To CCA or not to CCA? THAT is the question!

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janedoe
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To CCA or not to CCA? THAT is the question!

Post by janedoe »

I've owned a few rental properties for the past 3 years or so and on the advice of my accountant, have never claimed CCA on any of them. The recapture nature of CCA upon sale is what was given as the reason for that recommendation.

I've noticed that regardless of recapture, almost any post I read about real estate has the owner claiming CCA as a deduction.

Is this something every real estate investor should be doing or are there circumstances where claiming CCA is detrimental?
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DavidR
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Post by DavidR »

1. Claiming CCA can be very detrimental in cases where the house was at one point a principle residence and might become one again. Let's say you occupy a home as PR for a period of time, and then rent it out for a few years while on a job transfer to another city. If you end up moving back home and re-occupying the house, it can still be designated a PR (even for the years it was rented out!) as long as no CCA was claimed and as long as it was rented for 4 years or less. [At least, that is the way I remember the rules. They are complex and proper tax planning advice should be obtained...etc etc.]

2. Claiming CCA can also cost you if it is claimed while you are in a low bracket and repaid at a high tax rate. Assume CCA is $5,000 per year for 4 years while the owner is at a 25% tax rate. Tax savings $1,250 per year for 4 years = $5,000. Now if you sell, and have a large capital gain pushing you into a higher bracket (say 40%), then the $20,000 of CCA claimed is recaptured at 40% = $8,000 of tax.

BUT, if you expect to be in the same tax bracket for all years, and/or expect a long holding period, and do not have any possible PR uncertainties, then the 'time value of money' would favour claiming your CCA every year.
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Post by Shifty »

Claiming CCA offers a deferral of taxes owed. Accountants will often advise against claiming it, though, because it can present a cashflow issue upon sale to the unwitting. Investors who don't understand it will claim it every year for the tax break, then scream at their accountant when they get a big tax bill on sale for the gain.

Even more simply put, foregoing CCA on rental properties is the foolproof method, even if it is likely the less profitable one.
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Post by janedoe »

I like the idea of tax defferal. I like it less when it is likely being deffered to a year in which I am pushed into a higher income bracket.

Is it not likely that I will be in a higher bracket when I sell a property (as all that cap gain is added to my income)? Does the time value of money really make up for this? Is the notion that I am not currently in the highest tax bracket what is driving her to recommend I don't CCA?

Thanks for your answers guys - very illluminating.
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Post by andrew »

Foregoing a profitable action so that the accountant doesn't have to explain it can indicate someone representing their own interest over their clients' and also shows that even fee for servide professionals can have conflicts of interest.

It can be answered by asking them for their rationale.

Maybe your accountant is not fully representing your interests?

Maybe your accountant sees a relevant consideration that you do not, and therefore you haven't even mentioned?

Maybe you are not even entitled to the deduction?
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Post by jeebuz »

Interesting discussion! CCA recapture is something that that has puzzled me for quote a while...

A scenario: Suppose I own a rental property that I have depreciated by $20K. Prior to selling the property I invest $20K in the property (i.e. by making improvements, renovations, etc). This will increase the cost basis of the rental property by $20K.

Will this allow me to avoid having the CCA recaptured when the property is sold? i.e. which one of the two outcomes below is correct?

1. The $20K investment cancels out the amount depreciated and CCA recovery does not apply.
2. The government will fully recapture the CCA and will tax the $20K CCA recovery as income. The $20K investment will increase the cost basis of the property only for capital gains calculation purposes.

I've asked my accountant about this before but to be honest I didn't understand the answer (lots of accounting jargon that went over my head).

- Jeebuz -
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Post by AltaRed »

janedoe wrote:Is it not likely that I will be in a higher bracket when I sell a property (as all that cap gain is added to my income)? Does the time value of money really make up for this?
Only you can answer that question.
Is the notion that I am not currently in the highest tax bracket what is driving her to recommend I don't CCA?
Ask her for her reasoning. Expectation of that expertise is included in her $150-200/hr charge rate.

FWIW, I own rental property and did not claim CCA for a couple of reasons: 1) I was a non-resident for about 3.5 of the 5 years that I have owned it so far and CCA deductions would have been rather meaningless with minimal income in Canada and complicated with US filings during that time, and 2) This property is not a long term hold for me. Likely owning it 10 years max (halfway there already).

IOW, as DavidR said, be certain about what your longer term plan is and how it is to your advantage before triggering CCA.
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Post by janedoe »

jeebuz wrote:Interesting discussion! CCA recapture is something that that has puzzled me for quote a while...

