How Rental Depreciation Works
To take advantage of the benefits that depreciation offers, real estate investors should understand exactly how depreciation works as it pertains to rental properties. Keep reading to learn more about depreciation schedules for rental properties.
By Emily Southey | 16 minute read
Real estate depreciation offers many benefits to rental property owners. For example, it can allow you to reduce your taxable income by writing off certain expenses that come with buying and improving your property.
What Is Rental Property Depreciation?
To properly understand rental property depreciation, we must define the following terms:
- Depreciation: Depreciation is the decrease in value of an asset, whether through age, use, or deterioration. It can also be a deductible or expense claimed to make up for this decrease in value. When it comes to real estate, investors might acquire a depreciable property. While an investor cannot deduct the cost of the property when calculating their net rental income for the year, they can deduct the cost of the property over several years. In Canada, this type of deduction is referred to as capital cost allowance (CCA).
- Depreciable property: A depreciable property is a piece of property that wears out over time. Anything from cars to real estate to farm equipment can be considered depreciable property.
- Depreciable rental property: A depreciable rental property is any rental property on which a property owner claims capital cost allowance. The capital cost can be written off as CCA over several years.
How Does Rental Property Depreciation Work?
Rental property owners in Canada can claim capital cost allowance on the depreciable property, which is essentially a way of deducting the property’s improvement expenses from their taxes. However, the Canada Revenue Agency (CRA) has strict rules on what expenses can be claimed and the maximum amount of CCA that can be claimed. Ultimately, the amount of capital cost allowance that can be claimed on any one property depends on the type of property you own and the date it was acquired.
Most depreciable property is grouped into classes, and from there a specific rate of CCA applies. Most often, investors use the declining balance method to calculate their CCA. To use this method, you must apply the CCA rate to the capital cost of the depreciable rental property. Over the lifespan of the property, the rate is applied against the remaining balance. The remaining balance then declines every year that you claim CCA.
Calculating Capital Cost Allowance
To further explain how rental property depreciation and CCA work, please read the following example:
An investor purchased a rental property for $100,000 in 2020, and the CCA rate is 10%. Therefore, the maximum amount of CCA they can claim is $10,000. If they claimed $10,000 last year, then they would apply the same rate of 10% the next year. However, this 10% rate would be applied to $90,000, as the $10,000 claimed in the year prior would be deducted from the original purchase price of $100,000. Ultimately, investors must deduct the amount already claimed from the original purchase price each year before applying the specified rate to the remaining amount. Claiming CCA on a rental property over three years might look like this:
- First year: $100,000 (purchase price) x 10% (CCA rate) = $10,000. Therefore, $10,000 is the maximum amount of CCA that can be claimed in year one.
- Second year: $100,000 (purchase price) – $10,000 (first year CCA) = $90,000, and $90,000 x 10% = $9,000. Therefore, $9,000 is the maximum amount of CCA claimed in year two.
- Third year: $100,000 (purchase price) – $10,000 (first year CCA) – $9,000 (second year CCA) = $81,000, and $81,000 x 10% = $8,100.
This method of calculation would continue for every year that you claim CCA. Keep in mind that property owners are not required to claim the full amount in any given year. Rather, they can claim part of it or forgo a claim altogether. Ultimately, claiming CCA means that the amount available for you to claim in subsequent years will be reduced.
“Rental property owners in Canada can claim capital cost allowance on the depreciable property, which is essentially a way of deducting the property’s improvement expenses from their taxes.”
Limits on Capital Cost Allowance
There are a few limitations on capital cost allowance that rental property owners must be aware of. First, for the year the rental property is acquired, you may only be able to claim CCA on half of the net additions to a class. This is known as the half-year or 50% rule. Further, in the year you sell the rental property, you may be required to add an amount to your income as a recaptured capital cost allowance or deduct an amount from your income as a terminal loss. Additionally, if you own multiple rental properties, you must calculate your overall net income or loss for the year from all rental properties before claiming CCA. Another important rule is that a rental property owner cannot use CCA to create or increase a rental loss.
Deductions Versus Depreciation
Deductions and depreciation both represent ways of limiting how much tax you pay on your rental property. As we have covered depreciation above, now we are going to delve into deductions. But first, let’s briefly distinguish between the two. Deductibles are expenses paid on a rental property that can be deducted from your income taxes in the same year that they are incurred. Meanwhile, deprecation is a form of non-cash deductible and the total amount is amortized over multiple years. It essentially allows investors to take tax deductions on the predicted decrease in value over time of their rental property(ies). However, what they both have in common is that they can reduce a real estate investor’s taxable income. To further highlight the difference between the two, new light bulbs to replace burnt-out ones in your rental property would be considered an expense. However, new light fixtures that are installed and add value to your property would be depreciated over time.
