Principal Issues: Deductibility of interest on a line of credit that is secured on a principal residence.
Position: General comments only.
Reasons: Mixed question of fact and law. We have no information on how the borrowed funds were actually used or what the current use would be.
XXXXXXXXXX 2009-031032
Michael Cooke
May 8, 2009
Dear XXXXXXXXXX :
Re: Work-Space-in-Home
We are writing in response to your correspondence dated February 16, 2009. Briefly, you ask whether interest payable under a line of credit secured by a self-employed taxpayer's principal residence is deductible as a work space in the home expense under subsection 18(12) of the Income Tax Act (the "Act").
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. This Circular and other publications referred to in this letter are available on our website at http:///www.cra-arc.gc.ca. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office, a list of which is available on the "Contact Us" page of our website. While we are unable to provide comments on your specific fact situation we are able to offer the following comments.
As discussed in Interpretation Bulletin IT-514 - Work Space in Home Expenses, in computing income from a business for a taxation year, subsection 18(12) of the Act provides that otherwise deductible expenses may be deducted in respect of a work space in the home only if certain conditions are met. Specifically, the work space must be either
(a) the principal place of the business of the individual, or
(b) used exclusively to earn business income and on a regular and continuous basis for meeting clients, customers or patients of the individual in respect of the business."
Furthermore, work space expenses must not exceed the income from the business for the taxation year, determined prior to deducting such expenses and without reference to the off-calendar and stub period provisions in sections 34.1 and 34.2 of the Act. In other words, work space expenses cannot create or increase a loss for income tax purposes from the business for which the work space is used.
As described in paragraph 4 of IT-514, work space expenses may include electricity, heating, water, insurance and, where the individual owns the home, a portion of the property taxes and mortgage interest. In order for mortgage interest on a principal residence to be deductible under subsection 18(12) of the Act, such interest must otherwise be deductible under paragraph 20(1)(c) of the Act in computing income from that business.
Generally speaking, where borrowed money is used to purchase a principal residence any interest on such borrowed money would not be deductible because under the "current use test" used by the courts the borrowed money would not have been used for the purpose of earning income from a business or property. In determining the current use of borrowed money, taxpayers must establish a link between the money that was borrowed and its current use. If there is no link to a current eligible income-earning use then the interest would not be deductible under the Act. For more information on the CRA's views concerning the deductibility of interest please refer to Interpretation Bulletin IT-533 - Interest Deductibility and Related Issues.
We note that where an individual commences to use a portion of his or her principal residence as a work space (i.e. an income-earning use), paragraph 45(1)(c) of the Act generally results in a deemed disposition and reacquisition (at the property's fair market value) of the portion of the principal residence so converted to a business use at that time. However, as described in paragraph 32 of Interpretation Bulletin IT-120R6 - Principal Residence it is the CRA's practice not to apply this deemed disposition rule where all of the following conditions are met:
(a) the income-producing use is ancillary to the main use of the property as a principal residence,
(b) there is no structural change to the property, and
(c) no CCA is claimed on the property.
As such, where an individual commences to use a portion of his or her principal residence as a work space, as described above, an amount of interest on the borrowed money that was used to purchase that principal residence may be deductible as a work space expense. The deductible amount of interest should generally be determined by using the same proportion, determined on a reasonable basis, that the work space (i.e. the current eligible income-earning use) is of the principal residence and taking into consideration the personal use, if any, of the work space. For more information on these rules please refer to IT-120R6 and paragraph 4 of IT-514. Lastly, where money was borrowed under a line of credit that was secured by an individual's principal residence it remains a mixed question of fact and law as to whether interest on such borrowed money would be deductible under paragraph 20(1)(c) of the Act and whether a portion of such interest, if otherwise deductible, would be subject to the rules in paragraph 18(12) of the Act. However, where the borrowed funds were used to pay for personal items such as a vacation or home improvements that are unrelated to the work space, such as the installation of a swimming pool, no amount of interest would be deductible.
We trust that these comments will be of assistance.
Yours truly,
Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch