Deducting Interest on Borrowed Funds – Rental properties

The Income Tax Act permits a taxpayer to deduct a reasonable amount of interest paid or payable on the year that it was incurred, for the purpose of earning income from a business or property.  In the case of rentals or leasing properties, are there any differences if the property/loan is held by an individual or a corporation?

If held by an individual: The taxpayer will deduct all rental expenses including the loan interest, from the rental income.  As the taxpayer would be subject to capital cost allowance (“CCA”) restrictions, the taxpayer will be unable to claim CCA to create/increase net rental loss; the taxpayer may run into a situation where they cannot claim the maximum amount of CCA allowed.

If held by a corporation:  Although the corporation is subjected to the same CCA restrictions, the tax deductions may be maximized if the interest expense is incurred outside of the corporation, such as from the shareholder loan.  As long as the interest paid by the shareholder qualifies for deduction under the Act, the amount of CCA that may be claimed is maximized along with the rental income that is earned.

There are 2 ways a shareholder can generally inject capital into a corporation:

1. By lending money with or without interest to the corporation,
2. By subscribing for equity of the corporation, either common shares or preference shares.

When a shareholder personally borrows funds and loans these funds to a corporation, the deductibility of the interest generally depends on whether the loan is made for the purposes of earning income.  The term “income” was addressed by the courts which indicated that “income” does not mean “profit” or “net income”.  Consequently, if interest is charged on the loan to the corporation, the interest incurred by the shareholder is generally deductible.  In case of subscription for shares, where shares carry a stated dividend rate, the requirement that the acquired property produce income is generally met.  As common shares do not have specified dividend yields, the CRA usually considers there to be a reasonable expectation of dividends, so that interest on borrowed funds is deductible.  However, such a determination must be made based on an analysis of the facts in each situation.

This article is intended for general information purposes only and does not constitute professional advice.  Income tax law and regulation change frequently and the content on this article may no longer reflect the current state of the law. If you have any specific questions, you should consult a professional services advisor or email us for further advice.