Jul 19, 2017
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“The allocation of purchase price is important on the purchase of rental properties.”
When a rental building is acquired at a cost of $50,000 or more, it must be included in a separate capital cost allowance class. At present, a building that costsmore than $50,000 would be included in Class 1 and depreciated at a 4% declining balance rate.
In determining whether a building costs $50,000 or more, furniture and fixtures areexcluded. If a company acquires a rental property for $60,000, of which $15,000 is allocated to land, it does not have to be included in a separate class.
Where a building is under construction, it will be placed in a separate class until it is complete. Even though a building is in a separate class, it cannot be depreciated untilit is available for use. The cost can be accumulated in a separate class, but no depreciation can be taken until the property can be rented out.
A rental property is defined as a building used principally for the purpose of gaining or producing gross revenue that is rent. “Principally” is usually considered to mean more than 50%. The courts have generally held that floor space allocation is the key criterion in determining whether a property is considered a rental property.
When a rental property is purchased, it is important to determine the allocation betweenbuilding, land and other depreciable property. The best source for the allocation is thepurchase agreement. Where the purchase agreement does not include an allocation, the CRA could challenge the taxpayer’s allocation, particularly when the purchaser allocates the purchase price in one way, while the vendor allocates the sale price in a different way.
As always, clear documentation is the best defence against any CRA challenge.
“In some cases, assets can, or must, be placed in separate CCA classes.”
Generally, assets of the same type are pooled in one Capital Cost Allowance (CCA) class. For example, equipment would generally be included in one Class 8 pool.
Regulation 1101 of the Income Tax Act sets out the cases where separate classes are prescribed or allowed. There are many provisions in this Regulation, so this list is not meant to be exhaustive.
Where more than one type of property is included in one class, and one property is used to earn business income and the other is used to earn property income, then separate classes are required. An example is the case where a company owns two warehouses, where one is used in a storage business and the other is rented to a third party. Each warehouse would be in a separate class.
Separate classes of assets would be required where a business carries on a life insurance business and an insurance business other than a life insurance business.
Depreciable assets owned by a taxpayer would be in a separate class from assets held in a partnership by the taxpayer who has a partnership interest.
Generally, rental properties with a capital cost of $50,000 or greater are required to be held in separate classes.
Automobiles costing in excess of $30,000 before applicable sales taxes are required to be added to Class 10.1 and the amount to be added to the Class is restricted to $30,000 plus applicable sales taxes. Due to this restriction, each 10.1 automobile is required to be held in a separate class.
Assets that represent Rapidly Depreciating Electronic Equipment can be placed in a separate class if they would be included in Class 8 and they have a capital cost of at least $1,000. These assets must be of the following types: computer software, a photocopier, or office equipment that is electronic communications equipment, such as a fax machine or telephone equipment.
As the classification of assets is subject to many exclusions and limitations, taxpayers would be advised to review the Regulations in detail or to consult their tax advisor.
“Capital cost allowance on rental properties can be restricted to net rental income earned.”
The Regulations in the Income Tax Act restrict the amount of capital cost allowance (CCA) that would otherwise be deductible in respect of a rental property.
The Regulation applies where a taxpayer owns property of a prescribed CCA class and that class includes rental property owned by the taxpayer.
The taxpayer’s total allowable claim may not exceed the amount by which the taxpayer’s net income (before CCA) from renting or leasing rental property owned by the taxpayer(including its share of rental income from a partnership) exceeds its net losses from renting or leasing rental property owned by the taxpayer (including its share of rental losses from a partnership).
Recaptured CCA on the sale of a rental property is included in the above deduction limit for CCA. Similarly, a terminal loss is deducted from the income limit before CCA on the other properties can be claimed.
The taxpayer must combine all its rental income and losses to determine its allowable claim. The restriction is not on a property-by-property basis.
If there is more than one CCA class for rental properties, that taxpayer may choose which CCA pools report CCA (up to the each pool’s individual annual deduction limit), as long as the total CCA on rental properties do not exceed the total limit based onnet rental income.
The purpose of this legislation is to restrict the amount of rental losses that can be applied against other income sources. This is why the restriction does not apply to a corporation “whose principal business was the leasing, rental, development or sale (or any combination thereof) of real property owned by it.” For these corporations, rental losses are effectively trapped in a corporation until future income is earned.
In determining the particular CCA pool(s) where CCA is to be claimed, one must consider possible future sales of a particular property, so that future CCA recapture can be minimized.