What if you incurred certain renovation expenses in respect of your rental property and are unclear whether you can deduct the full amount of the expense in the current taxation year?
For tax purposes, the cost of repairs and renovations to a rental property may either be deductible as a current expense, or may be classified as a capital outlay, in which case the deductions are limited to those provided for under the capital cost allowance (CCA) tax rules. Under these rules, the cost is added to the same CCA class as the rental property and is deductible over time based on the applicable CCA rate. Generally, it is preferable to fully deduct an expense since if a rental loss is incurred for the year, you can apply the loss against your other sources of income.
The determination of whether a repair or renovation expense is current or capital in nature for tax purposes can be complex and there is always a risk that the CRA will challenge the classification in a future audit. As a general rule, renovations and repairs that extend the useful life of a rental property or improve it beyond its original condition are considered capital expenditures. However, there is a wide-range of factors that must be considered to appropriately classify an expenditure. Each situation is fact specific; there is no fixed list of factors to be considered, and there is not fixed weighting attributable to the importance of relevant factors.
The question of whether an expense is current or capital in nature has often come before the tax courts. Over time, the courts have tended to become more liberal in classifying renovation work as repairs as opposed to capital expenditures. Factors the tax courts typically consider relevant include:
Will the renovation result in an enduring benefit? Generally, if the work at issue creates something that will last for an extended period of time, this suggests that the expenditure may be capital in nature. For example, the cost of replacing a building’s exterior wood siding at the end of its useful life with new vinyl siding is likely a capital expense since this siding is substantially different from what it replaced and has an enduring benefit. However, some items might have a relatively short useful life. A recurring expenditure for the replacement or renewal of such an item would tend to be a current expense. For example, the cost of periodically repainting the wood siding from the previous example would be a deductible current expense;
If the repair or renovation creates an independent asset that can exist on its own, this would suggest the expenditure is a capital acquisition;
Repairs for the purpose of making a property once again suitable for its normal use are likely to be current expenses whereas repairs/renovations that improve a property are likely to be capital expenses (the degree of improvement is relevant);
“Repairs” do not become something other than “repairs” merely because they are carried out in the light of new technology that did not exist when the original structure was built or because the repairs take into account conditions (such as dampness) that were not taken into consideration when the original structure was built (i.e. the use of more modern technology/products in itself does not necessarily constitute a betterment/capital expenditure);
The sheer quantum of the repair is relevant. To some extent, a larger expense may point towards a capital expenditure, and vice versa;
The value of the repair/renovation in relation to the value of the property as a whole is relevant. The larger the expense in relation to the value of the property, the more it may point towards a capital expenditure, and vice versa;
The purpose of the work and the nature of the work must be considered. For example, if a taxpayer purchases an older property and incurs renovation expense to bring the property up to a condition that is suitable for renting, such renovation costs will likely be capital in nature. On the other hand, payment for repairs to fix or restore a property to the same condition as when the property was first purchased are normally considered recurring current expenses that are generally deductible in the year incurred;
Repairs that increase the value of the property suggest that the expenditure is more likely to be capital in nature (the CRA has, however, specifically stated that it does not consider an increase in a property’s market value because of an expense to be a significant factor in deciding whether a renovation expense is capital or current); it should be considered whether the work increases the value of the asset from what the value would be, assuming a good state of repair (provided one is not creating new capital property or causing the normal value of the property to be inflated, then the work done will typically amount to repairs and maintenance in efforts to restore the property to its normal value, as opposed to constituting a “betterment”);
Renovations that permit a higher amount of rent to be charged beyond the rent charged on similar properties in the area would suggest that the expenditure may be capital in nature;
If a property is being prepared for sale, expenditures such as real estate commissions or the cost of improvements to make the property more marketable will likely be capital expenditures;
Work that would otherwise be capital does not become current in nature simply because of a legal requirement to incur the expense. For example, a rental property may need repairs/renovations to satisfy building codes or safety requirements;
Generally, accumulating repairs over time, such that a large amount of repair expenditures is incurred in one-year, does not convert the nature of the expense from current to capital.
