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CCA vs Potential Recapture
From tax expert Gerry Vittoratos
May 25, 2017
When owning a rental property, an important tax planning consideration is whether or not to claim Capital Cost Allowance as an expense. In this article, we will take a look at the factors that should be considered when deciding on whether to take CCA.
Potential Future Recapture
This factor is arguably the most important. A recapture is very likely in the case of rental properties, due to the inflation seen in housing prices of the last few years. Also, the recapture amount is fully taxable on the tax return (ITA 13(1)), while the capital gain on the property is only taxable at 50% (ITA 38(a)). This potential recapture discourages many taxpayers from claiming CCA on these rental properties, but is that justified in all cases? Let’s look at some other factors.
When considering CCA, one must also consider the opportunity cost of not taking the expense deduction on the tax return. By taking the expense deduction now, you can deploy the tax deduction received to an investment that can provide a good return; for example, you can contribute the tax savings to your RRSP and not only shelter your earnings, but also get an additional deduction on your tax return. One strong consideration for this is the time period you intend on holding the rental property. The longer the time period, the more advantageous it becomes to take CCA even with the potential recapture that you might incur. You give the deduction expense more time to make money for you before the inclusion of the recapture and the additional tax payable at the time of the disposition.
Change-of-Use Elections Taken on the Property - ITA 45(2)/45(3)
An important factor to consider whether to claim CCA is the change-of-use elections on a principal residence under ITA 45(2) and ITA 45(3). If you have taken the election, or considering making this election on a principal residence under ITA 45(2), you cannot claim CCA on the property from the moment the change in use has occurred and during the period in which the election is to remain in force. The restriction is the same as in ITA 45(3), but in reverse: CCA claim is not possible for any tax year ending after 1984 and on or before the change in use of the property from income-producing to a principal residence (ITA 45(4)). If CCA is claimed on the property, the election is considered to be rescinded on the first day of the year in which that claim is made for ITA 45(2), and the election for ITA 45(3) is not available if CCA was already claimed. These elections defer capital gains for several years, and can translate into big tax savings for taxpayers.
For a detailed description of these elections, please see the “Principal Residence Part 2” article.
Tax Rate During Ownership vs Potential Tax Rate at Disposition
Another consideration to factor in when deciding to take CCA on a rental property is the tax rate the taxpayer is in during ownership vis-à-vis the potential tax rate they would be subject to when disposing of the property. For example, when claiming CCA for a rental property, the tax savings on the CCA claimed by the taxpayer would be equal to the expense multiplied by their tax bracket percentage. When they dispose of the rental property, the capital gain incurred might bump the taxpayer to higher tax bracket than the one they had during ownership. In that case, the potential recapture can be costly, because the income inclusion rate would be higher than the deduction rate claimed on the CCA. Of course the time period the taxpayer plans on holding onto the property is an important consideration as well. Thorough tax planning is needed for this consideration.
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