Current Expense vs. Capital Cost

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Current Expense vs. Capital Cost

October 29, 2012

Tax Question:

When is a property cost a current expense and when is it a capital cost?

Facts:

If your company owns a property, the costs incurred on the property may either be added to its capital cost or expensed in the year they occur. This depends on the type of cost. Costs that are capitalized will be amortized for tax purposes, usually at a rate of 4% per annum. Costs that are expensed are deducted at 100%. Therefore, it is important to distinguish between the two types as the impact on taxes can be significant.

Discussion:

There are several factors to consider when determining if a cost should be expensed or capitalized.

Does the cost have a long-term benefit? A long-term benefit adds value to the property. For example, costs for an extension built onto the existing property, such as a garage, would have a long-term benefit and would be capitalized. A cost that would not be expected to have a long-term benefit would be expensed, such as re-plastering an existing wall.
Does the cost maintain or improve the life of the property? A cost that just maintains or restores the property to its original condition would be expensed. This would include replacement of carpet or tile with a similar product or a recurring cost such as painting. If a cost improves the property past its original condition, then it would be a capital cost. This would include upgrading floor covering such as carpet to hardwood as hardwood is a more expensive durable floor option.
Is the expense for part of the property or for a separate asset not permanently fixed to the property? A cost that replaces an independent asset in the property is generally a capital expense and would be amortized at a different rate. This would include the replacement of appliances used in the property and would usually be amortized at a rate of 20%. A cost that just replaces one of the property’s existing parts would be a current expense. This would include replacing or repairing existing lighting fixtures.
Compare the value of the cost to the value of the property. If the cost is substantial compared to the value of the property, then the cost may be considered capital. This factor should be considered in relation to the other three factors above, not just on its own.
Timing of the costs. Generally, when work is done prior to a tenant moving in, the costs incurred would be capitalized as the costs are considered to be necessary to make the unit rentable. Once a tenant moves in, the costs are more likely to be expensed as they would be considered for just maintaining the unit.

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Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.