To assist landlords in deciding whether an amount is a current or a capital expense, the CRA suggests that taxpayers consider the following questions (the below is an excerpt from the CRA’s Rental Property Guide):
Capital expenses (see “Capital Criteria expenses—Special situations” Current expenses on this page)
Does the expense A capital expense generally gives A current expense is one
provide a lasting a lasting benefit or advantage. that usually recurs after a
benefit? For example, the cost of putting short period. For
vinyl siding on the exterior walls example, the cost of
of a wooden house is a capital painting the exterior of a
expense. wooden house is a
Does the expense The cost of a repair that An expense that simply
maintain or improve that improves a property beyond restores a property to its
the property? its original condition is probably original condition is
a capital expense. If you replace usually a current expense.
wooden steps with concrete For example, the cost of
steps, the cost is a capital repairing wooden steps is
expense. a current expense.
Is the expense for a The cost of replacing a separate The cost of repairing a
part of a property asset within a property is a property by replacing one
or for a separate capital expense. For example, of its parts is usually a
asset? the cost of buying a refrigerator current expense. For
to use in your rental operation instance, electrical wiring
is a capital expense. This is the is part of a building.
case because a refrigerator is Therefore, an amount you
a separate asset and is not a spend to rewire is usually
part of the building. a current expense, as long
as the rewiring does not
improve the property
beyond its original
What is the value of Compare the cost of the This test is not a
the expense? (Use expense to the value of the determining factor by
this test only if you property. Generally, if the cost is itself. You might spend a
cannot determine of considerable value in large amount of money
whether an expense relation to the property, it is a for maintenance and
expense is capital capital expense. repairs to your property
or current by all at once. If this cost was
considering the for ordinary maintenance
three previous that was not done when it
tests.) was necessary, it is a
and you deduct it as a
Is the expense for The cost of repairing used Where the repairs were
repairs made to property you acquired to put it for ordinary maintenance
used property you in a suitable condition for use of a property you already
acquired to put it in in your business is considered had in your business, the
a suitable condition a capital expense even though expense is usually
for use? in other circumstances it would current.
be treated as a current expense.
Is the expense for The cost of repairs made in Where the repairs would
repairs made to an anticipation of selling a property, have been made anyway,
asset in order to or as a condition of sale, is but a sale was negotiated
sell it? regarded as a capital expense. during the course of the
repairs or after their
completion, the expense
is considered current.
Q. My brother and I own an old apartment building that we have been renting for several years. In the current tax year, we had the roof and outside walls repaired. The repairs to the roof involved waterproofing and re-shingling several patches that had developed leaks. The building is made of brick, and the outside walls were redone using the original bricks. Can we deduct these expenses in calculating our rental income for the year?
A. Yes. The repairs to the building simply restored it to its original condition. As a result, they are current expenses.
In a 2011 Interpretation Document, the CRA stated the following to a taxpayer who asked whether certain rental property expenses that taxpayer had incurred (including re-roofing the property and replacing a water heater, two existing furnaces and two overhead garage doors) were current or capital in nature (the taxpayer was of the view that none of the expenses incurred result in an “upgrade” to the property):
There are no fixed rules when determining whether an expenditure is on account of income or on account of capital. The courts often look to what, from a practical and business perspective was the purpose of the expenditure. The jurisprudence suggests a number of guidelines that may be relevant, but also suggests that no one guideline is determinative. The main four guidelines that the courts have identified as being relevant to the determination are “enduring benefit”, “maintenance or betterment”, “integral part or separate asset” and “relative value”. These guidelines, along with some others, are explained in [Income Tax Folio S3-F4-C1, paragraphs 1.4-1.12, which read as follows:
1.4 An expenditure will normally be considered capital in nature if it brings into existence an asset or advantage that has an enduring benefit. For example, the cost of replacing a building’s exterior wood siding at the end of its useful life with new vinyl siding is likely a capital expense because it is substantially different from what it replaced and has an enduring benefit. However, some items might have a relatively short useful life. A recurring expenditure for the replacement or renewal of such an item is an indication that the expenditure is of a current nature. For example, the cost of periodically repainting the wood siding from the previous example is likely a current expense.
Maintenance or capital improvement
1.5 Where an expenditure made in respect of a property serves only to restore it to its original condition, that fact is one indication that the expenditure is of a current nature. For example, the cost to repair or replace wood steps with wood steps would typically be a current maintenance expense. However, the cost of replacing wood steps with concrete steps is a capital expenditure because it improves the property beyond its original condition.
1.6 A repair often involves some degree of improvement in technology, materials or workmanship. This does not necessarily mean the cost of the repair is a capital expenditure. For example, the cost of replacing a window with one that has a higher insulation value may still be a current expense if it otherwise qualifies. Whether the market value of the property is increased as a result is not a major factor in characterizing the expenditure.
1.7 Determining whether the cost of a particular repair or replacement constitutes a current or capital expense requires an examination of the facts in each individual case. Such an examination must take into account whether the replacement is substantially different from what it replaced along with a consideration of the other guidelines outlined in this section.
Integral part or separate asset
1.8 Another point to consider is whether the expenditure is made to repair a part of a property (generally a current expense) or whether it is made to acquire a property that is itself a separate asset (generally a capital outlay). For example, the cost of replacing the rudder or propeller of a ship is typically regarded as a current expense. While a rudder or propeller might be purchased as a separate asset, it is an integral part of the ship and there is no overall betterment to the ship on its replacement. Similarly, the cost of replacing electrical wiring that is part of a building is a current expense as long as the rewiring does not improve the property beyond its original condition. On the other hand, the cost of replacing a lathe in a factory is regarded as a capital expenditure, because the lathe is not an integral part of the factory but is a separate asset. Between such clear-cut cases there are others where a replaced item may be an essential part of a whole property yet not an integral part of it. Where such difficulties are encountered, other factors such as relative values must be taken into account.
1.9 It may be necessary to consider the amount of the expenditure in relation to: the value of the whole property; the previous average maintenance and repair costs or other expenses; and annual profits. This is particularly so when the replacement itself is purchased as a separate asset. For example, a spark plug in an automobile engine could be regarded as a separate asset, but one would normally treat the cost of replacing it as a current maintenance expense since its value is low when compared to the cost of the automobile. However, where the engine in an automobile is replaced, it is not only likely that such a replacement will substantially improve or prolong the useful life of the automobile, but the cost is also likely to be substantial in relation to the total value of the property of which the engine forms a part. In such a case, the expenditure would likely be regarded as capital in nature.
1.10 The relationship between the expenditure and the value of the whole property is not necessarily decisive in other situations. For example, a major repair job may be an accumulation of lesser jobs whose cost would have been classified as current expenses if each had been done when the need first arose. The fact that these jobs were not done earlier does not change the nature of the work when it is done, regardless of the total cost. Readying a used property for rental or other use.
1.11 Costs to ready depreciable property for use are generally capital expenditures. Likewise, a taxpayer might acquire used property that needs repairs or replacements to put it in suitable condition for use. The cost of such work is regarded as capital in nature even though, in other circumstances, it might be treated as a current expense. For example, the cost to renovate a newly-acquired property in order to ready the property for rental use would normally be considered on account of capital. Anticipation of sale.
1.12 Repairs made in anticipation of the sale of a property or as a condition of the sale are generally regarded as capital in nature. On the other hand, where the repairs would have been made in any event and the sale was negotiated during the course of the repairs, or after their completion, the cost should be classified as though no sale was contemplated.
… If a new roof clearly is of better quality and greater durability than the replaced roof, then the expenditure would generally be regarded as capital in nature. On the other hand, if an expenditure only restores the roof to its original condition using identical or equivalent quality materials, this would be an indication that it is current in nature.
We have not been provided with sufficient information to comment on whether the expenditures referred to in your letter would be current or capital in nature. However, we would note that you have indicated that the expenditures did not result in an upgrade to the building which leaves the impression that the new roof, furnace, water heater and garage doors would not be betterments, which may be an indication that expenditures relating to the new roof are current in nature.
A component part that ordinarily goes with the building when it is sold or that relates to the use and function of the building such as electric wiring, sprinkler system, air-conditioning equipment, lighting fixtures is included in the building [CCA] class. Accordingly, the costs of a roof, water heater, furnaces and garage doors, if they are considered to be capital in nature, are included in the same [CCA] class as the building to which it is attached.
As you can ascertain from the above, the question of whether a particular expense is current or capital in nature can be a complex and is intensely factual.
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