Canadian small businesses are often looking for ways to reduce their costs. Understanding the capital cost allowance (CCA) can benefit your business and help reduce the amount of income tax you pay. Learn how to calculate CCA and which class your depreciable property belongs to.
What is the capital cost allowance?
The capital cost allowance is a tax deduction based on the depreciating value of a business asset. Using it reduces the taxable income on your tax return. You cannot claim the full amount of the asset’s cost in the year you bought it. Instead, you deduct a percentage of that asset’s cost. The part you can deduct is called the depreciation or capital cost allowance.
The Canada Revenue Agency (CRA) groups assets into classes. For each class, a different percentage rate of depreciation can be claimed. But businesses can’t claim for all business assets: assets eligible for CCA include furniture, computers, buildings, software, machinery and equipment.
Small businesses can choose different methods to depreciate or amortize assets. These include straight-line or declining balance.
Quebec has special rules. Its accelerated investment incentive CCA program allows you to claim an extra 30% for eligible properties.
The benefits of capital cost allowance
There are some benefits to using the capital cost allowance. It enables you to invest in capital equipment while reducing your tax liability. Small businesses can spread out the depreciation costs and tax benefits over several years. In other words, you can claim the depreciation on your asset over multiple years, rather than all at once.
Let’s say you buy a computer for your small business. Over the years, the computer will wear out and its value will decrease. Instead of deducting the full cost of the computer from your income the year you buy it, you spread out that deduction over several years. This is known as “depreciating” the value.
CCA gives you a method of gradually deducting the cost of your business assets over time. This reflects the fact that most assets lose their value over time, rather than all at once.
Which method of depreciation can you use to calculate CCA?
Small businesses can use different methods of depreciation. The declining balance method is used for most assets for CCA; the exception is for leasehold improvements.
Three common depreciation methods are:
Declining balance method
An asset is depreciated at a specific rate for its useful life. The rate of depreciation is applied to the value, which declines each year as the asset ages and loses value. Let’s say the first year you deduct 20% of the computer’s original cost. In the second year, you deduct 20% of the remaining value of the computer, not the original cost. This reflects the idea that some assets lose more value in their first few years of ownership, such as a car.
You estimate the useful life of your asset and the salvage value at the end of the useful life. The salvage value is subtracted from the value and then depreciated each year of its useful life. So let’s say you buy a computer for $1000. You believe the computer will last eight years and at the end of eight years, will be worth $200. $1000 – $200 = $800. $800 divided by 8 years is $100. You deduct $100 a year for each of the eight years. This method is most useful for assets that lose their value at a consistent rate.
Unit of production method
You determine how much an asset, such as a vehicle or machine, will be used. The asset is depreciated against usage rather than useful life. For example, let’s say you buy a machine that can produce 500,000 pencils before it wears out. You divide the original cost of the machine (say, $1 million) by its total capacity. So, $1 million divided by 500,000 gives you $2. In terms of depreciation, the cost to produce one pencil is $2. Each year, you multiply the number of units produced by the cost per unit. If you produce 10,000 pencils each year, your depreciation is 10,000 pencils multiplied by $2. This equals $20,000. That’s your CCA for that asset for the year.
CCA classes of depreciable property
As part of the income tax regulations, the CRA divides depreciable properties into different classes. These have different CCA rates of depreciation assigned to them. Examples of classes include:
- Class 1: 4% – Any buildings acquired after 1987, including electrical wiring, plumbing, and heating
- Class 8: 20% – Furniture, business appliances (such as photocopiers), and tools costing more than $500
- Class 10: 30% – Computer hardware and software, motor vehicles, and some passenger vehicles (some may be class 10.1 for vehicles instead)
- Class 43: 30% – Eligible machinery and equipment used in manufacturing and processing goods for sale
- Class 53: 50% – Machinery and equipment acquired after 2015 and before 2026, used in manufacturing and processing goods for sale
Capital cost and rental property
Real estate often increases in value, whereas CCA is for assets that decrease in value. You can claim CCA on rental properties owing to wear and tear, but not on the land, as that doesn’t depreciate.
You’ll need to take into account:
- the type of rental property
- the purchase price or capital cost of a property (not the cost of the land)
- the proceeds of disposition if you sell a property
- whether the rental is a primary residence or not
You may be able to claim for:
- fees related to the purchase or construction (not the land) such as legal, accounting, engineering
- improvements or renovations not already claimed
- any additional fees not already claimed, such as building interest, accounting fees, and legal fees
The half-year rule
When a rental property or asset is bought, you can only claim 50% of the value in the first year. This allows businesses to make purchases at any time of the financial year rather than at the end.
Claiming CCA for rental properties can be complicated, so consult with a tax professional.
CCA for the self-employed
If you’re operating a home business, you can still apply the Capital Cost Allowance to certain assets you use in your business. These business purchases such as computers, machinery, vehicles and buildings.
However, it’s important to talk to your accountant to find out if it’s worth it to make the claim. If you claim CCA on part of your home, then capital gain rules will apply if you sell your home.
Additional assets that do not fit into specific classes and have a value of more than $500, such as some tools, can also be eligible for CCA.
Calculating capital cost allowance
Small businesses who want to claim a CCA deduction should review the classes of depreciable property to check the percentage allowed for each class. For example, if you own a moving company, you may be able to claim in several categories. These categories include motor vehicles, tools, equipment, and computing systems. Here's how you would claim those items:
- Combine the expenses by class and add them up.
- Multiply the total by the percentage rate applied to that class.
- Claim the total as CCA.
Businesses cannot claim the full cost of items. The portion not claimed is called unclaimed capital cost (UCC). It’s also called undepreciated capital cost.
If the amount of CCA is small, businesses can choose not to claim it and save it for the following year or a future tax year.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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