Being a property owner comes with certain responsibilities, which encompass knowing your province’s tax norms. If your property undergoes specific leasehold enhancements, you may be wondering how to handle the tax deductibles.
In this article, the insurance specialists at Surex have come up with a comprehensive guide. You can get a complete idea of the norms governing deductible taxes for leasehold improvements in Canada. Click the link to find more on the leading insurance specialists and reach out to the experts for any necessary consultation.
What Is Leasehold Improvements?
A leasehold improvement is a term used to refer to any change in a rental property that is necessary to customize the space. As a property owner, you must be incorporating specific features into your property to cater to the aspirations of specific tenants.
For instance, these changes might include but are not limited to partition installation, painting, new floor installation, installing customized light fixtures, etc.
While the landlord or property owner undertakes these improvement initiatives, they are generally paid for by the tenant. At times, the landlord might also finance these developments in their property. For most of the leasehold improvements, the economic life ranges between five and ten years.
However, some of these features or additions exist even after the tenant leaves the property. According to the established norms, these improvements would be undergoing some depreciation, affecting the building’s economic life.
Homeowners should also note that all enhancements to the property may not qualify as leasehold improvements. Some of these include installing escalators and elevators, fire protection, HVAC systems, and security systems.
Leasehold Improvements Types
Tenant Improvement Allowance
Here, the tenant gets the right to oversee the project. It takes off the responsibilities of the property owner. Generally, the landlord comes up with some provisions in the lease covering the budget of the improvements. The property owner might shell out the construction costs directly or get them reimbursed from the tenants.
Rent Discount
Sometimes, tenants get discounts on rent from the property owner. In these situations, they receive rent relief in some form or the other. Eventually, the tenant can save money on space alterations. In this case, too, the tenant is responsible for overseeing the project. In case the cost exceeds, the tenant would be responsible.
Building Standard Allowance
This is the case where a property owner pitches a property improvement package to the tenant. The owner of the property would manage the project in this case. This provides the tenant with more time for their work or business. If the tenant wants any additional improvements, they need to cover the extra cost.
What Are The Tax Implications On Leasehold Improvements?
The Income Tax Act of Canada states that if a property owner makes any enhancement on a leased property that continues to be a part of the premise at the end of the lease, they qualify for leasehold improvements. These additions do not get deducted during the period when you purchase them. However, they come under Class 13 assets. Over the term of the lease, they get written off.
In most cases, leasehold improvements are funded by the tenants. The cost is supposed to be the capital amount. Therefore, they are amortized throughout the entire period of the lease. In real estate, the leases generally range between five to ten years. The lessee and the lessor negotiate these rates, considering the fair market price.
For corporations, these periodic payments of a lease are actually deductions. When the lease is terminated, the enhancements generally revert to the lessor so long as the lessee is able to remove them.
When Canadian homeowners file their tax returns, these improvements come under Class 13 assets. For CCA (capital cost allowance), they are considered under the half-year rule. Unlike most CCA classes, where the declining balance method is used, they are amortized over the length of the lease.
In case the landlord directly bears the cost of these enhancements, the expenses are capitalized to the structure. These are generally classified for tax purposes as Class 1. The declining balance rate of 4% is applicable in these cases.
Dealing With Tenant Inducements
Tenant inducements refer to costs that property owners pay to the tenants during the initial phase of the lease. When tenants sign a long-term lease contract, property owners give these amounts as incentives to them.
For instance, unfinished space for an office might be leased out to a tenant. It might take around three months to finish the office setup. In this case, the property owner might provide an inducement to the tenant, which will help cover the expenses for leasehold improvements. These inducements are considered to be an income for the latter.
At times, the tenant might enter into an agreement with the property owner to minimize the capital expense of leasehold improvements. In these cases, you might provide them with rent- free periods as an incentive rather than money.
Tax Treatment Of Lease Inducements In Canada
In Canada, inducements for tax purposes in a lease are completely taxable for the period through which one would receive them. This might result in excessive tax burdens for individuals who are presently in a position to pay tax. It largely depends on the incentive amount.
Taxpayers can get an alternative option from the Canada Revenue Agency (CRA), where they can completely tax the inducement in the year when they receive it. Taxpayers enjoy the liberty to incorporate the lease inducements that they receive, as they can reduce the capital cost of Class 13 assets.
However, for this to happen, the actual capital cost should be equal to or higher than the inducements that they receive.
Individuals willing to avail this alternative option need to apply to CRA. However, no prescribed form exists for this purpose. Therefore, you need to draft a letter that must include these details:
● The subjection under which you make the election
● The amount that you elected
● The inducement amount and date or receipt
● Date of acquiring the property
● Original property cost before reduction
Remember, the election would be due at the time of filing income tax returns for the specific year.
Endnote
As a property owner, you must remember that Canadian tax norms are complex. Besides, they change frequently. Therefore, it would be wise to consult experts before planning your tax payments. This would save you from possible legal hassles arising out of ignorance of newer developments on tax norms.
