Are you a landlord in Canada and depend heavily on rental income? Then the Capital Cost Allowance (CCA) is for you. The CCA allows businesses to claim a tax deduction on asset depreciation and rental expenses like advertising, insurance, maintenance fees, mortgage interest, property management fees, property taxes, and utilities. As a result, CCA can bring significant tax benefits or future liabilities. Such extreme outcomes put many small business owners in the dilemma of whether to claim the CCA.
This article will discuss how CCA works for rental properties like buildings and land that appreciate over time.
What is Capital Cost Allowance?
Capital is an amount spent to buy an asset that will generate income directly or indirectly. Some assets that qualify for CCA include rental properties, buildings, equipment used for business, motor vehicles, and furniture. Assets used for personal use, like the house in which you are residing, do not qualify. However, you can deduct the cost of buying the asset in a phased manner under depreciation cost.
Any cost associated with buying and maintaining the asset is considered a capital cost allowance, and you can deduct it from your annual taxable income in a phased manner. For example, if you rent your property, you can deduct legal fees, essential equipment, furniture, and appliance costs in CCA. But if you rent out a part of your home, the CCA calculation changes as you cannot deduct expenses used for personal use. Therefore, CCA is a benefit that business owners can avail for business expenses only.
How does Capital Cost Allowance Work?
The Canada Revenue Agency (CRA) has divided depreciable properties into different classes and prescribed a specific rate against each class, which is the maximum CCA one can claim in a year. Therefore, as a property owner, you have to identify the category under which your property/properties fall, calculate all the capital costs associated with it and deduct the CCA according to the depreciation rate prescribed by the CRA.
Another element is the year of purchase or addition to the property. In the year of purchase, you can claim only 50% of the CCA under the half-year rule.
For instance, most buildings obtained after 1987 fall under Class 1, on which a 4% deduction rate applies. In May 2022, John purchased a Class 1 property for $100,000 after including all capital costs. Per the deduction rate, he can claim a maximum CCA of $4,000 (4% of $100,000) for the year. But because of the half-year rule, the maximum CCA amount he can claim reduces to $2,000.
Most CCA calculations use the declining balance method. So John claimed $2,000 CCA in 2022. In 2023, he can claim 4% CCA on a reduced base capital of $98,000 ($100,000-$2,000). This will reduce his CCA to $3,920. In 2024, the base capital will reduce to $94,080.
There is no hard and fast rule that you have to claim the maximum CCA. You may not claim CCA or claim a lower amount. Your decision depends on factors like tax liability, long-term financial goals, other investment assets, and opportunity cost.
Situations When Small Business Owners May Not Claim CCA
Remember, CCA is a tax benefit to help you avoid paying taxes on the business capital expenses incurred. You cannot use it to create a rental loss. So if your maximum CCA is $4,000 and your rental income is $1,500 (after deducting expenses), you can claim a CCA of up to $1,500 and free your rental income from taxes. But you cannot claim a $2,000 CCA and report a rental loss of $500.
If your overall rental income from a particular property class is harmful in a year, you cannot claim CCA. For instance, if you have three properties under Class 1, which earned a rental income of $2,000, $1,000, and -$5,000, respectively, your total rental loss is $2,000. Therefore, you cannot claim CCA on the first two properties even if they are giving rental income.
If you have no or low-income tax payable after all the deductions, you need not claim CCA for that year as it will reduce your base capital. Instead, preserve this allowance for years when the income tax liability is high.
Many business owners do not claim CCA for rental properties if they plan to sell them in future because the land is an appreciating asset. If your sale proceeds exceed the undepreciated capital cost (UCC), you must include the difference in your taxable income. This is called the recapture amount. Plus, you will pay a capital gain tax on 50% of the gains. (UCC is the capital cost of all your depreciable property in a particular class minus the claimed CCA)
Situations When Small Business Owners May Claim CCA
There are many situations under which you might not claim CCA. But opportunity cost encourages many small business owners to claim the deduction. The CCA can help you save on tax returns and increase your rental income. In addition, you can put the amount saved from reduced tax in the Registered Retirement Savings Plan (RRSP) and enhance your tax savings, as RRSP contributions are tax deductible. That is an opportunity cost.
And if you have another investment opportunity that can give you strong returns, you might opt to claim CCA and put the tax savings in that opportunity. The returns from alternate investments might more than offset the recapture cost from the UCC.
Contact ESS CPAs LLP in Burlington for Expert Tax, Accounting, and Business Advisory Services
Understanding how Capital Cost Allowance works will help you understand the importance of this deduction. But if you want to make the most of this deduction and other deductions the CRA offers, talk to a professional tax consultant. To discuss your tax planning and compliance needs with one of our experienced Chartered Professional Accountants in Burlington, contact us online or by phone at 905-517-2297.