Tax Deductions in Real Estate

To be taxed now or to be taxed later. That is the question. Is it nobler in the mind to take your Real Estate Expense deductions now or to take them later?

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When it comes to deducting real estate expenses, there is a lot of confusion in the minds of many. In reality it is all pretty simple and makes sense so long as you don’t listen to those who would have you believe otherwise.

The spirit of the law is that you can write off all expenses related to the business of real estate. The only real question is: Is it sooner or is it later?

The sooner or later depends on which side of the line in the sand the scenario appears to be. On one side you have capital expenses and on the other side of the line there are current expenses.

Where do current real estate expenses cross the line and become capital in nature? The line in the sand is not that obscure if you look to the spirit of the law.

On one side of the line you have current expenses which are fully deductible in the current year. On the other side of the line in the sand you have the capital expenses which are deductible over time by way of depreciation.

Maintenance and Repair is a current expense; so long as it does not improve the property to better than it was when it was new or if it is an addition to what was part and parcel of the original new condition edifice.

In my opinion, too many current expenses are not taken as a current expense because of timid tax preparers. Nowhere is it written in tax law that if you are in doubt about an expense, don’t take the deduction. If in doubt about it, you should get the facts. The facts usually make sense, it is the false stories that usually don’t make sense.

I have included below the table from CRA’s web site and in my opinion it is pretty clear as to what is deductible and what is not.

A bit of a side note here; the down payment on a real estate property is capital in nature, so it is not tax deductible in your current year. Your down payment is your capital investment and is going to be tied up in the property until you sell it. So remember that the higher the down payment the greater the profit produced, by way of reduced mortgage interest. The greater the profit produced, the greater the tax implications to the business’s annual bottom line. Always keep in mind the purpose of investing is to grow long term wealth.

When purchasing a property, make sure you make as small a down payment as you can. A smaller down payment frees up more cash to do maintenance and repairs. Those maintenance and repairs will reduce your current year profits and generate a significant tax reduction in your current year.

Getting back to the Maintenance and repair expenses; the following is taken directly from The CRA web site:

Current or capital expenses?

Renovations and expenses that extend the useful life of your property or improve it beyond its original condition are usually capital expenses. However, an increase in a property’s market value because of an expense is not a major factor in deciding whether the expense is capital or current. To decide whether an amount is a current expense or a capital expense, consider your answers to the questions on the following chart.

Does the expense provide a lasting benefit?

A capital expense generally gives a lasting benefit or advantage. For example, the cost of putting vinyl siding on the exterior walls of a wooden house is a capital expense.

A current expense is one that usually recurs after a short period. For example, the cost of painting the exterior of a wooden house is a current expense.

Does the expense maintain or improve the property?

The cost of a repair that improves a property beyond its original condition is probably a capital expense. If you replace wooden steps with concrete steps, the cost is a capital expense.

An expense that simply restores a property to its original condition is usually a current expense. For example, the cost of repairing wooden steps is a current expense.

Is the expense for a part of a property or for a separate asset?

The cost of replacing a separate asset within that property is a capital expense. For example, the cost of buying a compressor for use in your business operation is a capital expense. This is the case because a compressor is a separate asset and is not a part of the building.

The cost of repairing a property by replacing one of its parts is usually a current expense. For instance, electrical wiring is part of a building. Therefore, an amount you spend to rewire is usually a current expense, as long as the rewiring does not improve the property beyond its original condition.

What is the value of the expense?

(Use this test only if you cannot determine whether an expense is capital or current by considering the three previous tests.)

Compare the cost of the expense to the value of the property. Generally, if the cost is of considerable value in relation to the property, it is a capital expense. (*** Dan’s note: The definition of the word ‘considerable’ is too vague to be useful.)

This test is not a determining factor by itself. You might spend a large amount of money for maintenance and repairs to your property all at once. If this cost was for ordinary maintenance that was not done when it was necessary, it is a maintenance expense, and you deduct it as a current expense.

Is the expense for repairs to the used property that you acquired made to put it in suitable condition for use?

The cost of repairing used property that you acquired to put it in a suitable condition for use in your business is considered a capital expense even though in other circumstances it would be treated as a current operating expense.

Where the repairs were for ordinary maintenance of a property that you already had in your business, the expense is usually current.

A very important consideration about real estate properties is that sometimes people lose money on them and how losses are dealt with is a very important strategy. In the year of the disposal of a rental property, you do not have a capital loss on the sale of a rental property; you have a terminal loss or a rental loss. That is hugely different in terms of your tax scenario. A terminal or rental loss is obviously the better situation for the individual investor.

That is particularly interesting because if you have a capital gain, you only have to take half of the gain against your income.

The above is inconsistent with CRA reasoning, but hey! If they have it on their web site
I certainly won’t argue with them on this point.

As the days go on, it becomes increasingly clear on just how important tax strategies are.

So go forth and multiply your real estate investments and populate the earth with your assets.

Best Investing Wishes

Dan White

Tax Specialist