Major Repair Expenses: RENTAL PROPERTIES

In a February 11, 2021 Tax
Court of Canada case, the
deductibility of rental
expenses for a condo unit
that underwent major repairs
was considered.

In 2010, major structural repairs (the exterior repairs)
commenced on an entire condo complex. As a result, the
taxpayer lost the tenants for his particular unit, and was
unable to replace them. As the property was empty, the
taxpayer decided to carry out repairs within the condo itself
(the interior repairs) costing approximately $24,000. The
repairs consisted of fixing or replacing items such as
fixtures, appliances, walls, and counters.
Taxpayer wins – source of income
CRA argued that since the property was not being rented out,
there was not a source of income and the expenses could not be deducted. However, the Court found there was a
source of income since there was a continuing intent to
earn a profit, demonstrated by several attempts to rent the
property during the external structural repair phase. The
property was also rented out after the repairs were
completed, and the Court observed that the taxpayer
operated in a business-like manner.
Taxpayer wins – current vs. capital
The Court then considered whether all of the repairs could be
deducted immediately as “current expenses”, or must be
depreciated over time as “capital expenses”. In ruling that the
interior repairs were a current expense, the Court noted the
following:

– Betterment and enduring benefit – Although any
repairs improve a property, the question is whether the
improvement was significant enough to bring into
existence a different capital asset than what was there
before. No building permits were required; no
redesign or change to size, layout, or function
occurred; and materials used were “like for like” (no
upgrades). No new asset resulted; rather, the property
was just kept in rentable condition. The Court also
noted that being a “once in a lifetime” expenditure does
not mean it is not a repair.

– Typical repairs – If repairs are out of the ordinary,
the expenditures are more likely on account of capital.
However, these repairs, even though they occurred
infrequently, were typical.

– Timing of the repairs – CRA argued that since the
repairs were all done at once, they resulted in a new
asset. However, the Court noted that the test is only
whether the cumulative effect of the repairs was to
improve the property past its original condition. The
Court found that the timing of the repairs was not a
significant factor.

– Cost of repairs compared to value of the property –
The cost of the repairs was only 5% of the total fair
market value of the property, suggesting that the
expenses were current rather than capital.

– Increase in rent – The rent increased from $1,500 to
$2,200 after the repairs were complete. The Court
opined that the increase in rent was just as likely
attributable to exterior repairs as to the interior
repairs and that the increase in rent was not a
significant factor. It was not surprising that property in
good state commands higher rent than one needing
repairs.

If considering a major renovation to a
rental property, consider whether the repairs require
delayed deduction, or can be immediately deducted.

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