As we all know, equipment and buildings wear out over time. This gradual wear and tear results in depreciation – which is just part of the cost of doing business.
When you’re operating a business, and your equipment is gradually wearing out, or getting closer to being obsolete, you’re experiencing a hidden expense. It doesn’t show up in a cash flow statement, of course. But it’s a loss, nevertheless, and a very real one. In Canadian tax law, the way we account for this hidden cost is through capital cost allowance, or CCA.
Capital Cost Allowance is Taken Over Time
Some business expenses are taken in the year in which they are incurred. If you get an oil change for a work van, you can deduct the entire cost of the oil change immediately.
But if you buy a work van, you can’t normally deduct the price of the van entirely on your T2125 when calculating your business or professional income for that year. Unlike the oil change, which has a useful life of less than a year, the work van provides an enduring benefit that is likely to last for several years, at least.
So instead of deducting the entire cost of the van in the first year, you have to spread the cost out over the expected useful life of the van. That way, you’re accounting for your depreciation loss roughly as you experience it: Gradually, over the course of several years.
You can only claim CCA for property you own, or that you are deemed to own, or for property in which you own a leasehold interest.
That means you don’t have to hold the title to an asset to claim CCA. You can claim even if you don’t hold the title, if you have other incidents of ownership in the asset, including possession, use and risk.
CCA Classes of Property
The maximum amount of the cost of capital assets you can deduct in any one year depends on its property class.
|Real estate acquired in 1988 or later||4%|
|Real estate acquired prior to 1988||5%|
|Canoes and boats||15%|
|Tools costing > $500||20%|
|Equipment not used for manufacturing||20%|
|Automobiles costing < $30,000 (excluding taxis)||30%|
|Computer equipment and systems software||30%|
You can find a full breakdown of CCA classes of property here.
You should be familiar with these rules that may apply to depreciable property:
- You can generally only claim half of the CCA for all new net acquisitions to a given property class for the first year. After the first year, you can then take the full CCA for the following years, until you’ve depreciated the full cost of the property.
- To claim the CCA, the equipment must be available for use.
- You cannot generally claim the CCA for land (land doesn’t depreciate) or living things, such as shrubs, animals, trees, etc.
- If the first fiscal period is less than a year, you have to take a prorated CCA.
- If you receive income from woodlots, sand or gravel pits, quarries, etc., you can claim an allowance for depletion. The concept is similar, though: It’s just the tax code’s way of accounting for a business expense that doesn’t show up in cash flows, but is a very real expense, nonetheless.
Note that land doesn’t depreciate. But you can certainly deplete the income-generating resources in any given plot of land. Depletion laws take this into account.
Note: CCA is optional. You don’t have to claim capital cost allowance in any given year. So if you’re not profitable, or in a low marginal tax bracket this year, you can put off claiming CCA to a future year in which you may face a higher tax rate. This makes your CCA more valuable.
You can also claim less than your full CCA allowance, if desired.
Your tax professional can help you determine the most optimal CCA claiming strategy for you.
Capital cost allowance is complicated. It’s important to keep accurate records. But few entrepreneurs can keep track of everything they need to know to maximize their use of capital cost allowance and still have time to run their business.
This is why outsourcing your bookkeeping and accounting to a specialist makes sense: LedgersOnline.com can handle your bookkeeping – so you can handle your business.