Should I Claim CCA on my Rental?

During tax season, one question is frequently asked when a home/rental owner rents out a  portion of their home or a full unit: Should I claim Capital Cost Allowance (CCA) on the property?

The short answer is that you can, but in most circumstances, it is likely not a good idea. The main reason is a concept called recapture, which can eliminate much of the benefit you receive from claiming CCA in the first place.

Claiming CCA on a Rental

If renting a unit, or a basement apartment that is clearly separable from the portion of the home used personally, the owner can claim CCA on the rental portion of the building. In the case of a partial use of home, the sale must then be pro-rated between the personal and rental portions.

In terms of a partial use of primary residence, this means the Principal Residence Exemption (PRE) can still apply to the personal portion, while the rental portion is treated as a depreciable rental asset, and cannot benefit from the PRE.

In some cases, this may initially appear beneficial because it allows the owner to deduct CCA against rental income, there are long term consequences.

Understanding Recapture

When you claim CCA, you reduce the Undepreciated Capital Cost (UCC) of the asset. UCC essentially acts as the remaining tax cost of the building.

If the property is later sold for more than its UCC, the difference is called recapture.

Recapture represents the depreciation deductions you previously claimed that are effectively reversed when the asset is sold.

Recapture occurs when the proceeds of disposition exceed the UCC of the asset. It is calculated as the lesser of proceeds of disposition minus UCC, or original cost minus UCC.

Recapture is not treated as a capital gain. Instead, it is added directly to ordinary income, meaning it is taxed at the taxpayer’s full marginal tax rate.

Example

A rental unit is purchased for $600,000, and the building qualifies for 4% CCA.

Purchase price: $600,000
CCA rate: 4%
Annual CCA: $24,000

The owner claims 5 years of CCA then sells the unit:

Total CCA claimed: $120,000

Property sale price: $800,000

This reduces the UCC of the property to:

UCC in year of sale: $480,000

Two separate tax consequences arise:

Recapture

The portion of the sale price between the UCC and the original cost is recaptured:

Recapture = $600,000 − $480,000 = $120,000

Note the full cost is used as proceeds are above the cost.

This entire amount is taxed as ordinary income.

Capital Gain

Any amount above the original purchase price becomes a capital gain:

Capital gain = $800,000 − $600,000 = $200,000

Only 50% of the capital gain is taxable, so $100,000 would be included in income.

Why This Is Often a Poor Strategy

CCA appears attractive because it reduces taxable rental income each year. However, if the property appreciates, as most real estate does, the deductions are often reversed upon sale.

This creates two problems:

1. Recapture is fully taxable as ordinary income.
2. It often occurs in the year of sale, when the taxpayer may already have significant income from other sources as well as the capital gain.

As a result, many of the dollars deducted earlier end up being taxed later at the highest marginal tax rates, alongside any capital gains realized on the property.

When Claiming CCA Might Make Sense

Despite these drawbacks, there are situations where claiming CCA can be beneficial.

For example, if a taxpayer expects to be in a very high tax bracket short term but expects to be in a lower bracket or same tax bracket when the property is sold, the strategy can create a useful tax deferral. Timing horizons are often difficult to predict in this circumstance.

Similarly, if the property is expected to lose value, or if the taxpayer plans to hold the property indefinitely, the recapture risk may be less significant.

Practical Takeaways

Although claiming CCA on a building is permitted, it is often not the optimal strategy for most rental owners. Real estate typically appreciates over time, and when that occurs the CCA deductions frequently return as recapture income when the property is sold.

For this reason, many tax professionals recommend not claiming CCA on residential real estate that is expected to increase in value as the long-term tax consequences outweigh the immediate savings.

This publication is for informational purposes only and shall not be construed to constitute any form of advice. The views expressed are those of the author alone. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.