Tax Time – Depreciation Explained Part 1

Now that we are fully into tax season, we are going to dive deeper into a confusing tax subject: depreciation.  We touched on this subject briefly in our post from last week, but this topic deserves its own post. We frequently witness the impact of depreciation with our clients. Often, these impacts aren’t fully understood until tax time!

One of the benefits of owning rental properties is the claiming of expenses as deductions against rental income. This leads to a reduction in taxable income for that year. Typical expenses include property taxes, insurance, repairs and maintenance, mortgage interest, and more.

Another expense (unlike the above cash expense) is an accounting expense, the ability to claim depreciation. This expense in Canada is referred to as a Capital Cost Allowance (CCA). This capital cost allowance includes capital costs of a property including the purchase price, legal closing costs and renovations that can’t be expensed. For example, if you purchase a property for $300,000 and spend $5,000 on closing costs and $20,000 on renovations, you’ll have a value of $325,000 for CCA purposes.

There are different rates of CCA that you can claim, but in most cases the rate is 4%, which applies to most buildings that were obtained after 1987. The most used method for claiming CCA is the Declining Balance Method. In this case, your CCA amount is based on any allowance claimed in prior years, subtracted from the capital cost of the property. As you claim the CCA, in subsequent years your remaining balance declines. You can claim any amount of your allowance for the year—you do not have to the take the full amount all at once. For example, you might want to hold off on claiming your CCA if you don’t owe any taxes for the year, since taking the allowance lowers the amount you’re entitled to in upcoming years.

To better illustrate the declining balance method, imagine you have a property with a CCA value of $300,000 and the 4% rate is applied to your property. You can claim $300,000 x 4% = $12,000 of depreciation expense in that tax year.  The next year your new CCA balance would be $300,000-$12,000= $288,000. This new value would be applicable to the depreciation expense for the next year.

Next week we are going to discuss other considerations involving depreciation or CCA. 

Do you take depreciation expense on your rental properties?