Current expense versus capital expense
Before you can start deducting expenses from your rental income, you must understand the difference between current expenses and capital expenses. A current expense is a recurring expense that maintains or restores the rental property. Using the example above, new light bulbs would be an example of a current expense. General repairs or maintenance, such as painting, would also be an example of a current expense. Oppositely, capital expenses must boost the property’s overall value or provide a lasting benefit to the property. The entirety of such expenses usually cannot be deducted in a given year but they might be able to be spread out over several years via your CCA claim. In the example above, a new light fixture would be considered a capital expense. Basically, to qualify as a capital expense (depreciation) rather than an operating expense (deductible), the item purchased must add value to the property of the home and should have an expected lifespan of more than one year.
Deductions That Can Be Made to Rental Properties
The CRA allows rental property owners to make all kinds of deductions based on the expenses incurred for their rental properties. Each type of deduction that is eligible is given its own line on the T778 form, which makes it a relatively simple process for rental property owners filing their own tax returns. However, understanding exactly which expenses qualify and in what situations is important as not everything is fully deductible in all cases. Keep reading to discover a detailed breakdown of the deductions that can be made on rental properties in Canada.
If you own a rental property, then odds are you have home insurance or landlord insurance. Not only can insurance provide peace of mind to rental property owners but they also come with the benefit of being tax deductible. Specifically, property owners can deduct insurance premiums for the year they are incurred. That said, you must limit your deduction to cover expenses only incurred during the current year. If your policy has coverage beyond one year, you can only reduce the expenses in the current year they offer coverage.
Interest fees are another deduction that can be made to rental properties. Though the principal of your mortgage is non-deductible, rental property owners can deduct the interest payments made on their mortgage loan. They can also deduct other mortgage-related fees, such as the cost of mortgage applications, brokerage fees, appraisals, insurance, and more. Further, real estate investors can claim interest on any money they borrowed to improve the property (for example, loans they took out for updates or renovations), as well as any interest paid to tenants on rental deposits. However, for the former to qualify, the CRA stipulates that the expenses must be “soft costs,” which they define as funds borrowed for the purpose of financing construction, upgrades, and renovations of your rental property with the aim of increasing its value or making it more suitable to rent out. Overall, there are a variety of interest fees that rental property owners can claim to reduce how much they pay in taxes.
Rental property owners can deduct expenses incurred to advertise their property to potential tenants. This can include a wide range of advertising mediums, including print, radio, online, and television. It even includes finder’s fees. So if you paid to advertise your rental property in any way, be sure to claim it.
Professional fees and legal fees
Professional fees and legal fees incurred through the operation of the rental property might also be tax deductible. For example, many property owners hire a lawyer to review the lease agreement before the tenant signs it or even to collect overdue rent. Similarly, a landlord might hire an accountant for booking services relating to the property or to help them prepare financial statements or audit their record. Consultancy fees are another example of professional fees that can be claimed. Please note that fees incurred in the operation or maintenance of the rental property once purchased are often deductible. However, fees incurred to purchase the rental property, such as the cost of hiring a home inspector, appraiser, or real estate attorney, cannot be deducted from the gross rental income.
Property management fees and administration fees
When you buy a rental property, you become a landlord. However, if you don’t have the time or energy to take on the role of a landlord, you can hire a property management company to do it for you. While this costs money, the good news is that you can deduct this expense. The same goes for the costs of hiring a tenant agent to find and vet prospective tenants or collect rent from tenants.
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Repairs and maintenance costs
The cost of repairs and maintenance can also be deducted from your gross rental income. This includes the cost of materials, as well as labour. (Please note that the cost of labour can only be deducted when you hire someone to perform the repair. In other words, you cannot deduct the cost of your own labour.) Examples of common repairs include fixing a broken window, giving the property a fresh coat of paint, or repairing a broken HVAC unit.
However, things can get tricky when deducting repairs and maintenance costs owing to the fine line between current and capital expenses (this is where understanding the distinction comes in handy). Keep in mind that most repairs and maintenance costs will be considered current expenses, meaning they can be deducted. But some — especially those that improve upon the house and add significant or lasting value — may be considered capital expenses and are therefore not tax deductible. Specific examples of repairs that cannot be deducted from your gross rental income include:
- Repairs that increase the value of the property to a noticeable degree
- Repairs that extend the lifespan of the home
- Repairs that give the property a totally different use
Expenses incurred for improvements are depreciable rather than deductible and therefore cannot be deducted from your gross rental income in the year they are incurred.
Rental property owners might also be able to deduct property taxes from their annual taxes. The province your rental property is located in will determine how much you pay in property taxes. From there, your municipality will collect the amount. Generally, tax rules allow investors to subtract the property taxes charged by your municipality in the current financial year. Please note that depending on where the property is located, you may be responsible for paying both provincial and municipal property taxes.
If your rental property is a second property, one that is completely separate from your principal residence, you can claim the full property tax amount. However, if you only rent out a portion of your home or you rent out your property for part of the year, you cannot deduct the full amount of the property taxes. Rather you can deduct an amount proportional to the amount of space being rented out or the amount of time the space is rented. For instance, if you have a principal residence that features a basement apartment that you rent to a tenant, you can claim the percentage of your property taxes that is equivalent to the square footage of the rented unit. Similarly, if your basement apartment was only finished halfway through the year and was therefore only rented out for six months of the year prior, you can only deduct six months’ worth of property taxes.
