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Principal Issues: [TaxInterpretations translation] 1. What are the deductible expenses, entitlement to claim a loss, and loss carryforward for a rental operation that represents income from property?
2. What are the deductible expenses, entitlement to claim a loss, and loss carryforward for a bed and breakfast business that represents business income?
Position: 1. Deductible expenses from a rental operation that represents income from property are subject to paragraphs 18(1)(a), 18(1)(h) and section 67, and are referred to in inter alia Guide T4036. If the property is a rental property, the property is subject to the CCA rental property restriction rule. If the rental activity for a rental property is carried out for the purpose of earning income from the property, the rental loss is deductible from all income.
2. If the bed and breakfast is carried on as a business, the deductible expenses, which are subject to paragraphs 18(1)(a), 18(1)(h) and section 67, are essentially found in Guide T4002. If a taxpayer incurs expenses in excess of the income from the business, a business loss may be deducted from all of the taxpayer's income. However, home office expenses cannot create or increase a loss from the business. Home office expenses, which have been subject to such a restriction, may nevertheless be carried forward indefinitely to future years and deducted from business income in those future years.
Reasons: 1. Application of the Act and Regulations.
1. Application of the Act. By virtue of subsection 18(12) - which applies only to expenses used in a rental operation that generates business income - work space expenses cannot create or increase a loss from a business carried on in a home.
Lucie Allaire, Advocate,
CGA, D. Fisc.
July 26, 2010
Subject: Deductible expenses for operating a bed and breakfast and rental property
This is in response to your letter dated February 16, 2010, received by our Directorate on April 22, 2010, in which you requested our opinion regarding the deductibility of expenses incurred in the course of operating a rental property and a bed and breakfast.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
You inquired as to what expenses are deductible in the operation of a rental property and a bed and breakfast including, in particular, capital cost allowance ("CCA"). You also inquired about the loss carry forward rules.
It appears to us that the situation described in your letter and summarized below could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. However, we can offer the following general comments that may be helpful.
Generally, by virtue of paragraph 18(1)(a), in order to be deductible, expenses must be incurred by a taxpayer for the purpose of earning income from a business or property. In addition, paragraph 18(1)(h) explicitly precludes the deduction of a taxpayer's personal or living expenses in computing income from a business or property, other than travelling expenses incurred by the taxpayer in the course of carrying on the business while away from home. Finally, section 67 prevents the deduction of an otherwise deductible expense except to the extent that the expense is reasonable in the circumstances.
A taxpayer generally earns income from property if the taxpayer does no more than rent space and provides essential services. These essential services may include, but are not limited to, heating, lighting, parking, maintenance of furnishings provided in the rented premises, and laundry room services.
However, if a taxpayer provides additional services such as meal services, a continued supply of clean sheets, and supplies of bathroom items, the taxpayer's rental operation may be considered to be a business. The nature and number of services provided will determine whether a rental operation qualifies as a business.
Information on the eligibility of rental expenses related to income from property can be found in Guide T4036, Rental Income, which is available on our Web site at http://www.cra-arc.gc.ca/E/pub/tg/t4036/t4036-f.html. In this regard, Form T776, Statement of Real Estate Rentals, is used to record gross rental income, expenses, and to compute rental income or loss.
Thus, the operator of a bed and breakfast, who has a personal residence in which bed and breakfast rooms are rented out on a short-term basis, is generally considered to be carrying on a business. In this regard, information on the eligibility of expenses related to income derived from a business carried on in a home can be found in Guide T4002, Business and Professional Income, which is available on our Web site at http://www.cra-arc.gc.ca/E/pub/tg/t4002/READ-ME.html. To deduct expenses related to carrying on a business, an individual who carries on a bed and breakfast business can use Form T2125, Statement of Business and Professional Activities, particularly line 9945.
Notwithstanding the above, subsection 18(12) could apply to limit expenses in respect of a bed and breakfast business carried on in a self-contained domestic establishment in which an individual resides. For more information, please refer to Interpretation Bulletin IT-514 Work Space in Home Expenses at the following Internet address: http://www.cra-arc.gc.ca/E/pub/tp/it514/READ-ME.html.
Furthermore, a taxpayer may deduct, from all other income, a loss from a business or property arising when the total expenses from one of these sources is greater than the income generated. However, the taxpayer cannot deduct a loss if the taxpayer’s rental activity is primarily aimed at sharing personal expenses related to a building and not for the purpose of making a profit or with a reasonable expectation of profit.
Generally, business or property losses that have not been absorbed by income for the year may be deducted in computing taxable income as non-capital losses in the three preceding and twenty subsequent years by virtue of paragraph 111(1)(a).
Whether or not the rental of a building by an individual is a business, the property may be considered a "rental property" for purposes of the CCA restrictions under subsection 1100(11) of the Income Tax Regulations (the "Regulations"). Under subsection 1100(14) of the Regulations, a rental property is defined as a building owned by a taxpayer and used principally to gain or produce gross revenue that is rent. The term "principally" normally means 50% of the time for the purpose of gaining or producing gross revenue that is rent.
By virtue of subsection 1100(11) of the Regulations, a taxpayer may claim CCA that would otherwise be deductible in computing income for a taxation year in respect of classes of property owned by the taxpayer to the extent that the total amount does not exceed the excess of the taxpayer's rental income for the year (computed before any CCA claim is made) over the taxpayer's rental losses (computed before any CCA claim is made). Thus, by claiming CCA, a taxpayer cannot, in respect of a rental property, create or increase a loss.
Finally, in light of the facts you have described to us, it is possible that the change-in-use rules for a principal residence may apply to your situation. In this regard, we refer you to paragraphs 30 to 32 of Interpretation Bulletin IT-120 Principal Residence, which is available on our Web site at http://www.cra-arc.gc.ca/E/pub/tp/it120r6/READ-ME.html.
Finally, if you wish to request an adjustment to an income tax return for a previous taxation year, we suggest that you use Form T1-ADJ, which is also available on our Web site: http://www.cra-arc.gc.ca/E/pbg/tf/t1-adj/t1-adj-10f.pdf.
François Bordeleau, Advocate
Business and Partnerships Section
Income Tax Rulings Directorate.
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