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QUESTION:
We are purchasing a condo in a major city in Canada with a line of credit on our existing home in another province. Our son will live in the acquired condo but will be paying rent to stay there. Would this be considered rental or investment property, and if so, would we be able to claim the interest being paid on the mortgage and any other fees incurred in looking after this new property?
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david ingram replies:
It does not matter if the condo is next door, in another province or another country: if it is rented to a mother, father, brother, sister, child, grandchild or any other non arm's length individual (a business partner for instance), the CRA will not allow a loss to be created and used against your other income to create a tax refund.
Of course, there is an exception. The exception is "if" you bought a rental unit in a building where there are a lot of units and the rental value has been clearly established. If you can prove that you are renting the unit to your son at Market Value, a loss can be allowed.
The following was taken from the 18th edition of my Ultimate Income Tax Guide. You can read it all at www.centa.com find it on the left hand side of the screen under Tax Guide
In 1986, Ivan Glavanovic lost his claim for five years of rental losses. He had built a house for sale in 1975 and was unable to sell it. He therefore rented it out at a loss for six years. DNR turned down his losses for 1979 and 1980. Judge Tremblay of the Tax Court of Canada agreed with DNR. He ruled that the rental was not to earn income but to hold on to the property. The losses were therefore capital in nature and should be added to the adjusted cost base of the house. It was also clear that there was no reasonable expectation of profit from the rental.
Also in 1986, Kelvin Lee found the same thing. He had rented his house on an option to purchase. Judge Couture of the Tax Court of Canada ruled that the renting while holding had no expectation of profit and was not deductible.
in 1989, Virginia Maloney was turned down by Judge Mogan of the Tax Court of Canada. She had rented her house to her mother. The rent charged was not realistic with regard to the cost of and the maintenance to keep up the property. Ms Maloney had charged her mother $100 rent in 1984 with $4,600 of expenses and $1,800 rent in 1985 with $11,000 of expenses. See Special Problems below.
and in 1990, Michel-Guy Huot was also turned down for a deduction when he rented a house to his parents for less than market value. Judge Garon of the Tax Court of Canada ruled that the taxpayer "Had failed to establish that the rental expenses were incurred in order to earn income." Because of the low rent and the uncertainty of their stay, there was no "expectation of profit." (See Expectation of Profit Section at back of book for more information on this subject."
DOUBLE WARNING!!
In September 1986, Louis Vaillancourt lost his claim for CCA on a class 31 building which was part of a 44 unit limited liability partnership operation of a motel/hotel deal at a ski resort. The tax office rejected the claim on the grounds that it was not `residential' property but a motel room. I agree with them. What is interesting and of danger to many MURB purchasers is that in giving his decision, Judge Pinard of the Federal Court Trial Division gave a ruling that no individual apartment (condo) in a multiple unit building could qualify anyway. This means that 200,000 MURBs sold in Canada are suddenly not tax deductions. It is my understanding that DNR is going to ignore this ruling in terms of blanket enforcement, and will only use it when there are obvious attempts to take advantage of the policy. In particular, they will attack all units at ski or summer resorts.
SOFT COSTS
And in 1988, Ercole Tertulliani and Clement Cardin had their claim for soft costs turned down by Judge Couture of the Tax Court of Canada. They had purchased condominium units in a building which was not yet constructed. Clause 16 of the offer to purchase stated "Possession of and proprietary title to the property shall be transferred to the purchaser only upon execution of the sales contract". As the sales contract was only executed after all the monies had been paid, it was impossible for the purchasers to have spent the soft costs in the course of building their units. As every `soft cost' deal I have ever seen is structured in a similar manner, it is logical to assume that any other soft cost deals would fail if they were challenged by the department.
SPECIAL PROBLEMS
Common situations that also cause problems are:
(a) rentals to members of your own family (see Virginia Maloney above)
(b) rentals at unreasonably low rates to friends, business associates, or employees
(c) rentals of property where you use all or part of the premises some of the time for personal use.
In the first case, (rentals to members of the family such as your mother, father, brother, sister, son or daughter, or any of the respective in-laws), it is important to know that usually a loss cannot be created. If a father rents a building to a son and loses money in the deal, the tax office may not allow the loss because of the artificially low rent (i.e., renting a $500 per month house to a son for $100 per month). On the other hand, if the father was renting to the son at the same rate as to others and a loss was being incurred, the father should claim the loss as a tax deduction.
With regard to rentals to business associates or friends, we have a slightly different problem. If an employer provides a house for an employee at an unreasonably low rent, the difference between "fair" market value and actual rent charged should be added to the employee's T4 slip as a taxable benefit.
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