If the Canadian Income Tax Act was clear, judges would preside over very few disputes between the Canada Revenue Agency and taxpayers, and taxpayers wouldn’t need an accountant to guide you through these disputes. But, since the Act has no shortage of complexity, and the judges have no shortage of disputes, I won’t be retiring any time soon.
Judges interpretations of the Act are crucial to formulating rules and setting trends. So in this post, and future ones, I will review some of the recent decisions that relate directly and indirectly to real estate investors.
Repair costs
In Janota vs. The Queen (2010 DTC 1268 (TCC)) the taxpayer spent $37,000 in repair costs to fix up a century-old duplex that a father and son recently purchased for $419,000. Originally, the repair costs were minor—about $6,200. But during the repairs, it became obvious that larger repairs were required.
But the CRA denied the deduction and wanted to capitalize these amounts–they wanted them to include the repairs as part of the cost of the building and depreciate these costs over a long period of time because they argued the expenditures provided an enduring benefit. Further the CRA argued that a specific provision of the Act prevented an immediate deduction because the property was in a period of construction.
The judge determined the costs were relatively minor compared to the cost of the property. This is an important percentage to note as the costs were essentially less than 10% of the value of the property. While not conclusive, as other factors are relevant, clearly a benchmark is suggested. Further, and more importantly, the repairs merely brought the property to its original condition and were done to maintain the property, not improve it. Replacing a roof, windows, wiring etc, could all be simply bringing a property back to its original condition and thus in theory qualify for an immediate tax deduction.
Frequently we see auditors attempting to capitalize these amounts particularly if they are trying to essentially negotiate on other matters. Unfortunately auditors are often rewarded for this aggressiveness as they know that the determination of the amount is subjective, therefore, unless the taxpayer is ready to file a Notice of Objection and proceed to Tax Court (a significant number of cases are settled hours before the hearing) the auditor and appeals officer knows that the majority of taxpayers cannot compete with the unlimited spending power of the Crown for legal and tax advice. A horrible and inefficient decision making process to be sure, but extremely effective for auditors, in my opinion, because most people can’t afford to fight the system or are simply intimidated.
The argument preventing deductions during a construction period was fortunately tossed out as well. These deductions apply only to soft costs, such as development costs, interest, and professional fees, not to the renovation expenses themselves.
The case is quite similar to one that we are helping a client with currently which is awaiting trial. And we expect a similar result. Thus for real estate investors, being able to show the CRA that repair costs are relatively minor, and involve maintaining the building condition, not improving it, are crucial.
Portions of this article appeared in April 2011 Canadian Real Estate Magazine.
