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
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 2000-001735, 2000-0042655, 9823830, EA7611, E53820, 9866660, 9823830,
XXXXXXXXXX 2001-009695
G. Moore
July 4, 2002
Dear XXXXXXXXXX:
Re: 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.
You are requesting our opinion in the following two situations:
1. Your client purchased a rental property and initially paid for the property from his personal cash funds. About a year later, the client mortgages the rental property since he requires the funds to replace his original personal cash outlay. Would interest incurred by the mortgage be deductible against rental income?
2. If your client sets up a mortgage using his own funds rather than a bank's money to acquire rental properties, would the interest be deductible against rental income?
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.
1. 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. This is so regardless of the fact that the security for the loan of the borrowed funds is a personal residence or if it is another income earning asset such as a rental property. 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 not the nature of the security for the loan which determines the eligibility of the interest as a tax deductible item but rather it is the direct use to which those borrowed funds are put.
In our view, mortgage interest with respect to funds borrowed that are not directly used to produce income or acquire property to produce income, would not be deductible for tax purposes. This view is supported by the Supreme Court of Canada decision in The Queen v. Bronfman Trust (87 DTC 5059) where the Court concluded that the direct use of the borrowed funds is the test that predominates in determining the deductibility of the interest.
In the first situation you described, money is borrowed after the individual had already acquired a rental property and therefore, it is our view that the interest would not be deductible because the borrowed money is not used to buy an income earning asset. We currently are in the process of reviewing our existing positions on interest deductibility subsequent to the recent decisions of the Supreme Court of Canada on interest deductibility. You may wish to contact us subsequent to the completion of our study this fall to confirm our positions at that time.
2. You have also asked if interest would be deductible as a rental expense if your client sets up a mortgage using his own funds rather than borrowing money from a bank when he is purchasing rental properties. We are not clear on whether it is possible for an individual to borrow money from himself and therefore, we are unable to provide any comments on this matter.
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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