Should You Claim Capital Cost Allowance on Your Rental Property?

 In Real Estate, Tax

It’s no secret that I work with many real estate investors. Like most clients, their goal is to maximize deductions and pay less tax. But, once in a while, someone will tell me they want to forgo one of the most impactful tax deductions available to a real estate investor – I’m referring to claiming capital cost allowance on your rental property.

Today’s blog post is dedicated to helping real estate investors understand capital cost allowance and when it can be advantageous to claim.

What is Capital Cost Allowance?

Capital cost allowance or CCA is a tax concept which recognizes that some assets can be used over many years.

Examples include cars, furniture and buildings.

Instead of allowing these long-term assets to be written off in one year, the CCA rules require these costs be deducted over many years at a specified rate.

CRA publishes a list of the CCA rates on its website. Most residential buildings, such as a rental property, can be depreciated at a rate of 4% per year.

Keep in mind that…

Claiming CCA is optional. But if claimed, CCA can be deducted against your rental income to reduce your taxes.

For example:

You purchase a rental property for $600,000 and determine that $500,000 relates to the building while $100,000 relates to the land.
.
You further determine that you can claim CCA of $20,000 on the building. CCA cannot be claimed on land. If your tax rate is 40%, then you can potentially pay $8,000 less tax for the year.

You may be wondering…

If CCA is a tax deduction that reduces my taxes, why would some real estate investors choose not to claim it?

It’s because of a concept called recapture. Recapture becomes relevant when you sell the property.

What Happens if I Claim Capital Allowance and Sell my Rental Property?

If you sell your rental property for a profit, any CCA that you claimed in the past is recaptured in your income and increases your taxes.

Going back to our example:

It’s been 15 years since you purchased your rental property. Over the years, you deducted a total of $200,000 in CCA. At your tax rate of 40%, this provided $80,000 in tax savings over the last 15 years.
.
You now sell your property for $900,000. Not only do you pay tax on a profit of $300,000, but the $200,000 of CCA is also added to your income. The large profit pushes you into a higher tax bracket, and you end up paying tax at a rate of 53% on the $200,000 of recaptured CCA or $106,000.
.
Overall, recapture costs you $26,000 (i.e. $106,000 – $80,000) more in taxes than you saved over the last 15 years!

But is this a fair comparison?

Without getting into a discussion on present value calculations, I think most clients realize that a dollar today is worth a lot more than a dollar 15 years from now.

In other words…

If you can pay less tax today in exchange for paying more taxes 15 years in the future – would you?

From my experience, the answer from most investors is, “Yes! Because I can take today’s savings and grow it in the stock market or buy another rental property.”

 

Of course, a variety of factors will influence your answer such as your current tax rate, expected returns and long-term investment objectives.

Generally speaking…

It is more advantageous to claim capital cost allowance on your rental property if you are currently in a high tax bracket and plan to hold the property for a long time.

I hope this blog post helps you better understand CCA and how you can use it to your advantage. If you are a real estate investor, you may also enjoy my blog post on condo flipping.

Are you looking for a real estate accountant? Contact us for a consultation.

 

The content of this blog is intended to provide a general guide to the subject matter. Professional advice should be sought about your specific circumstances.