Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Whether certain expenditures incurred with respect to rental properties must be capitalized or whether they can be deducted.
Position TAKEN:
Expenditures relating to the drilling of the well, the cement block patio, the upgrading of the electrical system, the new furnace and the new stoves should be capitalized. All other expenditures, save the roof replacement expenditures, are current in nature. We cannot comment on the roof replacement expenditures.
Reasons FOR POSITION TAKEN:
IT-128R
5-943193
XXXXXXXXXX C. Chouinard
January 27, 1995
Dear Sir:
Re: Expenditures Incurred in Respect of Rental Property
We are writing in response to your letters of December 8 and 12, 1994, in which you requested our opinion with respect to the tax treatment of certain expenditures incurred in respect of rental properties which you own.
More specifically, you inquire whether the following expenditures can be added to the capital cost of a rental property:
- a steel roof, which replaced a shingle roof;
- drilling of well;
- cement block patio, to enhance use of house;
- mortgage interest;
- municipal and school taxes;
- upgrading electrical system to 200 amp service;
- new furnace;
- new electric stoves;
- gravel to improve access to road;
- painting of exterior of house; and
- interior panelling to upgrade the appearance.
Our Comments
As indicated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990, a request for a written opinion on a completed transaction is generally considered by the taxpayer's local district office. Therefore, while we are unable to provide an opinion in respect of the situation outlined in your letter, we are prepared to offer the following general comments.
The cost of property can be adjusted to include capital expenditures, such as the cost of additions and improvements made to the property. However, current expenses, such as maintenance and repair costs, cannot be added to the cost of property. They are, however, deductible from income in the year in which they are incurred.
The question of whether an expenditure is capital in nature, because depreciable property was acquired or improved, or whether it is currently deductible, because it is in respect of the maintenance or repair of a property, is largely a question of fact and often a question of degree. The determination cannot be made by the application of any rigid test or definition. Rather, it is derived from an appreciation of the whole set of circumstances, some of which may point to the conclusion that the expenditure is capital in nature and others which indicate it is an expense. While no single definition or test exists, a number of criterion have been established by the Courts. These criteria, which are set out in paragraph 4 of Interpretation Bulletin IT-128R (a copy of which is enclosed), are as follows:
(1)Enduring Benefit: when an expenditure is made "with a view to bringing into existence an asset or advantage for the enduring benefit of a trade", that expenditure normally is looked upon as being of a capital nature. Where, however, it is likely that there will be recurring expenditures for replacement or renewal of a specific item because its useful life will not exceed a relatively short time, this fact is one indication that the expenditures are of a current nature.
(2)Maintenance or Betterment: where an expenditure made in respect of a property serves only to restore it to its original condition, that fact is one indication that the expenditure is of a current nature. Where, however, the result of the expenditure is to materially improve the property beyond its original condition, such as when a new floor or a new roof clearly is of better quality and greater durability than the replaced one, then the expenditure is regarded as capital in nature. Whether or not the market value of the property is increased as a result of the expenditure is not a major factor in reaching a decision.
(3)Integral Part or Separate Asset: another point that may have to be considered is whether the expenditure is to repair a part of a property or whether it is to acquire a property that is itself a separate asset. In the former case, the expenditure is likely to be a current expense and in the latter case, it is likely to be a capital outlay. For example, the cost of replacing the rudder or propeller of a ship is regarded as a current expense because it is an integral part of the ship and there is no betterment; but the cost of replacing a lathe in a factory is regarded as a capital expenditure because the lathe is not an integral part of the factory but is a separate marketable asset. Between such clear-cut cases, there are others where a replaced item may be an essential part of a whole property yet not an integral part of it.
(4)Relative value: the amount of the expenditure in relation to the value of the whole property or in relation to previous average maintenance and repair costs often may have to be weighed. This is particularly so when the replacement itself could be regarded as a separate marketable asset. On the other hand, the relationship of the amount of the expenditure to the value of the whole property is not, in itself, necessarily decisive in other circumstances, particularly where a major repair job is done which is an accumulation of lesser jobs that would have been classified as current expense if each had been done at the time the need for it first arose; the fact that they were not done earlier does not change the nature of the work when it is done, regardless of its total cost.
Based on these criteria, in our opinion, the expenditures with respect to the well drilling, the cement block patio, the electrical system upgrading, the new furnace and the new stoves would be considered to be capital in nature. Therefore, these expenditures should have been added to the capital cost of the property to which they relate. On the other hand, the expenditures relating to the municipal and school taxes, the gravel, the paint and the panelling would, in our opinion, be considered to be current in nature and thus, fully deductible in the year incurred. We cannot comment upon the expenditures with respect to the replacement of the roof, since it is difficult to determine from the limited information you have provided whether these expenditures would be current or capital in nature.
In your letter, you quote from the Department's Fact Sheet, which states that the adjusted cost base or capital cost, as the case may be, of property includes "the cost of any additions or improvements made to the property up to and including February 22, 1994". It should be noted, however, that any expenditures which were deducted as current expenses in calculating rental income in prior years may not now be added to the capital cost of a property for purposes of the capital gains election.
Furthermore, as regards the interest on the mortgage, generally speaking, interest not in excess of a reasonable amount is deductible under paragraph 20(1)(c) of the Income Tax Act where it can be shown that the borrowed funds are being used to earn income from a business or property. Therefore, if the mortgage is being used to earn rental income, the interest on the mortgage will be deductible.
We trust that these comments will be of assistance.
Yours truly,
R. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch
