In early 2016, Toronto Real Estate Board has reported that a substantial 20 per cent increase compared to 5,032 rentals reported in Q4 2014.The real esate experts expect rent growth to remain strong in 2016. What a great year for a lot of investors owning the rental properties! It does not only bring in decent monthly cash flows, but also provides tax deductions when filing your tax. A popular question is whether you should claim CCA on the rental property to reduce the rental income.
Then, what is CCA?
CAA is the short form of the Capital Cost Allowance. It is allowable write-off of capital assets from tax perspective and can be claimed on the tax return. Two things are required to determine before claiming CCA. One is whether the property is depreciable properties and which tax class it belongs to.The other is the rate applied on that particular class.In most cases, buildings obtained after 1987 are categorized in Class 1 with a 4% deduction rate.
The basic tax rules
The Canada Revenue Agency has specific requirements for claiming the CCA, particularly on the rental property.
- When the cost of each building(multiple units)is greater than $50,000, the rental buildings should be track in a separate CCA class.
- Land cannot be depreciated but the building can be depreciated.
- A half-year rule applies in the year when the rental property is purchased.Only 50% of addition is allowed for the first year.
- CCA can be used to reduce rental income to zero.
- It is NOT allowed to either create a rental loss by claiming CCA or increase the net rental loss by claiming CCA.
- From sales tax perspective, no GST/HST residential property income. Similarly, no GST/HST input tax credit can be claimed either.
Here is the tax rule with HUGE IMPACT
Tax impact arises when you decide to sell the rental property. Here they are:
•Capital Gain / Losses
If a rental property is sold for more than its original cost, a capital gain can be easily figured out by the difference the proceeds and costs.
•Terminal loss
If a rental property is sold for less than the UCC of the depreciated property(remaining portion of the depreciated property) , a terminal loss will be triggered and used to deduct any source of income.
•Recapture of CCA
If a rental property is sold for more than the original cost of the depreciated property, any CCA claimed since the beginning is “recaptured” and taxed as regular income.
These days, it is reasonable that a lot of investors expect a huge profit on the disposition of the rental property. Likely, a rental property can be sold for more than the original cost of the building(let’s simplify, a condo), any CCA claimed in the past will be included as regular income, which is taxed at the full rate. As a result, a lot of investors have been advised not to claim CCA on the rental property. But why?
So, what is the logic?
First, claiming CCA will result in recapture when finally the property is sold and the recapture is taxed as regular income instead of capital gain, which has a favourable tax treatment(50% of gain is taxable).
Secondly, CCA should be claimed when individuals are in the top tax brackets.The reasoning is,by claiming CCA, the individual’s rental income is reduced as well as the total income.Obviously, more tax savings will be achieved while you are in the top tax brackets as compared to low tax brackets.
Does it make sense? Absolutely,but there are other factors that need to be considered. It does not apply every one’s tax situation. Here is why? Let’s assume the rental property is expected to be held for another 15 years.So, the question is which option provides better value:
1-CCA tax savings over 15 years
2-Paying recapture 15 years later
If we do some calculation, compare the time value of CCA tax saving for 15 years to the tax that arise as a result of recapture 15 years later,then you may see option#1 is a better choice. Why? One dollar today is worth more than one dollar 15 years later. To/not to claim CCA gets complicated when all factors are considered. Do some homework and discuss with your accountants to make a sound decision.
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