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.
Principal Issues: Is interest on borrowings with respect to a rental property deductible under the provisions of section 20.1 of the Income Tax Act, after the source of the income ceases to exit, due to the disposition of the property, which takes place prior to 1994?
Position: No
Reasons: Section 20.1 of the Act contains rules that apply to certain situations, because of a loss of source of income which occurs after 1993.
XXXXXXXXXX
2009-032917
July 16, 2009 V. Srikanth
Dear XXXXXXXXXX :
Re: Interest deductibility
This is in response to your letter dated June 19, 2009, requesting an advance income tax ruling concerning the deduction of interest expense. Specifically, you wanted to know if you could deduct interest expense payable on a promissory note, for the period XXXXXXXXXX , with regards to a property that was disposed of in XXXXXXXXXX .
The relevant facts can generally be summarized as follows:
You and your wife acquired a property in XXXXXXXXXX which you used as your principal residence. You had XXXXXXXXXX mortgages on this property. You converted your principal residence to a rental property in XXXXXXXXXX and claimed as rental expense, the interest paid on the mortgages. Your rental operations ended when you sold this property in XXXXXXXXXX . Further, the sale consideration you received on the disposition of this property was less than its cost of acquisition. As a result, you still had some amount outstanding from the XXXXXXXXXX mortgage at the time of sale of the property. Therefore, prior to the sale of the property, you entered into an agreement with the XXXXXXXXXX mortgagee, wherein you issued a promissory note (the "Note") for the outstanding loan amount, in return for the cancellation of the mortgage. The Note carried the same rate of interest as that of the mortgage.
The Note was fully settled in XXXXXXXXXX . Neither you nor your spouse claimed any interest expense on the Note during the period the Note was outstanding, i.e., from XXXXXXXXXX . However, you now want to claim the interest expense for those years and you would like to know if you are eligible to do so.
Our Comments
Written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled Advance Income Tax Rulings. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on our website at http://www.cra-arc.gc.ca. If, however, the particular transactions are completed or partially completed, the enquiry should be addressed to the relevant Tax Services Office. Since your request relates to a completed transaction, we cannot provide you with an advance income tax ruling. However, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries which are not advance income tax rulings and we are prepared to provide you with the following comments.
It is a question of fact whether the rental operations carried on by an individual is a source of income from property or business. Paragraphs 2 to 8 of the Interpretation Bulletin IT-434R - Rental of Real Property by Individual, discuss this issue in detail. Based on your submission, in our view, the income source of your rental operations is property and not business. Hence, we will provide our comments below based on your rental operations resulting in income from a capital property. However, we will also provide comments on the ceasing of a business.
Section 20.1 of the Income Tax Act (the "Act"), contains rules that apply where, because of a loss of source of income which occurs after 1993, borrowed money ceases to be used for an income-earning purpose. The 'disappearing source rules' in section 20.1 ensure that interest on such borrowed money will, in certain circumstances, continue to be deductible under paragraph 20(1)(c). Please refer to paragraph 19 of the Interpretation Bulletin IT-533 - Interest Deductibility and Related Issues, for a short discussion and example of the disappearing source rules.
When the Department of Finance introduced section 20.1, applicable to dispositions after 1993, they stated the following in their Explanatory Notes:
"New subsection 20.1(1) of the Act applies where a taxpayer who has used borrowed money for the purpose of earning income from a capital property, other than real property or depreciable property, ceases to use the money for that purpose after 1993 and a portion of the borrowed money has been lost because of a decline in the value of the property. The portion of the borrowed money that has been lost is deemed to continue to be used for the purpose of earning income from the property. Consequently, that portion of the borrowed money will satisfy the use test in subparagraph 20(1)(c)(i) of the Act, and the property will continue to be considered a source of income of the taxpayer even though the taxpayer may have disposed of it. Thus, the taxpayer will be able to deduct interest on the portion of the borrowed money that has been lost (assuming none of the rules in the Act restricting the deduction of interest is applicable)."
However, the exception to the application of subsection 20.1(1) of the Act is where the capital property is either a real property or a depreciable property. In your case, the property under consideration is a rental property, which is considered a depreciable property and, therefore, falls within the exception to the application of subsection 20.1(1). Further, as stated earlier, section 20.1 of the Act applies where the loss of source of income occurs after 1993. Again, in your case, you disposed of the property in XXXXXXXXXX . Therefore, the provisions of section 20.1 of the Act do not apply to your situation.
Please be aware that, while subsection 20.1(1) of the Act deals with borrowed money used to earn income from property, subsection 20.1(2) is applicable where the borrowed money is used to earn income from business. Unlike subsection 20.1(1), there is no exception for real and depreciable property in the application of subsection 20.1(2).However, like subsection 20.1(1), subsection 20.1(2) is applicable only in situations where a business ceases after 1993.
In conclusion, since the provisions of section 20.1 are not applicable to your situation, in our view, you are not eligible to deduct interest payable on the Note, for the period XXXXXXXXXX , with regards to a property that was disposed of in XXXXXXXXXX .
We trust our comments will be of assistance to you.
Yours truly,
R. A. Albert, CA
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
cc: Sudbury Taxation Centre
Account #: XXXXXXXXXX
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