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: Where a taxpayer owns his principal residence, Property A, and acquires Property B with borrowed money and the intention of earning rental income from it, what impact does the taxpayer's action of moving into Property B and renting out Property A have on the deductibility of the interest on the borrowed money used to acquire Property B.
Position: The interest will not be deductible.
Reasons: Interest is not deductible where the current use of the borrowed money can be directly linked to a non-income producing asset.
XXXXXXXXXX 2008-026796
L. Carruthers, CA
March 10, 2008
Dear XXXXXXXXXX :
Re: Interest Deductibility
This is in reply to your email of February 13, 2008, wherein you asked our assistance to clarify the interest deduction that would be allowed in the circumstances you described.
In summary, those circumstances are that while you owned the home you lived in (Property A), you purchased a residential property (Property B) with borrowed money. At the time of its purchase, you intended to earn rental income from Property B. Two months following the closing date of your purchase, and after a failed attempt to rent Property B, you moved into Property B and commenced earning rental income from Property A.
In your submission, you requested our opinion as to what, if any, impact your moving into Property B and renting out Property A had on the deductibility of the interest on the borrowed money used to purchase Property B.
Your request appears to be an actual fact situation relating to a proposed if not a completed transaction. Written confirmation of the tax implications inherent in a proposed transaction is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. (This Information Circular and the Interpretation Bulletins referred to below can be accessed on the internet at http://www.cra-arc.gc.ca.) This Directorate does not give verbal or written confirmation of the tax implications inherent in a completed transaction. Such requests should be submitted, with all relevant facts and documentation, to your tax services office for their views.
As stated in paragraph 22 of IC 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Canada Revenue Agency (the "CRA"). The following comments are, therefore, of a general nature only.
Interest on borrowed money is deductible for purposes of the Income Tax Act (the "Act") if it meets all the requirements of paragraph 20(1)(c) of the Act. Paragraph 20(1)(c) of the Act provides notably 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 money in a particular year rather than the original use of the money, which must be considered in determining whether the interest paid or payable with respect to the borrowed money is deductible in the particular year. Therefore, in order to determine whether borrowed money has been put to an eligible use in a particular year, it is necessary to determine the current use of the original borrowed money.
We would draw your attention to our response to Q.18 at the 1984 Canadian Tax Foundation Revenue Canada Round Table, in which we stated:
"It is the Department's position, supported by several cases, including Trans-Prairie Pipelines Ltd. v. MNR, 70 DTC 6351, that interest sought to be deducted under paragraph 20(1)(c) of the Act must relate to a business or property income source. This requirement will not be satisfied in circumstances where the income source ceases to exist, is transferred, or changes use (for example, where a rental property becomes the owner's personal residence). Where one income source is disposed of and the proceeds are used to acquire another income source, interest on the borrowed money that was used to acquire the first income source will continue to be deductible to the extent that the borrowing is reflected in the cost of the new income source."
This position has been confirmed numerous times over the years. Also note the Supreme Court of Canada decision in The Queen v. Phyllis Barbara Bronfman Trust, 87 DTC 5059, confirmed that it is the current use made of the borrowed funds in a particular year, rather than the original 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 a particular year.
In the scenario you described, due to the fact that you are using Property B as your personal residence, the current use of the borrowed money can be directly linked to a non-income producing asset and, therefore, would not meet the requirements of paragraph 20(1)(c) of the Act such that any interest paid on the borrowed money would not be deductible.
The circumstances you described in your email are very similar to those of Cascone v. The Queen, (2000 DTC 1621) in which a taxpayer and his spouse ("the taxpayers") acquired one property ("Property 1") in 1978, which was used as a principal residence. In January 1988, the taxpayers acquired a second property ("Property 2") and financed the acquisition with a $220,000 mortgage registered on Property 1. The taxpayers moved into Property 2 in February 1988 and commenced to rent out Property 1. Property 2 was eventually sold in October 1988, with the proceeds being used to acquire a third property ("Property 3"). The taxpayers claimed an interest deduction against the rental income, which was denied. Their appeal to the Tax Court of Canada was dismissed with the Court ruling that the borrowed funds were never "used for the purpose of earning income". The borrowed funds were used to purchase a property (Property 2) that never earned income (as rent), but was only used as a principal residence, and was eventually sold.
We trust our comments are of assistance.
Yours truly,
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
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