Canada CFP Practice Questions - Weekly Question #1
Want to know the types of questions you will see on the CFP Examination in Canada? Welcome to the start of our Weekly Question series! We will be posting a new sample question each week.
Question
Your client, Jordan Bennett, owns a residential rental property. During the year, Jordan received monthly rent and a tenant’s reimbursement for utilities. Jordan also paid mortgage interest, repainted several rooms, and upgraded worn laminate flooring to hardwood. When reviewing the tax implications, Jordan asks how these amounts affect net rental income and whether claiming capital cost allowance (CCA) is beneficial.
What would you advise your client?
A. Rent and utility reimbursements are included in gross rental income; mortgage interest and repainting are generally deductible current expenses; hardwood flooring is a capital expenditure; claiming CCA may reduce current taxable income but could lead to recapture later.
B. Rent is included in gross rental income, but utility reimbursements are excluded; mortgage interest is a capital expenditure; hardwood flooring is a current expense; claiming CCA always provides a permanent tax savings.
C. Rent and utility reimbursements are included in gross rental income; mortgage interest and hardwood flooring are current expenses; repainting is a capital expenditure; claiming CCA is mandatory whenever net rental income is earned.
D. Rent is included in gross rental income, but utility reimbursements are excluded; repainting and hardwood flooring are current expenses; mortgage interest is a capital expenditure; claiming CCA can create or increase a rental loss.
Technical Knowledge Required
Rental Income for Investors (Topic 9.7.2 in the BoK)
Gross rental income is the total amount you receive from renting a property. It includes rent and other amounts paid by tenants that relate to the rental arrangement, such as reimbursements for expenses that would otherwise be the landlord's responsibility.
A current expense is an expenditure that typically provides a benefit in the current period and is incurred to maintain or operate the rental property. You generally deduct current expenses in calculating net rental income for the year.
A capital expenditure is an expenditure that acquires, improves, or extends the useful life of a property or asset. Rather than being deducted immediately, the amount is generally added to the cost of a depreciable asset or the property's capital cost.
Deductible rental expenses may include costs such as mortgage interest, property taxes, insurance, utilities paid by the owner, maintenance, and repairs incurred to earn rental income, subject to applicable tax rules.
Capital cost allowance (CCA) is an optional deduction that allows you to allocate the cost of eligible depreciable property over time for tax purposes. One advantage of claiming CCA is that it can reduce current taxable rental income.
A disadvantage of claiming CCA is that it may result in recapture when the property is disposed of or when proceeds exceed the remaining undepreciated capital cost. In addition, CCA cannot be claimed to create or increase a rental loss.
Solution
Correct answer: A. Rent and utility reimbursements are included in gross rental income; mortgage interest and repainting are generally deductible current expenses; hardwood flooring is a capital expenditure; claiming CCA may reduce current taxable income but could lead to recapture later.
“Choice A is true.” Gross rental income generally includes rent received and amounts paid by tenants on the owner’s behalf, such as utility reimbursements. Mortgage interest and repainting are typically current expenses because they relate to financing and maintaining the property. Replacing laminate flooring with hardwood generally improves the property and is therefore a capital expenditure. CCA may reduce current taxable rental income, but previously claimed CCA may be recaptured if the property is later sold for a sufficient amount.
“So, choice A correctly identifies gross rental income items, distinguishes current expenses from a capital expenditure, and explains a key advantage and disadvantage of claiming CCA.”
“Choice B is false.” Tenant reimbursements for utilities generally form part of gross rental income. Mortgage interest is normally a deductible current expense rather than a capital expenditure. Upgrading laminate flooring to hardwood is generally considered a capital expenditure because it improves the property. In addition, claiming CCA may result in recapture later, so the tax benefit is not necessarily permanent.
“So, choice B incorrectly excludes utility reimbursements from gross rental income, misclassifies expenses, and overstates the benefit of CCA.”
“Choice C is false.” Utility reimbursements are generally included in gross rental income. However, repainting is usually a current expense because it restores or maintains the property, whereas upgrading flooring to hardwood is generally a capital expenditure. Furthermore, CCA is optional rather than mandatory.
“So, choice C incorrectly classifies repainting and flooring costs and incorrectly states that claiming CCA is mandatory.”
“Choice D is false.” Utility reimbursements received from tenants are generally included in gross rental income. Repainting is usually a current expense, but upgrading flooring to hardwood is generally a capital expenditure because it improves the property beyond its previous condition. Mortgage interest is generally a current expense. In addition, CCA cannot be used to create or increase a rental loss.
“So, choice D incorrectly excludes part of gross rental income, misclassifies expenses, and incorrectly describes the limitation on claiming CCA.”
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