Slash capital gains with cost deductions

Q: We are planning to sell the cottage in the next year or so and I would like to know what kind of renovations/improvements qualify as capital costs? For instance, does the cost of changing a shingle roof to a metal roof qualify? And what about updating and replacing old windows? Or even replacing flooring? We’ve kept receipts and now we want to try and minimize the taxes we’ll end up paying when we sell.

— Cashing in, Bruce Peninsula, Ont. 

Ayana Forward is a certified financial planner in Ottawa:  

Only capital costs can be used to increase your adjusted cost base, thereby lowering your capital gain. As defined by Canada Revenue Agency: a capital expense “provides a lasting benefit and/or improves the property beyond its original condition.” There is also generally a significant cost associated with a capital expense.

Roof: Upgrading the roof from shingles to metal would qualify as a capital expense as it is considered to be an upgrade.

Flooring: Replacing carpet with carpet would be considered a current expense while replacing carpet with hardwood would be considered a capital expense as it is considered an upgrade.

Windows: Repairing part of a building and ordinary maintenance are not considered capital expenses, but replacing all old windows could be considered a capital expense. Talk to your accountant to be sure.

For a nice summary read the Canada Revenue Agency’s own material.

Ayana Forward is a real estate investor who also holds the Certified Financial Planner (CFP®) designation. Ayana is fee-based Financial Planner with Ryan Lamontagne Inc in Ottawa, ON.

Romana King, senior editor and real estate specialist at MoneySense:

There is a distinction between a capital expense—which increases your cost base of a property for capital gains tax—and a current expense, which is a repair. When someone owns a rental property, they generally prefer current expenses, as these are fully tax deductible in the year in which they are incurred. Capital expenses, on the other hand, are only 50% deductible as they reduce the ultimate capital gain.

That said, the Canada Revenue Agency offers some good insight into definitions of a capital expense versus a current expense:

Capital expenses provide a benefit that usually lasts for several years. For example, costs to buy or improve your property are capital expenses. Generally, you cannot deduct the full amount of these expenses in the year you incur them. Instead, you can deduct their cost over a period of several years as capital cost allowance (CCA).

These expenses can include:

• the purchase price of rental property;

• legal fees and other costs connected with buying the property; and

• the cost of furniture and equipment you are renting with the property.

In your case, a good example of a capital expense would be your cost to change a shingle roof to a metal one. A metal roof provides a lasting benefit to the cottage, it’s an improvement to the existing roof and is considerable in value. That said, you could also argue that the windows and flooring also provide a lasting benefit—as they are more than repairs or replacements, but, rather, upgrades that cost more and add more value to the cottage.

Keep in mind that the Canada Revenue Agency does not give a specific list of capital expenses, but rather, guidelines for determining the nature of the expense.

Now, when you finally sell your cottage, the calculation of your cost base, for tax purposes, will be equal to your original purchase price, plus closing costs on acquisition and the capital expenses you’ve paid for over the years. The profit from the sale, less the selling costs and your cost base will give you your total capital gain. Now, divide this total capital gain by half: This is what is considered taxable, according to the CRA, in the year of the sale.

Finally, when timing the sale of your cottage, remember that a large capital gain—say, from the sale of property—during a high income year can significantly increase the amount of tax you pay, overall, depending on your province of residence and your income sources.

Romana King is the senior editor and real estate specialist at MoneySense. She is also a licensed real estate sales agent. Follow her on Twitter (@RKHomeowner) or on Facebook. If you have real estate concerns or questions, please email Romana directly at [email protected] or call her on her direct line at 647-436-7123 or 604-366-9868.