What CCA is worth
Let me show you my reasoning using a real property. A Kansas City rental bought in August 2016 for $85,000, held for ten years, and worth about $145,000 today. It is the same house I use in my case study on selling a US rental as a Canadian, where the full ten year model lives.
To be clear about that house: I do not own it, and the sale I model is hypothetical. It is a real property with a complete public record, which is why I picked it.
First, land is not depreciable in either country, and the building portion of the purchase price was $68,000. So that is the amount we are depreciating.
Then, to be clear about how I arrived at the property's current value, I am helping a client purchase a rental a couple of blocks away that we have just had appraised.
At 4% on a declining balance, with the half year rule in 2016, that produces about $21,850 of CCA over the decade to 2026.
A little less than the US depreciation on the same house, which came to $24,727. That is because 4% on a declining balance, which is Canada's rule, is slower than straight line over 27 and a half years, which is the IRS rule.
One thing to remember. CCA cannot create or increase an on-paper loss the way US depreciation can. You can only claim CCA up to the amount of your net rental income from that property, before CCA, not your taxable income generally. If more is available in a given year, you cannot use all of it. On this property that cost $256 in 2017, when the available CCA exceeded that year's net rental income. Small, but worth being aware of.
What it saves. Claiming CCA cut the ten year Canadian income tax bill from C$18,736 to C$6,283. A saving of C$12,409.
Then Canada takes it back
On sale, the CCA is recaptured and added to your income.
And Canada recaptures it at your full marginal rate. Not at a capped 25% like the United States. So there is no rate arbitrage here, only timing.
On this property, C$30,016 of CCA claimed over ten years would be taxed at 43.41% for a higher rate payer, which is C$13,030 added to your final tax bill on exit.
The pure cash position over ten years. Amounts in parentheses are deducted.| Canadian income tax saved over ten years | C$12,409 |
| Recaptured on sale | (C$13,030) |
| Net, in pure cash | (C$621) |
Which is exactly where the standard advice comes from. Pretty much a wash, and very slightly negative. So why bother?
Two differences from the American rules
Before the answer, two mechanics worth knowing, because people assume CCA and US depreciation work the same way and they do not.
CCA does not reduce your cost base. In America, depreciation lowers your basis, which makes your capital gain bigger. In Canada it reduces the undepreciated capital cost but leaves the adjusted cost base alone.
So on sale you get two separate charges: the recapture, taxed as ordinary income, and the capital gain, worked out on your original cost exactly as though you had never claimed a penny.
On this house the capital gains tax in Canada was C$16,516 whether CCA was claimed or not.
And the recapture rate is your full marginal rate. The US caps depreciation recapture at 25%. Canada does not cap it at all. If you are at 43.41%, you claim at 43.41% and you repay at 43.41%.
On this property that difference is worth C$5,526. The same C$30,016 of recapture would cost C$7,504 under the American cap and costs C$13,030 here.
And on the American side you are charged whether you claimed it or not, which is its own trap.
That second point is why claiming CCA is a much closer call in Canada than claiming depreciation is in America.
Why the cash figure is the wrong number
Back to that C$621.
It assumes you took the money and put it in a drawer.
You had that C$12,409 for years before the recapture arrived. The 2016 saving sat with you for a decade. Put it anywhere that earns anything and the picture changes.
What the saving is worth if it earns something, against the recapture that eventually arrives. Illustrative returns, not a forecast.| If it earns | Grows to by 2026 | Against recapture of | Net |
|---|
| 0% | C$12,409 | C$13,030 | (C$621) |
| 3% | C$14,639 | C$13,030 | C$1,609 |
| 5% | C$16,358 | C$13,030 | C$3,328 |
| 7% | C$18,290 | C$13,030 | C$5,260 |
The breakeven return is 0.89%.
You can work out the US side of your own position with our US rental income tax calculator, then apply the Canadian treatment on top.
That is roughly a savings account. Anything with equity exposure over a decade clears it comfortably, and a plain balanced fund at 7% leaves you over five thousand dollars ahead.
So the standard advice is only right if you leave the money in cash and earn nothing on it.
The argument that actually matters
Now forget the return entirely, because there is a better reason.
That money is a reserve.
Put each year's saving into a high yield savings account at 4% and look at what it lets you do.