A scenario: Suppose I own a rental property that I have depreciated by $20K. Prior to selling the property I invest $20K in the property (i.e. by making improvements, renovations, etc). This will increase the cost basis of the rental property by $20K.

Will this allow me to avoid having the CCA recaptured when the property is sold? i.e. which one of the two outcomes below is correct?

1. The $20K investment cancels out the amount depreciated and CCA recovery does not apply.
2. The government will fully recapture the CCA and will tax the $20K CCA recovery as income. The $20K investment will increase the cost basis of the property only for capital gains calculation purposes.

I've asked my accountant about this before but to be honest I didn't understand the answer (lots of accounting jargon that went over my head).

- Jeebuz -
Hey Jeebuz - excellent question! Do deductions first come off any recapturable CCA or do they first come off regular income (cap gains treatment). Inquiring minds want to know!
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Post by janedoe »

AltaRed wrote:
janedoe wrote:Is it not likely that I will be in a higher bracket when I sell a property (as all that cap gain is added to my income)? Does the time value of money really make up for this?
Only you can answer that question.
Is the notion that I am not currently in the highest tax bracket what is driving her to recommend I don't CCA?
Ask her for her reasoning. Expectation of that expertise is included in her $150-200/hr charge rate.

FWIW, I own rental property and did not claim CCA for a couple of reasons: 1) I was a non-resident for about 3.5 of the 5 years that I have owned it so far and CCA deductions would have been rather meaningless with minimal income in Canada and complicated with US filings during that time, and 2) This property is not a long term hold for me. Likely owning it 10 years max (halfway there already).

IOW, as DavidR said, be certain about what your longer term plan is and how it is to your advantage before triggering CCA.
I'm pretty sure that once the cap gains from the sale of any of our properties gets added to our income, it would vault us into a higher tax bracket.

As for part two of your reply - you introduce another variable here - the duration of holding the property. I do recall being asked how long I think I will keep the property (over 5 and under 10 years was the answer). I have no idea though why this makes any difference to our calculations. If I'm keeping it for 5 years or for 20 years how does that change the desirability of claiming CCA?
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Post by marty123 »

janedoe wrote:As for part two of your reply - you introduce another variable here - the duration of holding the property. I do recall being asked how long I think I will keep the property (over 5 and under 10 years was the answer). I have no idea though why this makes any difference to our calculations. If I'm keeping it for 5 years or for 20 years how does that change the desirability of claiming CCA?
Basically, you are borrowing money from CRA when claiming the CCA and repaying it when paying re-capture. Whether it's a good deal depends on what you do with the funds in the mean time. The rate at which you get the deduction (at CCA time) and the rate at which you repay it (at recapture time) will be necessary, and so does the the compounding period. For example:

1. If you get CCA of $10,000 in 2007 while taxed at 21%, you'll get $2,100 for claiming CCA in 2007. If you put it in a taxable investment or principal property mortgage repaymentthat yields 5% after-tax, you'll end up with $3583 after 10 years ($2,100x1.05^10), $4573 after 15 years, or $5837 after 20 years. The recapture will be payable on $10,000 when you sell, and if it's taxed at 46%, you'll pay $4600. Bottom line with these assumptions, the break-even point is around 15 years.

2. If you get CCA of $10,000 in 2007 while taxes at 46%, you'll get $4,600 for claiming CCA in 2007. If you sell the building next year, and get a 0% ROR on the CCA amount during that time, you'll end up with $4600 in 2008, which is equal to the recapture amount due.

3. If you put the CCA proceeds in an RRSP instead, the calcs are more complicated, because you get compounding taking place on more than 100% of the amount. That should shorten this timeline. Put all the numbers in a spreadsheet.

3. If you blow it on a cruise, or a plasma TV, then just understand that it could be expensive financing.

As a rule of thumb, CCA should be claimed for those in the top brackets, because their risk is reduced. The lower the current marginal tax rate, the more risk you take by claiming it.

Only the house/condo portion is eligible for CCA. The lot cannot be depreciated. If your municipality (or assessor) evaluates both separately, it's possible (and should be normal) that the lot appreciates faster than the house, which can lead to a situation where lower recapture is due.

