17 May 1994 External T.I. 9408325 - RECAPTURE AND INTEREST DEDUCTIBILITY

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 Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1.When a property is sold for land value only, does the taxpayer have to allocate part of the proceeds of disposition to the building?

2.Where one spouse borrows money to purchase the principal residence from the other spouse, will the interest on the borrowed money be deductible if the property is thereafter rented and the money used to buy another principal residence?

Position TAKEN:

1.Question of facts.

2.Not if the sale is merely a formality or sham for the purpose of obtaining the interest deduction.

Reasons FOR POSITION TAKEN:

1.IT-220R2

2.7-2313 and 5-920222

		5-940832
XXXXXXXXXX	L. Roy

May 17, 1994

Dear Sir\Madam:

Subject: Recapture and interest deductibility

This is in reply to your letter of March 23, 1994 in which you requested our opinion concerning the allocation of proceeds of disposition between land and building when the property is sold for land value. You also requested our opinion with respect to interest deductibility on rental property.

All references to statute are to the Income Tax Act S.C. 1970-71-72, c.63, as amended, consolidated to June 10, 1993 (the "Act").

The situations described in your letter appear to involve actual proposed transactions. 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 matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2, dated September 28, 1990. Where the particular transactions are completed, the enquiry should be addressed to the relevant district taxation office. The following comments are, therefore, of a general nature only, and are not binding on the Department.

When a taxpayer disposes of both depreciable and non-depreciable property for a lump sum, the part of the consideration which can reasonably be regarded as being consideration for the depreciable property will be deemed to be its proceeds of disposition. However, whether the consideration for the depreciable property is "reasonable" is a question of fact, and in order to make such a determination, it is necessary to review all the facts surrounding a particular situation.

Also, where land and building are sold and the purchaser demolishes the building shortly after the sale, the department may nonetheless consider that some portion of the vendor's proceeds are reasonably attributable to the building. However, where the total sale price does not exceed the fair market value of comparable land, it may be reasonable to conclude that the sale was essentially one of land and that the price was in consideration only of land. But, where the total selling price exceeds the fair market value of comparable land, it may be reasonable to conclude that the amount of the excess is attributable to the sale of the building.

In this respect, it should be noted that where the proceeds of disposition of a building are less than both the capital cost and the undepreciated capital cost, the terminal loss on the building will be reduced to the extent of any gain on the sale of the land.

With respect to interest deductibility, interest on borrowed funds is deductible for tax purposes if it meets all the requirements of paragraph 20(1)(c) of the Act. Paragraph 20(1)(c) provides that the money must have been borrowed for the purpose of gaining or producing income from a business or property. It is the current use made of the borrowed funds in a particular year rather than the initial use of the funds, which must be considered in determining whether the interest paid or payable with respect to the borrowed funds is deductible in the particular year. In order to determine whether borrowed funds have been put to an eligible use, it is necessary to trace the use of funds through successive reconversion.

In sales between spouses, where one spouse borrows money to purchase property from the other, the Department will allow the interest deduction if the requirements of paragraph 20(1)(c) of the Act are otherwise met and if the sale is a bona fide transaction. However, the Department will scrutinize situations where the sale is merely a formality or sham for the purpose of obtaining a deduction of interest and the borrowed money can indirectly be linked to personal use of a taxpayer, such as the purchase of a principal residence. In such situations, the Department may disallow the interest deduction.

We trust our comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate