If you own a rental property that is a condo unit and have been given a special assessment by the condo board, you’ll want to know more details on what the special assessment involves to make sure it’s handled properly on your tax return.
CRA will want to review the return to make sure the special assessment is treated properly for taxes – and there are a few criteria you can use to determine how it gets treated.
Condo special assessments can be treated in two ways – capitalized (added to the cost base of the property) or expensed (reducing the rental income for the year). Below are the factors used to determine how the special assessment is treated for taxes by CRA.
Expense vs. Capital
When a transaction is expensed (deducted), it means it was used to earn business income (in this case rental income) and is in the ordinary course of business. An example of some rental expenses includes advertising, property taxes and mortgage interest. These are all common examples of rental property expenses.
When a transaction is capitalized, it means it’s more long lasting than an expensed item and will provide a lasting benefit over a long period of time. An example of some capital items for a rental property is the addition of a garage, adding a separate balcony or replacing some appliances with new ones.
Here are the 3 criteria that CRA uses to determine whether something is capital or a current expense:
- Lasting benefit. Capital items provide a lasting benefit whereas current (expense) items do not. For example, minor yardwork is usually routine maintenance (expense) but adding siding to the rental property is capital because it provides a lasting benefit, and possibly an advantage if other comparable properties don’t have new siding.
- Maintain or improve. Something that improves the rental property beyond its original condition is capital – such as replacing a wooden balcony with a concrete one. Something that maintains the rental property is a current expense – such as repairing a balcony so that it is repaired back to its original state. A capital item makes the property better, whereas a current expense brings the property back to its original state.
- Part of the property or separate. A capital item is usually when you replace an asset within another asset (in this case the rental property). An example of a capital item would be new appliances in the rental property. This is because the appliances in themselves are separate from the rental property. A current expense item is not separate from the rental property, and an example of this is replacing the tiling in the kitchen or replacing the electrical within the walls. Both items are within the property itself and don’t improve the property beyond its current condition.
The final criteria used to determine if something is capital or current (expense) is cost – the higher the cost, the more likely it is a capital item. However – it’s important to use the 3 criteria above first before considering cost.
If you own a condo rental property and have to pay a special assessment, you’ll need to determine what exactly it is for before you file your tax return.
How the special assessment is treated for taxes depends on where the money is going. If there is money being spent on adding something new to the building, then it could be considered capital. But if the special assessment is being used to repair the electrical in the building it could also be considered a current expense and would be deductible.
Effect on Taxes
When an item is expensed it will reduce the net rental income for the year, which then gets taxed at the marginal rate of the property owner. This means the tax savings would be realized in the year the expenses were paid. If the condo owner has a special assessment for $5,000 and their marginal tax rate is 30%, this means their taxes will be reduced by $1,500.
When an item is capitalized it will reduce the gain when it gets sold. If the rental property is sold 5 years later and the gain is $20,000, then the special assessment of $5,000 will reduce the gain to $15,000 – of which half is taxable. Assuming a marginal rate of 30%, the tax savings will be $750 (since only half of capital gains are taxable).
For more information on special assessments for condo rental properties and determining whether something is capital or current, see CRA’s Rental Income Guide.
It’s important to mention that the above criteria are used assuming the special assessment is not eligible for insurance. If it’s eligible for insurance, CRA will not let you deduct the amount of the special assessment since it wouldn’t have been paid by you (your insurance would cover it). If insurance only covers a portion of the assessment, only the portion paid by you can be claimed on your tax return.
Also, the above discussion is meant as a guide – you should always check with CRA to make sure your tax return is filed correctly based on your situation.