27 June 2013 External T.I. 2013-0485721E5 - Election to Capitalize Cost of Borrowed Money

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: Whether a taxpayer can add interest expense to the capital cost of a condominium where the money was borrowed to make various capital improvements to that condominium.

Position: A question of fact. In our view it would only be appropriate to capitalize interest under section 21 if the cost of a particular improvement has been properly added to the capital cost of the depreciable property for capital cost allowance purposes.

Reasons: Section 21 allows a taxpayer to elect to capitalize the cost of borrowed money when it is used to acquire depreciable property.

XXXXXXXXXX
2013-048572
Andrea Boyle, CGA

June 27, 2013

Dear XXXXXXXXXX:

Re: Section 21 Election to Capitalize Cost of Borrowed Money

We are writing in reply to your email dated April 16, 2013. You asked us whether, under section 21 of the Income Tax Act, a taxpayer can add certain interest expense to the capital cost of a condominium. Money was borrowed to make various "capital improvements" to the condominium over the years that the taxpayer owned it. During this time the condominium was used to earn rental income with less than 10% personal taxpayer use of the condominium.

Specifically, you indicated that the taxpayer used funds from a line-of-credit to pay for improvements which include items such as the taxpayer's share of landscaping, lighting, and re-siding the condominium development, and other capital improvements which the taxpayer made to the condominium unit. No capital cost allowance has been claimed on the depreciable property and none of the interest in question has been previously claimed as an expense for income tax purposes.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. We are, however, prepared to offer the following general comments, which may be of assistance.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act").

OUR COMMENTS

Among other things, section 21 allows a taxpayer to elect to capitalize, instead of deducting as a current expense, the cost of borrowed money used to acquire depreciable property. In order to qualify for the election, the interest expense must otherwise have been deductible in computing the taxpayer's taxable income for the year.

It is a question of fact whether the "capital improvements" to which you alluded would constitute an acquisition of depreciable property and whether, therefore, the borrowed money would be considered to have been used to acquire depreciable property. As stated in CRA Interpretation Bulletin IT-304R2 Condominiums, whether a unit owner who uses a condominium unit to earn rental income can deduct an amount as a current expense or must capitalize it "…depends on the nature of the work done."

As per paragraph 1 of the cancelled CRA Interpretation Bulletin, IT-121R3 Election to Capitalize Cost of Borrowed Money, "…Depreciable property is property in respect of which the taxpayer is entitled to deduct capital cost allowance in computing income for a taxation year, whether or not any such deduction is actually made." Therefore, in our view, it would only be appropriate to capitalize interest expense under section 21 if the cost of a particular capital improvement made has been properly added to the capital cost of the depreciable property for capital cost allowance purposes. Each capital improvement would need to be considered on a case-by-case basis and the related interest expense apportioned accordingly.

Generally, an election under subsection 21(1) must be filed with the taxpayer's return for the taxation year in which the taxpayer acquired the depreciable asset. A late-filed election to capitalize interest costs may be allowed, at the discretion of the Minister, per subsection 220(3.2) of the Act and section 600 of the Income Tax Regulations. Information Circular IC 07-1, Taxpayer Relief Provisions, (which is available on our website at: http://www.cra-arc.gc.ca/E/pub/tp/ic07-1/README.html) provides guidelines for the CRA's acceptance of late, amended, or revoked elections. It should be noted that these requests must be made within a 10-year time limit and such requests, if accepted, are subject to a penalty under subsection 220(3.5).

Finally, the possible application of subsection 18(3.1) may need to be considered. Under subsection 18(3.1) of the Act, except to the extent of related income, no deduction may be taken for expenditures that relate to a period in which a building is undergoing "construction, renovation, or alteration" where the expenses relate to that construction, renovation, or alteration. Under paragraph 18(3.1)(b) the amount of such an expense would, to the extent that it would otherwise be deductible in computing a taxpayer's income for the year, be included in computing the cost or capital cost of the building.

It would be a question of fact whether any work carried out was more in the nature of repairs to the condominium unit rather than the renovation or alteration of that unit. Generally, subsection 18(3.1) is not intended to apply to periods during which general repairs are being undertaken; rather, subsection 18(3.1) requires more extensive work. You have not provided details as to the magnitude of the capital improvements which the taxpayer has made to the particular condominium unit therefore we cannot comment as to whether any portion of the interest expense should, or should not, be capitalized under this subsection.

We trust that these comments will be of assistance.

Yours truly,

Doug Watson
for Director
Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch