The timing of tax deductions related to multi-unit purpose-built rental buildings differs depending on the classification of the expense. Current expenditures are deductible in the year incurred, whereas capital expenditures are deducted over several years based on the “capital cost allowance”. The distinction is often a matter of interpretation.
Given the subjectivity of the expenditures, much of the guidance on this matter is provided by the Canada Revenue Agency’s (“CRA”) administrative guidelines and case law. The four main guidelines are as follows:
- Enduring Benefit – A capital expenditure will bring into existence an asset or advantage for the long term. A current expenditure would be frequently recurring, such as replacement or renewals, because its useful life will be relatively short term.
- Maintenance or Betterment – A capital expenditure materially improves the property beyond its original condition and is clearly of better quality and greater durability. A current expenditure serves only to restore the property to its original condition, using identical or equivalent material.
- Integral Part or Separate Asset – A capital expenditure introduces a new and separate asset. A current expenditure repairs an integral part of an existing asset.
- Relative Value – The amount of the expenditure in relation to the value of the property as a whole may also be considered when determining classification. Where the total new expenditure approaches the total value of the property, it will likely be deemed to be of a capital nature. However, relative value may not necessarily be a determining factor. For example, where a major repair is an accumulation of lesser repairs, the expenditures may be classified as current or capital expenditures based on a review of the lesser repairs separately. The fact that the repairs were not done earlier does not change the nature of the work when it is done, regardless of its total cost. Whether the market value of the property increases because of the expenditure is not a factor in determining whether a cost is current or capital.
Although there have been many court cases on this issue, these cases have not provided further clarity. The courts tend to follow the listed guidelines because each case is analyzed on its own facts, and certain factors may outweigh others. Therefore, predicting how the courts will rule remains problematic. The courts have, however, put more emphasis on the maintenance or betterment guideline. Therefore, consideration as to whether the expenditure resulted in restoring a building to its original state or creating a lasting improvement is important.
Some examples of capital improvements include new and improved wiring, heating, air conditioning, ventilation systems and lighting, changing floor space, moving bathrooms, wider and better windows and doors, structural strengthening of the roof, and replacing stucco exterior by an enameled porcelain surface. The classification of these expenditures may differ depending on the facts of a specific case.
Work relating to the exterior walls of a building generally results in a capital treatment. On the other hand, the cost of repairing damage to the internal components of a building requires application of the guidelines discussed above.
Be sure to provide adequate detail to your accountant when preparing your tax return information.
Before embarking on any major expenditure on your property, consider seeking the advice of your accountant on the relevant tax treatment, as the tax deduction of the expenditure in the year or over a number of years may have a significant impact on its feasibility and on cash flow.
Smythe LLP is a proud member of LandlordBC and is one of the leaders in accounting, tax and advisory services in the real estate and construction industries in BC. For further information contact Maggie Puhacz at (604) 687-1231 or visit our website at smythecpa.com.
The information provided is a general overview and should not be construed as tax advice. We recommend seeking professional advice from your tax advisor in respect of your specific situation.