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I’m trying to figure out whether I can claim renovation-related expenses — including property taxes, insurance, interest, utilities and rental loss — for an investment property I bought and renovated.
I purchased a duplex that was occupied when I bought it but the tenants were removed once the sale completed so I could carry out a full renovation. The plan was to renovate and then rent the units again.
Before re-renting was finished, another investor offered to buy the duplex. I accepted and sold the property after completing the work.
I’ve been told that because the property was not rented during renovations I can’t claim those expenses. I removed the tenants only to upgrade the units so they would need less maintenance going forward and provide better housing for future renters.
— Shawn
Tax deductions for investment property renovations
Expenses related to real estate can have different tax treatments depending on their nature. Some public programs and credits exist for specific residential improvements — for example, federal or provincial tax credits for home accessibility upgrades or for creating a legal secondary suite — but those apply to principal residences and qualifying homeowners rather than rental properties.
For rental properties, common deductible expenses when the property is actively used to earn rental income include property taxes, insurance, mortgage interest, condo fees, repairs, utilities and other operating costs. When a rental property runs at a loss, those losses can sometimes be used to offset other sources of income, subject to tax rules and restrictions.
Rental properties: current expenses versus capital expenses
It’s important to distinguish between current (operating) expenses and capital expenses. Current expenses are routine costs that you can deduct in the year they are incurred. Capital expenses are investments that provide a lasting benefit or improve the property; those costs cannot usually be deducted immediately but instead adjust the property’s cost base and reduce any taxable capital gain when you sell.
A current expense generally recurs periodically and is for maintenance or minor work. A capital expense usually provides a lasting improvement or creates a new asset.
The Canada Revenue Agency offers guidance to help decide whether a cost is current or capital. Key considerations include:
- Does the expense provide a lasting benefit? If yes, it is more likely a capital expense.
- Does the work maintain the property or does it improve it? Improvements tend to be capital expenses.
- Is the cost for part of the property or for a separate asset (for example, a new appliance)? Separate assets are more likely capital expenses.
- What is the size and value of the expense? Larger, one-off expenditures are more likely to be capital.
- Was the expense incurred mainly to prepare the property for sale? Costs incurred in anticipation of a sale tend to be capital expenses.
In your situation, Shawn, because the duplex was taken out of rental use for an extended renovation and then sold, many of the carrying costs incurred during that downtime — such as property taxes, insurance, mortgage interest, utilities and condo fees — are likely to be treated as capital costs. That means they would not be deductible against income in the year incurred but would instead increase your adjusted cost base for the property and reduce any capital gain on sale.
What are soft costs and how are they treated?
Soft costs are indirect expenses related to renovating a property to make it suitable for rental. Examples include legal fees, accounting fees, permits and some professional services. Depending on the circumstances, soft costs can sometimes be deductible against rental income, but if the property was taken out of service for renovation or the costs are part of an overall improvement program, they are more likely to be capitalized and added to the property’s cost base.
Where soft costs are treated as capital, they won’t offset rental income in the renovation year; instead they reduce the taxable gain (or increase the loss) when the property is later sold.
Capital gain versus business income
One additional tax risk to consider is whether the profit from the sale will be treated as a capital gain or as business income. Capital gains are only partially taxable (for example, a portion is included in taxable income), whereas business income is fully taxable. If you buy, renovate and sell properties frequently, or if the renovation and sale resemble a property-flipping business, the Canada Revenue Agency may treat the proceeds as business income rather than a capital gain.
In your case, although you may not be able to deduct the carrying costs during the renovation period as current expenses, those costs should still provide tax relief by increasing your adjusted cost base and thereby reducing any capital gain on the sale. Keep careful records of all expenses, including invoices and contracts, so you can support whether costs were repairs, capital improvements, or carrying costs related to preparing the property for sale.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell financial products.
Read more from Jason Heath:
- Should you claim the principal residence exemption on a property you bought your child?
- Can you use the Home Buyers’ Plan to buy a foreign property?
- When does the “plus 1” rule apply to a principal residence?
- What are the tax implications of selling U.S. real estate?