Recapture of Depreciation When Selling a Rental Property

If you have owned a rental property for a few years and claimed depreciation on your tax return, a sale can bring a tax bill that surprises you. The gain you expected to be taxed lightly may come with an extra amount that is taxed in full.

This article explains in plain terms what recapture of CCA is, why it happens, how it differs from a capital gain, and what to gather before you sell. Your numbers will depend on your own records, so treat this as background to bring to an accountant or lawyer.

What CCA is and why it matters when you sell

Capital cost allowance is the tax version of depreciation. Instead of deducting the whole cost of a building in the year you buy it, you claim a portion each year. CCA is calculated on the declining-balance method, and you do not have to claim the maximum in any year.

CCA generally can be claimed only once the property has become available for use. Land is not depreciable property, so CCA is claimed only on the building. A rental building may fall in Class 1, 3, 6, 31 or 32 depending on what it is made of, and Class 1 generally includes most buildings acquired after 1987. Which class applies to your building is worth confirming with an accountant.

CCA also has a limit: it cannot be used to create or increase a rental loss, and net rental income is calculated across all your rental properties before CCA is claimed.

How recapture happens

Each year of CCA reduces the undepreciated capital cost (UCC) of the class. If you later sell the building for more than the remaining UCC, you have effectively deducted more than the building actually lost in value. Recapture is the tax system taking that excess back.

On a disposition, the CRA tells landlords that a negative amount in column 7 of the CCA schedule (UCC after additions and dispositions) means a recapture of CCA, which is added to income. The Income Tax Act says the same thing: if at year-end the class's undepreciated capital cost is negative, the excess is included in your income for the year.

The key point is the tax treatment. Recapture is taxed as ordinary income rather than as a capital gain.

Recapture, capital gain and terminal loss compared

A single sale can involve more than one tax result. The table sets out the main ones.

The capital gain is worked out as proceeds of disposition minus the adjusted cost base and the outlays and expenses of the sale. Selling costs such as commissions, legal fees and advertising reduce the gain and cannot be deducted from other income. Capital improvements are added to the adjusted cost base, while maintenance and repairs are not.

Situations that change the picture

• Land and building are reported separately on Schedule 3, and only the gain on the part used to produce income is reported on line 13800.
• Mortgage principal repayments are not deductible, and land transfer taxes are added to the property's cost rather than deducted as a rental expense.
• In the year you acquire a rental property, you can usually claim CCA on only one-half of net additions to a class, which affects the UCC you carry forward.
• If you rent part of your home, CCA on the rented area requires that you are not designating the building as your principal residence.
• If you make the subsection 45(2) election, no CCA can be claimed on the property while the election is in effect.
• Every change in use is treated as a sale at fair market value unless an election applies, so converting a home to a rental, or the reverse, can create a deemed disposition.

Whether these points apply to you depends on your facts, including how the property was used and what elections were filed. These are the questions to put to a tax professional before you sign a sale agreement.

What to do next

Recapture is calculated from your past tax filings, so the best preparation is to pull those records together before the sale closes, not after.

• Collect your Form T776 filings and the CCA schedules for every year you owned the property.
• Find the purchase statement of adjustments, legal fees and any invoices for capital improvements.
• Confirm which CCA class the building is in and what UCC remains.
• Estimate the likely sale price and selling costs, including commission and legal fees.
• Ask an accountant to model recapture, capital gain and any terminal loss before you accept an offer.
• Check whether the property was ever your principal residence or had a change in use.

If you did not claim CCA, there is nothing to recapture, but claiming it is a choice with trade-offs, so decide with advice rather than guesswork. A lawyer can review the sale agreement, and an accountant can run the tax numbers.

Frequently asked questions