Could your business benefit from some help with business expenses? Basic Canadian tax rules allow you to deduct capital goods purchased for use in your business from your income. Before you do so, it’s important to determine which purchases are capital goods for the most effective results. Keep these key elements in mind in order to successfully maximize your deductions.
Differentiating Current Expenses From Capital Goods
A current expenditure is made with a view to short-term consumption. Examples of current expenditures include basic office supplies, monthly rent, and employee salaries, since they’re consumed immediately. These expenses are deductible in the year in which they’re incurred.
In contrast, the Government of Canada states that capital goods expenses are made with a view to long-term use in your business. The clearest example is the purchase of a building to house your business because you expect to stay in the building for several years. Other frequent examples include the purchase of specialized machinery and tenant improvements to rented premises.
Accounting rules are in place for recording the loss of value of these capital assets over the period of their useful life in your business, known as depreciation. For tax purposes, similar rules exist for the capital cost allowance that lets you deduct the portion of the capital asset that has been used by the business in the current year.
Claiming Allowance for Capital Goods
To start, use Form T2125 to claim and calculate your capital allowance. Although there are exceptions, capital allowance is usually claimed using the declining balance method. A percentage of the purchase price is deductible in the year when the property is acquired, and a percentage of the remainder is deductible in subsequent years, until the balance reaches zero.
The applicable percentages for all types of capital goods are found in the regulations of the Income Tax Act. The percentages used for accounting purposes often differ from the ones used for tax purposes.
If you choose to use it, the capital allowance is claimed as an expense on your business’ income tax return. You could decide to do so if you feel that the good has not really lost market value and that an eventual sale would cause you to pay more taxes than the deduction would save you. For example, buildings often go up in market value even though they can be depreciated for tax purposes. When such a building is sold, costly recapture can occur.
Recapture of Capital Cost Allowance
When a capital good is sold, any amount received between its depreciated value and its original purchase price is known as a recapture and is included in regular income. Any portion of the sale price above that is a capital gain.
Consider this example:
- Imagine you purchase a building for $100,000
- The building’s depreciated value is $70,000.
- You later sell the building for $120,000.
- The recapture is the $100,000 purchase price minus the $70,000 depreciated value, or $30,000.
- The capital gain is the $120,000 sale price minus the $100,000 purchase price, or $20,000
- 50% of this capital gain is taxable.
There are many tax laws that promote success in a small business. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.