Tax Write-Offs for Home Improvements and Renovations Explained

When investing in real estate, it is common to make home improvements and renovations to an existing property. This can involve costs such as installing a new furnace, repainting, or completely renovating a bathroom or kitchen. A common area of confusion is whether these costs can be deducted and, if they can, the process for doing so. The implications for tax deductions vary based on whether the incurred costs are classified as capital or current expenses. Therefore, understanding the nature and purpose of incurred costs is essential. Let’s first take a step back to clarify the difference between capital and current expenses.

Capital Expenses vs. Current Expenses

Like many aspects of the Income Tax Act, distinguishing between capital and current expenses isn't always straightforward. The Canada Revenue Agency provides guidelines to help determine whether an amount qualifies as a current or capital expense. This process involves considering the following questions:

Does the expense provide a lasting benefit?

In general, a capital expense provides long-term benefits that last for several years, such as installing new kitchen flooring or a new roof. In contrast, current expenses are recurring and typically short-term, like a fresh paint job around the house.

Does the expense maintain or improve the property?

The cost of a repair that upgrades a property beyond its original condition is usually classified as a capital expense. For example, installing wooden fencing in your backyard would be seen as a capital expense. In contrast, an expense that simply restores a property to its original state is typically considered a current expense; for instance, repairing a broken wooden slate of your existing wooden fence would be classified as a current expense.

Is the expense for a part of a property or for a separate asset?

The cost of replacing a specific asset within a property is considered a capital expense. For example, purchasing a new furnace for your rental operation qualifies as a capital expense since a furnace is a separate asset. Conversely, the cost of repairing a property by replacing one of its components is typically viewed as a current expense. For instance, electrical wiring is part of the building, so expenses for rewiring are usually classified as current, provided the rewiring does not enhance the property beyond its original condition.

Is the expense for repairs made to used property you acquired to put it in a suitable condition for use?

Expenditures for repairing used assets acquired for business purposes are classified as capital expenses, even if these repairs would typically be deemed current operating expenses in other contexts. Conversely, expenditures incurred for regular maintenance on assets already owned are generally categorized as current expenses.

Is the expense for repairs made to an asset in order to sell it?

Repair costs incurred in preparation for selling a property, or as a condition of the sale, are classified as capital expenses. However, if the repairs would have been made regardless of the sale, and the sale was negotiated during or after the completion of the repairs, those expenses are considered current expenses.

What is the value of the expense? 

This criterion alone is not a definitive factor. Generally, if the expense is substantial relative to the property's value, it is likely considered a capital expense. However, this may not hold true in situations where, for example, maintenance work was neglected for an extended period, resulting in a larger cost. Therefore, this criterion should be assessed alongside the other criteria discussed above.

Home Improvements and Renovations: The Different Tax Implications

If an expense is classified as a current expense, it can be fully deducted from rental income in the same period. In the event of a rental loss, this loss can be offset against other income, including employment income.  This could potentially even put you in a tax refund position.

On the other hand, if your expense is classified as a capital expense, you are unable to write off the expense incurred immediately. You can only deduct a portion of your expense as a capital cost allowance (CCA) against your rental income, allowing for tax deferral. You can think of this as annual depreciation that is deducted. The deduction amount is based on the specific CCA class of the asset and its corresponding rate. It is important to remember that any CCA claimed in previous years must be added back to your income if you sell the property for a profit down the road.

When you sell your property, you can add the capital expenses to your purchase cost before subtracting this total from the sales proceeds to determine your capital gain. This adjustment will lower the capital gain that is subject to partial taxation due to the capital gain inclusion rate. Looking at it another way, this means that capitalized expenses are only partially deductible from the profits you earn in the future. 

As a taxpayer, you generally prefer to have your expenses categorized as current expenses, which allows for an immediate write-off since the costs have already been incurred.

Navigating the criteria for determining whether an expense is capital or current can be challenging. A qualified accountant or tax advisor can offer insights tailored to your specific situation and assist you in accurately categorizing expenses, ultimately optimizing your financial outcomes.