Owning a residential or commercial rental property can be a great way to supplement your income and provide another source of diversification to an investment portfolio traditionally consisting of stocks, bonds and other securities.
But as any landlord knows, it's those unexpected repairs or renovations that can turn a profitable rental into a costly venture.
Perhaps one of the more controversial tax issues in the rental business is whether the cost of a renovation or repair can be deducted in the current year as an expense or must be capitalized and depreciated over a number of years.
As a general rule, repairs are generally considered to be a current expense. Since repairs are recurring, they generally provide only a short-term benefit, in that repairs likely need to be done each year to keep your rental property in the same condition as when you bought it.
Capital expenses, however, provide a benefit that usually lasts for a number of years. Costs incurred to improve your property are generally considered to be capital expenses and can only be deducted over a number of years.
In its T4036 Guide to Rental Income, the Canada Revenue Agency provides a number of questions you can ask yourself to help determine whether an expense is current or capital in nature. For example, does the expense improve or maintain the property? If, for example, you replace wooden steps with concrete steps, it's a capital expense. But if you simply repair the wooden steps, the expense is currently deductible.
Despite the CRA guidance, the issue often ends up as judgment call between the CRA and the taxpayer, as witnessed in Tax Court last month.
Marquita Martinello owns three modest rectangular wooden Nova Scotia homes that she has rented out for many years. She found herself in court when she tried to deduct the costs of various repairs she made in 2005 to one of the homes damaged by tenants and by a hurricane-strength storm. The Martinellos spent considerable time and money repairing the home to its original rentable condition. When the work was done, their rental property, "which had suddenly become uninhabitable, returned to be habitable," they claimed.
With repairs completed, the house was rented out profitably at the same amount as before and the same rent as their other two rental homes.
Ms. Martinello claimed her costs were current expenses and therefore immediately deductible. The CRA argued they should be capitalized, largely based on the fact that she had obtained a GST New Housing Rebate for the cost of the repairs, on the basis the home was substantially renovated.
The judge considered the expenses currently deductible since "the repairs did not improve the house beyond its original condition in any manner."