Happy Birthday Canada and How to Calculate Capital Cost Allowance – Part 2

Happy Birthday Canada and How to Calculate Capital Cost Allowance – Part 2
Most importantly, my Canadian Dream came true. Kids are happy and healthy and I have my own business. Thank you Canada & Happy 150 years.

Happy 150 years old Canada!

I have lived over half of my life here in Canada, more than 18 years and counting.

I still remember the moment when we stepped out of the airport and saw the ENTIRE sky, I was stunned.  

You may take seeing the entire sky for granted. Hong Kong is a big city, busy and crowded.  We are constantly surrounded by many tall buildings.  Few people can enjoy living in a house.  

I grew up with a sky covered by multiple towers, mostly 35 floors or more.

When I first came to Canada, I started in Grade 12.  Back then, we still had OAC (for those of you who are old enough to know what it was).

Schools here are gigantic compared to all of Hong Kong’s high schools.  

I got lost finding my classrooms the first week of school.  My brother was especially upset because he had no one to turn too. He couldn’t ask people because he didn’t speak the language.

Before the class started, we all had to stand up to listen to the national anthem.  Some students sang along.  

This small act was a cultural shock to me.  

I was born and mostly raised in a British colony.  Hong Kong wasn’t handed back to China until I was 15 years old.  

We never had the tradition to listen to Britain’s national anthem.  Heck, I don’t even know what it sounds like.

Growing up, I never experienced the national pride that people have for their countries. We were far from being British. But people in Hong Kong were generally afraid of the Chinese government at the time. We weren’t British and we were reluctant to call ourselves Chinese.

The first time I went to a Toronto Raptors game, everyone stood up, hats down, when the national anthem was sung.  The crowd even cheered toward the end and truly enjoyed the song and the pride of being Canadian.  

That almost bought tears to my eyes. It’s the pride of being Canadian that I’ve never experienced anywhere else.

If our national anthem does not mean much to you, there’re people selling Canadian mountain air in China. No joke!  It’s our air!  

I am extremely lucky to live here and make a small contribution locally.

Happy 150 years, Canada. Thank you for being the best country in the world. 😊

Last week, I started on the topic on how to calculate capital cost allowance.

We discussed the way CCA is calculated for properties and the special rules that are applied to rental properties.

Most savvy real estate investors would ask me, “should I take CCA against my rental income or should I not?” – you can find out more about the logic behind this common question in this other blog post.

This week, I am going to discuss the tax impact if you sell the property for a profit or if you sell it for a loss.

What happened when you sell the property for a profit?

Continuing from last week’s example, the property was purchased for $300,000.  

Year 1 CCA claimed was $6,000 and Year 2 CCA claimed was $11,760.

Undepreciated Capital Cost (UCC) at the end of year 2 = $300,000 – $6,000 – $11,760 = $282,240

In year 3, you sold the property for $500,000.  

Assuming that there are no other assets in the same class, here is the calculation of your taxable income:

Capital gain = $500,000 – $300,000 = $200,000

Taxable capital gain = $200,000 x 50% taxable = $100,000

Recapture on sale of property

= lower of sale proceeds or ACB – Undepreciated Capital Cost

= lower of ($500,000 or $300,000) – $282,240

= $300,000 – $282,240

= $17,760

Taxable income from the sale = taxable capital gain + recapture = $117,760

In another words, you are required to take all the capital cost allowance you’ve claimed over the years into income the year you sell the property.  

Capital cost allowance is a deferral mechanism, similar to RRSP.  You get the deductions the year you take it, but you must take all the deductions back into income the year you sell.

What if the real property you purchased is strictly used for business?

One of the most common questions I get asked is whether a real estate investor could defer taxes by buying a replacement property shortly after the sale of the old one.

The answer to that question for most investors is no.  There’s no such replacement property rule in Canada.  

BUT, it is different if you buy a property for your business AND you use it for running your business.  

Provided that you are purchasing your next property for running your business, you are eligible to defer the capital gain until you eventually sell the second property.

You will also be able to defer taxes on recapture calculated above.

What happened when you sell the property for a loss?

If you sell the property for a loss, this can be an interesting calculation.

Say the sale price is $290,000 in year 3, but you purchased the property for $300K 3 years ago.

You now have a capital loss on the property.  

Capital loss = $290,000 – $300,000 = $10,000

This loss can be used to offset against any capital gain you incurred during the year.  

You are eligible to carry back the losses to 3 preceding years and it is available to be carried forward indefinitely in the future.

Remember that the UCC at the end of year 2 is $282,240.

Recapture on sale of property

= lower of sale proceeds or ACB – Undepreciated Capital Cost

= lower of ($290,000 or $300,000) – $282,240

= $290,000 – $282,240

= $7,760

And yes, even though you lost money on the sale of the property, you still would be required to take the recapture into income.  

Taxable income = $7,760.  

Capital loss cannot be offset against regular income.  It can only be offset against capital gain.

Let’s change our example a bit more.  Let say you sold the property for $250,000 instead.

Similarly, you would have incurred a capital loss = $250,000 – $300,000 = $50,000.  

Again, the capital loss can be applied to capital gain you incurred from other sale during the year, can be carried forward indefinitely and carried back 3 preceding years.

There’s no immediate tax benefit in your personal tax return, if you don’t have capital gain incurred in the same year.

UCC before sale = $282,240

Terminal loss on sale of property

= lower of sale proceeds or ACB – Undepreciated Capital Cost

= lower of ($250,000 or $300,000) – $282,240

= $250,000 – $282,240

= ($32,240)

Now all of a sudden, you have a terminal loss on the property instead of recapture.  

Recapture means that you have a take it into income.

Terminal loss means that you can deduct the $32,240 loss against your other income.

If the property is a rental property within a corporation, this can be equivalent to $16K tax savings against other rental income you’ve incurred.

If you don’t have any rental income to deduct this loss against, similarly, you can carry back this loss to 3 preceding years and carry forward for 20 years to be applied against future income.

CRA still gives you a rain check if you can’t use the loss.  Not bad, eh?

Until next time, happy Canadian Real Estate Investing.

Cherry Chan, CPA, CA

Your Real Estate Accountant

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