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:
Whether interest is deductible on borrowed funds used to
1)acquire land to construct principal residence;
2) borrowed funds used to acquire land to subdivide and resell; and
3) a combination of 1) & 2)
Position:
1. Not deductible
2. Likely not deductible - added to cost of land
3. Not deductible - a portion can be added to cost of land
Reasons:
1. Direct use of funds for ineligible purpose;
2) & 3) 18(2) limitation.
XXXXXXXXXX 2002-012293
July 2, 2002
Dear XXXXXXXXXX:
Re: Mortgage Interest Deductibility
We are replying to your facsimile of February 12, 2002, in which you inquire whether interest on a mortgage may be deducted. In the facsimile, you provided the following facts:
1. You currently own a rental apartment property purchased in XXXXXXXXXX for $XXXXXXXXXX.
2. You currently value the rental property at $XXXXXXXXXX.
3. You currently have a mortgage balance of $XXXXXXXXXX remaining on the rental property.
Specifically, you requested our comments with respect to the deductibility of interest on borrowing $XXXXXXXXXX, secured by a mortgage on the above-mentioned property, under the following hypothetical situations:
Scenario A
Under this scenario, you would re-mortgage the said rental property, receiving an additional $XXXXXXXXXX cash to be used to acquire a non-rental real estate property which you will construct your principal residence.
Scenario B
Under this scenario, you would re-mortgage the said rental property, receiving an additional $XXXXXXXXXX cash to be used to acquire a piece of land with the intent of sub-dividing the land into XXXXXXXXXX residential lots to be individually sold in the future.
Scenario C
Under this scenario you would re-mortgage the said rental property, receiving an additional $XXXXXXXXXX cash to be used to acquire a piece of land which will be subdivided into XXXXXXXXXX residential lots. You intend to sell XXXXXXXXXX of these lots in the future and to construct a principal residence on the XXXXXXXXXX lot.
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 70-6R5. As stated in paragraph 22 of Information Circular 70-6R5, written opinions are not advance tax rulings and, accordingly not binding on the Agency. The following comments are, therefore, of a general nature only.
Generally, interest paid or payable in the year on borrowed money is deductible by virtue of paragraph 20(1)(c) of the Income Tax Act ("Act"), if the borrowed money is used to produce income or to acquire property to produce such income. 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.
Furthermore, subsection 18(2) of the Act limits the deduction of interest expense and property taxes incurred in connection with undeveloped land to the extent of the net income from the land for the year (being the gross income from the land for the year less other deductions exclusive of the interest and property taxes). For a corporation whose principal business is the leasing, rental or sale or the development for lease, rental or sale (or any combination thereof), of real property owned by it, to or for a person with whom the corporation is dealing at arm's length, the deduction for interest and property taxes incurred in a taxation year is limited to the extent of the aggregate of the net income from the land for the year and the corporation's base level deduction for the year by virtue of paragraph 18(2)(f) of the Act. Subsections 18(2.2) to 18(2.5) of the Act provide the rules that determine a corporation's base level deduction. The amount of interest and property taxes denied as a deduction in the year under subsection 18(2) of the Act is added to the cost of inventory of land by virtue of subsection 10(1.1) of the Act.
The above limitations on the deduction of interest and property taxes do not apply in connection with land that can reasonably be considered to have been used in the course of a business, other than a land development business carried on in the year by the taxpayer, by virtue of paragraph 18(2)(c) of the Act, or held primarily for the purpose of gaining or producing income of the taxpayer from the land for the year, by virtue of paragraph 18(2)(d) of the Act. Whether land may reasonably be considered to have been used in the course of a business carried on in the year by the taxpayer is a question of fact that can only be determined based on a review of all of the relevant details of the particular situation.
We refer you to Interpretation Bulletin IT-153R3 - Land Developer - Subdivision and development costs and carrying charges on land for further information with respect to the tax treatment of interest and property taxes on land held for the purpose of resale and development.
In the scenarios that you describe above, we provide the following general comments:
Scenario A - the interest would not be deductible since the borrowed funds were not used for the purpose of producing income from a business or property.
Scenario B - since it is your intention to sell the land at a future date, the interest would not likely be deductible by virtue of subsection 18(2) of the Act, because the land will not be used in the course of a business, other than a land development business, or used to produce income. The amount of interest denied would be added to the cost of the land.
Scenario C - the interest would not be deductible on the borrowed funds used to construct your primary residence for the reasons described in Scenario A, above. The interest on the borrowed funds relating to the XXXXXXXXXX lots you intend on reselling would not likely be deductible for the reasons described in Scenario B above. The interest denied on the XXXXXXXXXX lots to be resold would be added to the cost of each lot.
However, we are currently 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.
We trust these comments will be of assistance
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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