Wednesday, May 26, 2010

Property Improvements - Cost Recovery & Class Life

There is an annual deduction against taxable income of the investment base of your improvements to a property. If you build a building on land you own, the tax laws allow you to 'recover' your cost over the life of the asset.

Class life is set by legislative statute. Properties are either classified Residential or Commercial. Residential Improvements to land are written off, or the cost recovered over a period of 27.5 years. Commercial is recovered over 39 years. These are set by statute and cannot vary.

What is even easier, is that you are required to use Straight-Line Cost Recovery. This means that you divide the property improvement by the Class Life, 27.5 or 39 years and you get to deduct that much against taxable income, to reduce your tax bill.

The only kicker, or twist is that since we do not acquire everything on January 1 of each year and sell it on December 31, then the rules have a formula for the month of acquisition and or disposition. It requires you to reduce what you can take in those months. there's a table, so use that.

Property purchase price (sample)             $565,000
Allocated to land ( see allocation blog)   $120,000
Allocated to Commercial Building           $345,000
Asset Class - Commercial
Cost Recovery for 39 years $345,000 divided by 39 = $8,846.15
Acquisition year from table $345,000 times 2.457% =  $8,476.65

This means that in the year you acquired the property you can deduct the smaller number from your taxable income to figure your tax. In subsequent years you will deduct the larger number until the year you dispose of the property, then it's back to the smaller number. This is a 12 month number. You will divide these numbers by 12 and only use the portion to the month you acquired it in.

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