To Depreciate or Not, That is the Question!
When you operate a rental property, one of the big questions is whether or not to claim “capital cost allowance” (or CCA) on the cost of the building itself. CCA is another term for depreciation, which is how you deduct a portion of the cost of large assets each year as an expense over time, rather than the full amount at the time they are acquired. Depreciable (or “capital”) assets can include buildings, furniture, equipment, etc.
With a rental property, you will likely have a couple of different classes of capital assets including the cost of the building itself, various appliances that you have purchased, furniture and fixtures you may provide for your tenants, and so on. Claiming the CCA on things like appliances and furniture is usually a no-brainer - you will often want to make that deduction each year.
But, we always recommend to clients to think twice about claiming CCA on the building itself. The reason is based on the potential that you will save tax in claiming the annual CCA deduction at a lower rate than you will eventually have to pay tax on the recapture of it when you sell the property.
Let’s say, for illustration, you currently pay tax on your rental property profits at 31%, based on which tax bracket your total personal income (including the rental) puts you in. When you claim that CCA expense, you will save tax at that percentage each year (assuming your income remains consistent). However, when you sell the property, assuming you sell it for more than you paid for it, you will pay tax on half of the capital gain (difference between what you sold it for and what you bought it for), as well as tax on the “recapture” of all of the CCA you claimed over the years (ie. because you essentially recovered that money in the sale of the property).
In a year where you have sold a property, that taxable capital gain and the recapture of the CCA both get added on to your other personal income, possibly boosting you up into a higher tax bracket for that year. For many people, this causes tax paid on the recapture to be at a much higher percentage (and therefore total amount) than tax you saved over the years by claiming it.
Some clients make the decision to maximize their write-offs each year, and do claim the CCA as they go in order to pay the least tax each year, knowing that when they eventually sell they will likely pay tax on the recapture at a higher percentage. However, they feel that because they will have lots of cash on hand from the sale proceeds, that it’s affordable - in essence, they trade the percentage/amount of tax paid for how easy it is to pay based on available cash.
Other clients who plan long-term for the disposal of their rental properties also claim the CCA each year to get the deduction when they are in their highest income-earning years, with the idea that they will wait to sell the property until after they retire and their other personal income is lower - this way, they may pay tax on the recapture at a similar, or even lesser, rate than what they saved tax on over the years of claiming CCA, since their total personal income (even with the capital gain and recapture) is similar or lower than the years they claim the CCA.
So, to claim or not to claim depends on your ability or willingness to have some long-term plans in mind for your rentals, or perhaps is dictated by cash flow and your potential need to claim the CCA and minimize the tax as you go. Either way, it is important to understand the possible implications of claiming CCA, and to choose in an informed way!