Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
Interest deductibility on money borrowed to acquire a rental property and a principal residence
Position TAKEN: General comments given.
Reasons FOR POSITION TAKEN:
The direct use of borrowed funds is the test that predominates in determining the deductibility of interest. See 9208755, EA1916, E53820, 9201585, 5C7999, 9327485, 2002-0125475, 9821955,
XXXXXXXXXX 2002-014254
G. Moore
July 10, 2002
Dear XXXXXXXXXX:
Re: Mortgage Interest Deductibility
This is in reply to your letter of August 13, 2001, regarding interest deductibility with respect to money borrowed to acquire a rental property and a personal residence.
As we understand the situation, you recently sold your principal residence for $XXXXXXXXXX and purchased a farm property for $XXXXXXXXXX which required financing of $XXXXXXXXXX. The property consists of a principal residence, two additional houses and a horse barn with an apartment in it. All of these buildings are on one unsevered lot of about XXXXXXXXXX acres. A real estate appraisal sets the value of the principal residence at $XXXXXXXXXX and the value of the land and other buildings at $XXXXXXXXXX . The land and other buildings provide rental income of $XXXXXXXXXX a year. You believe that you can deduct the interest as a rental expense on borrowed money of $XXXXXXXXXX.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. As stated in paragraph 22 of Information Circular 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Agency. The following comments are, therefore, of a general nature only.
Paragraph 20(1)(c) of the Income Tax Act governs the deductibility of interest expense for income tax purposes and, generally, that provision limits the deduction to interest on borrowed money which is used for the purpose of earning income from a business or from property. In other words, it is the direct use to which the borrowed money is applied which governs whether the interest is deductible for tax purposes. For example, if funds are borrowed and used to buy income earning assets such as a rental property, the interest is generally deductible. If, however, the borrowed funds are used to purchase a personal asset, such as a personal residence, the interest is not deductible. Again, it is the direct use to which the funds are put which determines the eligibility of the interest as a tax deductible item.
It is our view that mortgage interest with respect to funds borrowed and directly used to purchase a personal residence would not be deductible for tax purposes. The purchase of a principal residence is considered to be a personal expense. Therefore the deduction of interest expenses incurred for these purposes is prohibited. On the other hand, mortgage interest and other costs related to maintaining a rental property are generally deductible in arriving at taxable income. Where funds are borrowed in order to purchase or construct a property that will be partly used by the owner as a personal residence, and partly used for rental purposes, the interest paid on financing the rental portion would be deductible, providing that these funds are laid out to earn income and that there is reasonable expectation of profit from the rental property.
Under the definition of principal residence in the Income Tax Act, if the total area of the contiguous land upon which a housing unit is situated exceeds 1/2 hectare, the excess land is considered not to be part of the principal residence unless the client establishes that such excess land is necessary for the use and enjoyment of the housing unit as a residence. The onus is on the client to establish how much, if any, of the excess land is necessary for the use and enjoyment of the housing unit as a residence. Generally, an individual's use of land in excess of 1/2 hectare in connection with a particular lifestyle does not, in itself, mean that the excess land is necessary for the use and enjoyment of the housing unit as a residence. A minimum lot size and a severance restriction imposed by local municipal by-laws may be factors indicating that land in excess of 1/2 hectare may be required for the use and enjoyment of the housing unit as a residence. However, if it is feasible to sever part of the excess land, say by special application to the municipal authorities, this could be an indication that the severable excess land is not necessary for the use and enjoyment of the housing unit as a residence. Where the housing unit is located on land not exceeding 1/2 hectare, usually the land qualifies as part of the principal residence, with no requirement to prove that it is necessary for the use and enjoyment of the housing unit as a residence. However, where a portion of that land is used to earn income from business or property, such portion will not usually be considered to contribute to such use and enjoyment. Where the taxpayer claims a portion of the expenses related to the land (such as property taxes or mortgage interest) in computing income, the allocation of such expenses for this purpose is normally an indication of the extent to which he or she considers the land to be used to earn income.
You are asking if you can deduct the interest expense relating to all of the borrowed money of $XXXXXXXXXX. We do not believe it is reasonable to allocate 100% of the interest expense to the rented land and buildings since the income earning portion of the property only constitutes a portion of the whole property. It is our view that a reasonable allocation of the interest expense to the income producing source should be made based on factors such as the fair market value of the rented land and buildings as a portion of the total fair market value of the entire property, as determined by an independent third party, for example, by real estate appraisal.
We trust that the foregoing will be useful.
Yours truly,
S. Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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