a property to be classified as Class 6, it must be made of frame, log, stucco on frame, galvanized iron, or corrugated metal.
Additionally, it has to meet one or more of the following conditions:
- The building must have been acquired before 1979
- The building is used to produce income from farming or fishing
- The building has no footings or other base supports below ground level
The second factor to consider is the date that the property is bought.
In the year that a property is first purchased, the half-year rule applies.
This means that only 50% of the allowable CCA can be claimed in the first year.
This rule ensures that property owners do not claim the full benefit of CCA in the first year for an asset they only owned for part of that year.
Amount You Can Claim
Below is an example for how the CCA works.
In this calculation, we have embedded both Year 1 to demonstrate the half year rule as well as the treatment for subsequent years once the half-year rule is phased out.
For this example, let’s take a $100,000 property classified as Class 1.
If you had to spend an additional $10,000 on registration fees associated with the property, the total cost of the property is now $110,000.
That is the number you would use for your CCA calculation.
Step 1: Identify the CCA rate attached to the class
In this case, we know that the property is classified as Class 1 by the CRA.
Class 1 properties all receive the same rate of 4% CCA.
Step 2: Apply the half-year rule for Year 1
$110,000 x 4% x ½ = $2,200
Step 3: Find the undepreciated capital cost
For subsequent years after Year 1, the new amount that the CCA rate is applied to is called the ‘undepreciated capital cost’ or UCC.
To find the UCC, you have to subtract the initial cost from the cumulative CCA deductions you have claimed.
In the example above, Year 2 would have a UCC of $110,000 – $2,200 = $107,800
Step 4: Calculate CCA for subsequent years
Year 2: $107,800 x 4% = $4,312
Year 3: ($107,800 – $4312) x 4% = $4,139.52
Benefits of claiming CCA
1. Lower taxable income
The Capital Cost Allowance enables the taxpayer to reduce their tax liability in a given year.
The tax benefit you gain from this benefit can be used to invest in your RRSP, add to your TFSA, or be used for other savings or investment purposes.
2. Accounting flexibility
Due to the nature of the CCA, you can use its policies to your advantage during tax season.
For example, if you buy a piece of land and expect it to appreciate over time, you may not want to claim CCA on the land.
This is because the gain you record on the disposition of the land in future will be taxed at a lower rate if it is treated as a capital gain.
Limitations
1. CCA cannot be used to result in a net loss
When your rental expenses are higher than your rental income, you are said to have made a loss on your rental property.
In this scenario, you are not eligible to claim any CCA on your property for that tax year.
2. CCA has to be calculated on overall rental income
For those that own multiple properties, CCA on these properties cannot be calculated separately.
It must be done at the portfolio level.
For example, if a business owner has two properties generating rental income of $1,000 and $2,000, respectively, and a property with -$4,000 in rental loss, the total portfolio made a loss of -$2,000.
In this case though, CCA cannot be claimed on the first two properties even though they are generating income.
3. CCA recapture
You are said to have a recapture of CCA on your property when the sale from the proceeds of depreciable property is higher than your undepreciated capital cost (UCC) and the capital amounts of any additions you made during the year.
This recapture amount is treated as taxable income which increases your tax liability for the year.
As a result, CCA decisions should be made in close contact with a CPA to ensure tax-optimized outcomes.