Each year's saving held in a high yield savings account at 4%.| Year | Reserve | What it now covers |
|---|
| 3 | C$3,698 | A water heater |
| 5 | C$6,845 | A furnace, or a full turnover |
| 8 | C$11,532 | A roof |
| 10 | C$14,878 | Against a C$13,030 recapture |
Read the right hand column, not the middle one.
By year three you can replace a furnace without borrowing. By year five you can absorb a heavy turnover. By year eight you can put a roof on.
The investor who paid the tax instead has the same house, the same rent and the same tenant. What they do not have is the ability to absorb a shock.
The one thing to remember: the question is not which option produces a slightly better number in ten years. It is which option leaves you able to pay for a new roof when the roof fails.
What happens the day the furnace dies
Make it concrete. Year three, the furnace goes. Call it $5,000.
If you claimed CCA, you have C$3,698 sitting there. You top it up, you pay, you are annoyed, you move on.
If you did not, your options are:
- A credit card, which will also block your next US mortgage application, because lenders will not accept unsecured borrowing as deposit funds and will see it in your file
- A personal loan, same problem
- Leave it broken, which loses you the tenant, and on a voucher tenancy fails the inspection and stops the rent
- Sell in a hurry, which is the worst price you will ever get
Every one of those is worse than the C$621 you were optimising for.
Now make it a tenant causing $20,000 of damage in year eight. Claimed CCA and you have C$11,532 towards it. Did not, and you have nothing.
On a voucher tenancy the housing authority requires the repair done promptly and is not much interested in who caused it. So it is not a choice about whether to fix it. It is a choice about where the money comes from.
All said and done, the best advice I can give any new real estate investor is to hold enough liquid reserves to absorb problems. And this is real estate. You will have problems to deal with at some point.
If you paid all that money to the tax collector instead, so you could be a few hundred dollars better off in ten years time, that is stepping over hundred dollar bills to pick up pennies.
Four things that would change my mind
I am not going to pretend this is universal. Here is when the standard advice wins.
If you will not actually reserve or invest it. The whole argument assumes the money goes somewhere useful. If it funds a holiday, you have borrowed C$13,030 from your future self at your marginal rate and bought nothing with it.
If your marginal rate will be higher when you sell. You claim at today's rate and repay at the rate in the year of sale. Move up a band in the meantime and the recapture costs more than the relief was worth.
If the recapture itself pushes you up a band. C$30,016 of extra income in a single year can easily do that. This is the sharpest version of the risk, and it argues for timing your sale in a low income year if you have any choice about it.
And if you can genuinely write a cheque for a new roof out of income without it registering, then the reserve argument does not apply to you and you should optimise the spreadsheet instead.
The bottom line
In pure cash terms, over ten years on a real house, claiming CCA left the owner about C$621 worse off. That is the number the standard advice is built on and it is accurate.
It is also almost meaningless. Invest the saving at anything above 0.89% and you are ahead. Hold it as cash and you spend a decade able to fix things.
Paying money to the government early, in exchange for a marginally better number a decade later, is a poor trade for anybody who cannot absorb a five thousand dollar repair out of income.
Which is most people, most of the time.
Remember, this is a game of probabilities. The probability that a rental property needs something expensive over ten years is close to one.
If you want to see the full ten year model this comes from, including the sale, it is in selling a US rental as a Canadian, and you can run your own numbers with the free tools in my investor starter kit.
This article is general information, not legal, tax or investment advice. David Garner is a property investor and is not a tax adviser, accountant or CPA. Cashflow Rentals is a real estate consultancy, not a tax practice or law firm. 5240 Brooklyn Avenue is a real property used as an illustration; it is not owned by the author or by Cashflow Rentals, and the sale described is hypothetical. The comparable property referred to is one Cashflow Rentals is currently helping a client to purchase, which is disclosed above. The figures are modelled using published county tax records, real letting listings and Bank of Canada exchange rates, and assume an Ontario taxpayer at a 43.41% marginal rate throughout. Your own bracket, both now and in the year you sell, will change the answer. Investment returns used to illustrate the compounding argument are hypothetical and not a forecast. Tax rules change. Always consult a qualified cross-border CPA before deciding whether to claim CCA.
