Whether an expenditure should be classified as a repair or a capital asset for tax purposes is a common question.
The classification of large expenditures on your buildings, machinery and other farm property can significantly change your tax situation. Some expenditures such as oil filters or belts are easy to classify as repairs, while others such as purchasing a combine are easy to classify as capital assets.
Some expenditures are not as easy to classify. One example is spending $75,000 to fix up an old barn. If you spend $25,000 on an electric overhead door to replace an old pull-chain door, the expense should be capitalized for tax purposes because it improves the barn from its original state. For tax purposes this would then be deducted from income through capital cost allowance at 10 percent per year (ignoring the half year rule).
On the other hand, spending $50,000 to get a new roof to bring the building to its original condition may be classified as a repair, which means the entire $50,000 could be expensed in one year. There can be huge tax benefits from properly classifying such an expenditure as a repair expense.
The following are key criteria to consider when determining if you can write off an expenditure as a repair:
- Does the expenditure provide a lasting benefit? For example, adding siding on the exterior of your wooden barn may have a lasting benefit so it likely is capital in nature. On the other hand, repainting the exterior of the barn would likely occur regularly and be classified as a repair expense.
- Does the expenditure maintain or improve the property? Generally, if you are restoring the property to its original condition, the expenditure can be classified as a repair as per the previous example.
- Is the expense for part of the property or for a separate asset? For example, if you are replacing electrical wiring, this is likely a part of the barn and more likely a repair expense. However, if you are buying a new air compressor for the barn, this is likely a capital asset in which the capital cost allowance may be claimed on the expenditure over time.
- What is the value of the expenditure in relation to the property? If the expenditure is a low dollar figure compared to the value of the barn, then it is likely a repair. When the expenditures increase, you should go through all the criteria to determine if it is capital in nature.
These criteria are subjective. There was a recent court case that allowed a taxpayer to replace a parking garage roof and claim it as a repair expense. However, the factors will vary in every situation.
Whether to categorize an expenditure as a repair or a capital asset is not black and white. Therefore, you should consult a tax professional.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: firstname.lastname@example.org.