Example:

2007: FMV Lot = $100,000, FMV house = $100,000 (CCA claimed on $100,000)
2017: FMV Lot = $150,000, FMV house = $100,000 (no recapture due)

Both assets are booked under different accounts, and both assets are sold based on a different UCC account. The reality is that recapture can sometimes be less than expected if the lot can be shown to appreciate faster than the house. That would be true in most cases.
Last edited by marty123 on 06 Nov 2007 12:56, edited 1 time in total.
marty123
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Post by marty123 »

janedoe wrote:
a rental property that I have depreciated by $20K. Prior to selling the property I invest $20K in the property (i.e. by making improvements, renovations, etc). This will increase the cost basis of the rental property by $20K.

Will this allow me to avoid having the CCA recaptured when the property is sold? i.e. which one of the two outcomes below is correct?

1. The $20K investment cancels out the amount depreciated and CCA recovery does not apply.
2. The government will fully recapture the CCA and will tax the $20K CCA recovery as income. The $20K investment will increase the cost basis of the property only for capital gains calculation purposes.

I've asked my accountant about this before but to be honest I didn't understand the answer (lots of accounting jargon that went over my head).

- Jeebuz -
Hey Jeebuz - excellent question! Do deductions first come off any recapturable CCA or do they first come off regular income (cap gains treatment). Inquiring minds want to know!
Renovations required to sell the property (or sell at more advantageous rates) must be capitalized. If:

- the house was bought for $100,000
- CCA of $10,000 was claimed
- $20,000 of renovations are invested
- The house sells for $150,000

ACB = $100,000 + $20,000 - $10,000 = $110,000 (+fees, I know)
Recapture = $10,000
Capital gain = $30,000
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Post by jeebuz »

marty123:

Thanks for responding. Your answer is what I expected i.e. that there is no free lunch from the CRA when it comes to CCA recapture.

- Jeebuz -
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Post by marty123 »

jeebuz wrote:marty123:

Thanks for responding. Your answer is what I expected i.e. that there is no free lunch from the CRA when it comes to CCA recapture.

- Jeebuz -
CRA free lunches are all listed in this forum ;-)
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Post by Yukon Maiden »

marty123 wrote:
CRA free lunches are all listed in this forum ;-)
:lol:
" I reject you reality, and substitute my own!"-Mythbusters
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Post by janedoe »

marty123 wrote:
jeebuz wrote:marty123:

Thanks for responding. Your answer is what I expected i.e. that there is no free lunch from the CRA when it comes to CCA recapture.

- Jeebuz -
CRA free lunches are all listed in this forum ;-)
Thank you for the detailed reply and the great link!!! :lol:
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Post by andrew »

CRA free lunches are all listed in this forum
The forum you selected does not exist.
Of course! Everybody pays the same rate of tax on everything. That's a given.

Very helpful. Thank you.
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Re:

Post by wwwKris »

marty123 wrote: Only the house/condo portion is eligible for CCA. The lot cannot be depreciated. If your municipality (or assessor) evaluates both separately, it's possible (and should be normal) that the lot appreciates faster than the house, which can lead to a situation where lower recapture is due.

Example:

2007: FMV Lot = $100,000, FMV house = $100,000 (CCA claimed on $100,000)
2017: FMV Lot = $150,000, FMV house = $100,000 (no recapture due)

Both assets are booked under different accounts, and both assets are sold based on a different UCC account. The reality is that recapture can sometimes be less than expected if the lot can be shown to appreciate faster than the house. That would be true in most cases.
I know this thread is quite old but I thought I'd do a quick post for anyone (like me) that may be referring to it to understand CCA and recaptures for rental properties. I may be incorrect and welcome someone to correct me if I am, but I'm pretty sure the quoted example is incorrect. In this scenario, I think there would be a recapture of 100K and a capital gains of 50K.

The logic I'm applying to come to that conclusion is that the balance of the UCC account for the building would be $0 before the sale (as the example indicated it was all claimed/used) and the sale of the property would be attempting to reduce the account by $100K (the value of the building at the time of sale). If I understand what's written in the recapture section of CRA's Rental Income Guide, a negative in the UCC account would indicate a recapture.

Logically, this also makes sense to me as, in essence, what has happened is that the building was depreciated to $0 and then turned out to be worth 100K. The owner in this case would have unfairly benefited from the deductions over the years (as the asset turned out to be worth $100K, not the $0 implied by the deductions) and CRA would want that to come back in the form of a recapture.

Again, I welcome being proven wrong if I'm incorrect as I'm definitely not an accountant and this is simply what I've gathered from reading about CCA and recaptures.
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