If you pay utilities for your rental property, you can also deduct this amount from your taxes. Utilities can be a major expense. From water and heat to cable, internet, and hydro, these expenses can quickly eat into your profits. Luckily, there is a line on your tax return that allows you to claim the utilities related to your property. Keep in mind that if your tenant(s) pays the utility bills, you cannot deduct these costs. In addition, if you only rent out a portion of your property, you can only claim a portion of your utility bills.
Office expenses incurred for business use may also be deducted. Examples of such items include stationery, pens, pencils, paper, stamps, printer ink, and much more. However, any office supplies purchased and used for personal reasons cannot be deducted as these would be considered personal expenses rather than business expenses.
Travel and motor vehicle expenses
Did you know that rental property owners in Canada are allowed to deduct specific travel costs from their gross rental income, so long as the travel expenses pertain to your rental property? Both local and long-distance travel expenses can be claimed. There are a few ways to calculate and claim these expenses. If you own a vehicle, you can make the deduction using the mileage rate or by subtracting the value of the expenses incurred (for example, gas, repairs, and maintenance). Other types of motor vehicle expenses can also be claimed, such as toll roads, interest on your car loan, licence costs, parking fees, registration fees, and related taxes. If you don’t own a motor vehicle, you may be able to deduct other travel expenses, such as public transportation expenses, that are related to your business or rental property.
Please note that the CRA allows real estate investors to deduct motor vehicle expenses in accordance with the number of properties they own. For example, if you own a single rental property, you can deduct certain motor vehicle expenses if the right conditions are met. Please note that a rental property owner cannot deduct motor vehicle expenses incurred to collect rent unless they own multiple rental properties.
Other expenses that a rental property owner may be able to deduct from their taxes include landscaping, condominium fees, salaries and wages, and prepaid expenses.
Please note that although many expenses can be deducted from rental properties, some cannot be. A few examples of non-deductible expenses include land transfer taxes, tax penalties, the value of your own labour, and the mortgage principal.
Frequently Asked Questions
What happens if I don’t claim depreciation on a rental property?
Real estate investors are not required to claim depreciation on their rental property, though generally speaking, it is recommended as doing so can significantly reduce your taxable income. However, you are under no obligation to do so. Instead, a rental property owner can choose to forgo a CCA claim altogether or make a claim that is less than the maximum amount available to them. The way that CCA works is that the more you claim, the less you will be able to claim in the future. So failing to claim in a certain year would leave you with a larger amount to claim in future years. It’s worth noting that failing to claim depreciation on a rental property in any year that you own it can be a major financial mistake. This is because, when you eventually decide to sell the property, you will still pay a depreciation recapture tax, regardless of whether or not you claimed the CCA during your tenure as the property owner.
What’s the rental property depreciation income limit?
The limit of capital cost allowance you can claim in any given year depends on the type of rental property you own, the cost of the property, and the date you purchased it. Therefore, the amount will ultimately vary between rental property owners. Be sure to consult the Government of Canada’s Rental — classes of depreciable property chart to find out which class your property fits into and subsequently, what rates apply.
Does the cost incurred in repairing the rental property affect the rental property’s depreciation?
The costs of repairing a rental property are often tax deductible in the year the expense is incurred. Examples of common repairs include repairing drywall, updating HVAC units, fixing leaky faucets, and more. These repairs will not affect the rental property’s depreciation. However, major improvements, updates, or renovations that add significant value to the rental property usually must be recaptured through depreciation. Therefore, while repairs may not affect the rental property’s depreciation, improvements may.
What deductions can I claim on my rental property?
Real estate investors can claim all sorts of deductions on rental properties. These may include property taxes, insurance premiums, interest fees, property management and administrative fees, professional and legal fees, travel expenses, office expenses, utilities, repairs and maintenance costs, advertising fees, and more. If you aren’t sure whether a certain expense can be claimed or how much of it can be claimed, we recommend consulting with a tax professional, such as an accountant.
How does filing rental income work?
Filing rental income works similarly to filing personal income. In fact, your rental income will be reported along with the rest of your personal income and expenses during the tax season. To claim rental income in Canada, you must complete and submit form T776, which allows you to declare your rental properties and applicable incomes. On this form, there are several lines to help you calculate your total rental income (or loss), with key lines indicating your gross rental income and outlining the types of expenses that can be deducted.
Is rental income taxable?
Yes, rental income is taxable in Canada. However, in some cases, the deductions you make or tax credits you are eligible for may be enough to balance out the amount of tax owed. Regardless, reporting all rental income as income is crucial when filing your taxes. Further, how your rental income is taxed varies. For an individual rental property owner, the net rental income will be taxed at their marginal tax rate. Similarly, for partnerships, each partner will be taxed at their own marginal tax rate for their portion of the income. Meanwhile, rent collected by a business or corporate entity will be taxed at the corresponding business income tax rate.