Real estate: current or capital expenditure?

Did you make major renovations to a rental property in 2021? Be aware that it is important for tax purposes to clearly distinguish current expenses from capital expenses. Briefly, current expenses are fully deductible from rental income in the year they are incurred, while capital expenses are added to the cost of the building and can be amortized over several years thanks to the capital cost allowance ( DPA).

Since the Income Tax Act is silent on this subject, the Canada Revenue Agenda (CRA) has given some criteria to follow to determine if it is a capital expenditure or a current expense.

Lasting benefit

Where the expenditure provides a lasting benefit, it will normally be considered a capital expenditure. Conversely, it will be a current expense if it is recurring and has a short useful life. For example, replacing the wood siding on a building with brick siding would be a capital expense, while the cost to have the wood siding repainted would be a current expense.

Maintenance or improvement

If the expense is to restore an asset to its original condition, it is considered a current expense, but if it improves the asset beyond its original condition, then it is likely a capital expense. For example, replacing the wooden steps with concrete steps would be considered a capital expense, but if the expense is incurred to reinforce the wooden steps, it will be a current expense. Be careful here: the authorities specify that whether or not the building has increased in value following the expense is not an important factor in determining the nature of the expense.

The integral or distinct part

It is important to know whether the expense is made to repair part of the asset, or whether the expense is incurred to purchase property that is a separate asset. Any expense considered an “integral part” of assets will be deemed to be a current expense. An expenditure made to acquire a separate asset will be considered a capital expenditure. For example, a refrigerator you purchased to include in a rental unit would be considered a capital expense since the refrigerator is separate property and not part of the building. The circuit breaker would be considered an integral part of the building and its replacement is a current expense. To determine this criterion, the relative value of the expenditure must also be taken into account.

Relative value

If it is still not possible at this point to determine the type of expense, the CRA suggests assessing the expense against the value of the entire property. If the expense relative to the value of the property is significantly high, it is a capital expense. For example, if you built a detached garage for tenants, this is a capital expense even though you used materials that are used as a current expense, such as repairing a crack in an existing garage wall. The new garage will cost a lot more, relative to the value of the house, than just fixing a wall.

Preparing the second-hand property for rental or other use

When repairs are made to a purchased second-hand item to make it usable, these repairs are considered a capital expense, even though they would otherwise be a current expense. For example, repairs to an abandoned rental property to make it habitable would be considered capital expenditures.

Anticipation of the sale

Repairs made in anticipation of, or as a condition of, the sale of the property are considered capital expenditures. However, if the repairs were anticipated anyway and the sale was negotiated during the course of the repairs or after they were completed, their cost should be classified as if no sale had been anticipated.