Owning rental property provides not only income but also deductions you can take at tax time. This includes rental expenses, such as homeowner’s insurance, property taxes, maintenance fees, advertising, mortgage interest, utility costs, and property management fees. You also may qualify for the capital cost allowance, or CCA, which is depreciation that can be claimed on your return. The Canada Revenue Agency has specific requirements for claiming the CCA on Rental Property.
Define Your Depreciable Property
Depreciable properties are those that have been worn out from use over the years, such as automobiles and farm and business equipment. You can take the CCA for depreciable rental property. This means you can write off the capital cost of the property including the purchase price, legal fees associated with the purchase of the property and cost of equipment and furniture that comes with renting a building. If you rent out part of your principal residence, you should exercise caution before making a CCA claim for your home. “Because real estate values usually trend upward rather than downward, like an automobile’s, any depreciation taken may have to be included back into income after a sale is made,” says Lior Zehtser, partner and co-founder of ConnectCPA.
Figure Depreciable Rate by Class
For tax purposes, depreciable properties are grouped into various classes. To figure the CCA amount you can claim, you must first determine the rate that applies to the class. For example, a 4-percent deduction rate applies to depreciable property in class 1, which includes most buildings obtained after 1987. The same type of property can belong to a different class, so check each class carefully before categorizing it. For example, most buildings acquired prior to 1988 belong to class 3 or 6. The complete list of depreciable property classes is posted on CRA’s website.
CCA Calculation Method
Your CCA is based on the type of rental property and when you obtained it. To determine the amount, you would likely use the “declining balance method.” In this case, your CCA amount is based on any allowance claimed in prior years subtracted from the capital cost of the property. As you claim the CCA, in subsequent years your remaining balance declines. You can claim any amount of your allowance for the year—you do not have to take the full amount all at once. For example, you might want to hold off on claiming your CCA if you don’t owe any taxes for the year since taking the allowance lowers the amount you’re entitled to in upcoming years.
Selling a Property
Selling the property may result in a “recapture” of your CCA. You would add this recaptured amount to your taxable income when preparing your tax return. Recapture may happen if upon selling the property the proceeds from the sale exceed the remaining undepreciated capital cost. Your undepreciated capital cost is the capital cost of all your depreciable property in the class subtracted from the allowance you claimed in prior years. Alternatively, you might be allowed to take a “terminal loss” deduction from your income. Terminal loss is when you don’t have any depreciable property in the class at the end of the year, but you have an outstanding CCA amount that you have not claimed. “Upon sale, any profit you earned on the rental property over and above your initial cost will be treated as a capital gain. Capital gains are taxed at 50 percent of the gain, whereas recapture is 100 percent taxable,” says Lior Zehtser.
Claiming CCA on Full Net Additions
A half-year, or 50 percent, the rule applies in the year that you obtained the rental property. Therefore, in the year you bought the property, you cannot claim the CCA on all your net income additions in a given class. Instead, you would claim the allowance on only half of your net additions. For example, if you purchased a rental home for $20,000, your allowance would be based on $10,000 for the first year.
Taxes and Rental Losses
If your rental expenses exceed your gross rental income, you have incurred a loss. You may be able to deduct your rental loss from other sources of income, but you cannot use CCA to increase or produce a rental loss. For example, you own two rental properties. The net income for one property is $3,000, while the other property yielded a loss of $5,000. This means you suffered a loss of $2,000. Because you cannot increase your net rental loss by claiming CCA, you cannot claim any CCA on your rental buildings or equipment.
Know the Effects
There are pros and cons to taking CCA. On the upside, the allowance lowers your taxable income, which ultimately reduces your tax liability. On the downside, when you sell the property all prior CCA claims are recaptured and treated as taxable income, which increases your tax liability. According to Lior Zehster, “The decision as to whether to take CCA should be discussed with a professional.”
COVID-19 Impact on Rental income
Both landlords and tenants are facing difficulties during the COVID pandemic. Landlords are facing challenges with financing, managing from distance, leasing, paying employees, etc. CRA offers COVID incentives to support your rental business during this difficult time whether through CERB or CEBA.
If you are running the rental income properties as a personal, you will be able to apply for CERB. If you are running your rental income as a business with a business bank account and a business number with CRA, you will be able to apply for CEBA.
Since the government had panned eviction during the pandemic to support renters in most provinces, you as a landlord will have to accept partial rents or no rents from some of your tenants, then find ways to fill the gap in the cash-flow. If you are still paying mortgages on your residential rentals or leases on your commercial rentals, you will be able to apply for deferred payments to overcome the losses from your tenants who are also requesting deferrals themselves.
References & Resources
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