Buildings, vehicles, equipment and more, when used for a business or for professional purposes, degrade and depreciate in value over time. The Canada Revenue Agency provides investors and business owners with a way to maximize the value of their depreciable long-term investments. Revenue Canada allows you to deduct the cost of depreciation over time through the capital cost allowance (CCA).
Capital cost allowance explained
The CCA allows investors and business owners to recoup the costs associated with buildings that need maintenance or equipment that becomes obsolete and needs replacing. Any depreciable assets you use in the operation of your multifamily investment property likely qualifies for CCA. CCAs take the form of a yearly deduction from your annual federal tax burden. Provincial tax systems may also allow for CCAs or similar deductions.
The Accelerated Investment Incentive (AII) is a new tool, introduced in late 2018, that allows new investors to maximize the potential of their CCA.
Any Canadian real estate investor hoping to maximize their potential profits from an investment property need to possess a thorough, robust knowledge of the benefits associated with their potential CCA deductions. If you’re a new investor, you may qualify for the Accelerated Investment Incentive, which could help you leverage your capital even further this tax year.
Defining depreciable property
The CCA deduction applies to rental properties themselves, the legal fees associated with purchasing an investment property and the cost of equipment and appliances necessary to operate a multifamily building.
Revenue Canada has a series of classes it uses to determine how much of a deduction taxpayers can claim for different types of depreciable property. For instance, CCA Class 1 includes most rental buildings acquired after 1987, which entitles investors to a deduction of 4 percent of the asset’s declining balance.
Once you’ve determined the CCA class your asset belongs to, it’s time to calculate the deduction you’re eligible to claim. While the different classes and their subsequent deductions are available on Revenue Canada’s website, it’s advisable to consult with a qualified tax professional to ensure you’re claiming the correct deduction.
If you purchased your investment asset after November 20, 2018, it may be eligible for the Accelerated Investment Incentive. This allows investors to claim between one-and-a-half to three times the usual amount of their first-year CCA deduction.
It’s important to note that you don’t have to claim the entirety of your CCA at once. You can claim as much of the deduction as you want in any given year. If your asset is in Class 1, for instance, you could claim 1 percent of the asset’s balance each year for the next four years.
If you don’t owe any taxes for this fiscal year, you shouldn’t claim any part of the CCA deduction, because it’ll lower the amount you’re entitled to claim in the future.
While the CCA is a valuable tool that can significantly lower your tax burden, it’s important to realize that claiming it may result in an elevated tax burden if you sell your property in the near future. If you sell your property for more than the depreciated balance you claimed it’s worth when claiming your CCA deduction, Revenue Canada will view this as a ‘recapture,’ of your depreciation losses.
They will thus treat any deductions you claimed as a CCA from that asset as taxable income. This means you’ll need to pay back the entirety of the CCA when filing your federal taxes after selling the building, so long as it sold for more than the depreciated balance you claimed.
If the building sells for less than the depreciated balance, however, you may be allowed to claim a terminal loss deduction. This is when you have a remaining CCA balance that you didn’t claim, but no longer have any assets within that CCA class.
Determining if CCA is right for you
Using the CCA deduction has several clear benefits and drawbacks. Ultimately, you should determine if you’re planning to hold the asset long-term, or sell it off at some point in the near future. If you expect to hold the asset and use it to generate passive income for years to come, it probably makes sense to claim a CCA deduction, especially when your building is in need of renovation or repairs.
If, however, you expect to sell off your asset within the next five to 10 years, you may want to hold off on claiming the CCA deduction. Doing so could significantly elevate your tax burden for a year and require you to pay back the balance of the CCA.