When you can write off business expenses in the year they incur, your tax return may feel simple. But what do you do with capital expense?
These expenses must be depreciated, or written off incrementally over a period of several years, and their tax treatment is more complicated. The Canada Revenue Agency (CRA) divides capital expenses into several categories, each of which has its own special depreciation rate.
What is Depreciation?
Depreciation refers to the accounting practice dealing with assets as they get older and decrease in value. The Canada Revenue Agency (CRA) lets your business claim a tax deduction based on the decreasing value of equipment over time.
The CRA organizes depreciable business assets into classes. Each class determines the portion of the expense you can write off each year. For example, buildings in class 1 have a depreciation rate of 4% per year, while computer hardware in class 10 has a depreciation rate of 30% per year. To simplify the accounting process in your business software, you may want to use the same depreciation rates as the CRA.
Depreciation of Buildings
Buildings and their major components, such as electrical wiring, HVAC systems, and elevators, fall into class one, which has a capital cost allowance rate of 4%. This means you write off 4% of the purchase price each year. It takes 25 years to claim the whole expense.
For example, if you pay $500,000 for a building for your business, you may claim $20,000 during the first year as well as during each of the following 24 years. There are some exceptions to this rule, such as corrugated steel buildings, which fall into class six with a rate of 10%.
Furniture, Appliances, and Tools
If you buy a new desk, a refrigerator for your restaurant, or a tool worth more than $500, those expenses fall into class eight. This class, which also includes displays and fixtures, machinery, and outdoor advertising signs, incurs a 20% capital cost allowance rate.
At this rate, it takes approximately five years to write off the expense. If you sell the asset before you finish writing off the expense, the CRA has special rules for reporting the disposition and claiming the remaining capital cost allowance.
CRA Vehicle Depreciation Rates
Vehicles purchased for your business fall into class 10, which has a rate of 30%. In some cases, vehicles fall into class 10.1. This subclass has the same rate, but it uses different rules for the treatment of GST. In general, if you purchase a $10,000 vehicle for your business, you may claim $3,000 as your capital cost allowance during the year of purchase, regardless of whether the vehicle falls into class 10 or 10.1.
Computer Equipment Depreciation Rates
Like vehicles, computers also fall into class 10 with a rate of 30%. System software also falls into this category. For example, if you buy a computer for your business, you can write off the cost of the hardware and any additional costs for the operating software under this category.
Uniforms, Tools, and Computer Software
Software other than operating software typically falls into class 12. This category contains a mixture of other items including dishes, cutlery, dies, and jigs. Although these items are considered capital assets, you can write off 100% of the cost in the year of purchase as long as the cost per item is less than $500.
If you purchase manufacturing machinery or equipment, it falls into class 29 or 43. Class 29 applies to purchases made after March 18, 2007 and before 2016. You may write off 25% the first year, 50% the second year and 25% the third year. Manufacturing equipment purchased outside those dates falls into class 43 and receives a steady rate of 30% until you’ve written off the entire expense.
How to Claim & Calculate Capital Cost Allowances
The CRA requires you to break down your purchases into capital classes to determine the amount you can claim. This lets you deduct a percentage of the value of your items, depending on the type, or class, of item you have on hand.
For example, buildings fall into class one, which means you can deduct 4% of their depreciated value. Office furniture and expensive tools fall into class eight, which means you can deduct 20% of their depreciated value.
Preparing a list of all your capital purchases made in the current tax year makes it easier to calculate your capital costs. This simplifies the process of comparing those capital costs against Areas A through F and Charts A through D on your Form T2125 and fill in each column as prompted.
Calculating Capital Costs
To perform a capital cost allowance calculation, use the instructions on Form T2125 to total your listed purchases. Keep in mind that you can omit deductions from your current year’s return if you’d like to save them to use on a future return. This proves a good option if you expect your taxable income to rise in future years.
When to Claim the Capital Cost Allowance
You can claim this tax deduction over a span of several years for your depreciable property’s cost. Your depreciable property consists of long-term assets that become obsolete or lose value over time, such as furniture, buildings, vehicles, or equipment.
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