Principal Issues: [TaxInterpretations translation] The taxpayer has bought a property which he rents to his daughter. The question is how should this rent be reported for tax purposes?
Position: In this case, the rental income is not taxable.
Reasons: Since the rental activity appears to have a personal aspect, it is necessary that the activity be carried on in a sufficiently commercial manner. If this is not the case, the CRA cannot conclude that a source of income exists.
2006-017113
XXXXXXXXXX Anne Dagenais
(613) 957-2121
January 10, 2006
Dear Sir,
Subject: Request for written interpretation
This letter cancels and replaces our letter of September 26, 2006, in which we commented on rental income on a residence in the situation described below. Please note that we have highlighted the change to the last sentence of the paragraph beginning "In the situation of an inter vivos gift [...]" on page 5 of this letter.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
Facts
The facts you have given us are as follows:
- Your wife (XXXXXXXXXX years old) and you (XXXXXXXXXX years old) have owned a bungalow in XXXXXXXXX for several years;
- Your daughter (XXXXXXXXXX years old) is a single parent with XXXXXXXXXX dependent children (XXXXXXXXXX years old) and had her rent increase every year and had to move constantly;
- Her gross annual salary is between $XXXXXXXXXX and $XXXXXXXXXX;
- In 2004, in order to help her and her children, you bought her a single-family home (bungalow) in XXXXXXXXXX;
- You still hold the title to the house;
- The purchase price of the house was $XXXXXXXXXX;
- You paid a cash deposit of $XXXXXXXXXX and later an additional payment of $XXXXXXXXXX;
- You stated that you consider the purchase of this house (which you say she will eventually inherit) to be part of the inheritance you are making to your daughter during your lifetime;
- Currently, she pays rent that varies from $XXXXXXXXXX to $XXXXXXXXXX per month to cover maintenance, insurance, municipal and school taxes as well as mortgage interest;
- You stated that since you do not intend to make a profit with this property, the rent will eventually decrease as the mortgage is repaid;
- According to the form which you have completed for 2005, the rental income indicated is $XXXXXXXXXX and the total expenses amount to $XXXXXXXXXX;
- Knowing that the rent charged for your daughter's rent is lower than that which you would charge a stranger, you are not claiming a rental loss for this property.
Question
Your question is how you should defer this rent for tax purposes.
Our comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue written opinions on proposed transactions otherwise than by way of advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
Inter vivos gifts - Acquisition of property by the taxpayer
In the situation as you describe it, we are of the view that the property you have acquired for the purpose of inter vivos donation is not a gift for tax purposes since the property is in your name at the time of acquisition. Thus, there are no tax consequences for you when you purchase the property.
Tax treatment of rental income from your daughter
Where an activity carried on by a taxpayer may have a personal or hobby aspect, it is necessary to determine whether the taxpayer's activity is carried on for profit in order for there to be a source of income for the purposes of section 9. In determining whether an activity with a personal aspect is carried on for profit, it will be necessary to consider whether the taxpayer is carrying on the activity in a sufficiently commercial manner. The question of whether an activity is carried on in a sufficiently commercial manner is a question of fact that can only be resolved after a full analysis of the facts surrounding a particular situation. That determination is usually made in the course of an audit assignment by our Tax Services Offices.
As stated above, the first step in this analysis is to determine whether the rental activity constitutes a source of income for purposes of the Act.
As stated by the Supreme Court, this aspect should only be analyzed if the activity in question has a personal or recreational aspect. Where an activity is clearly commercial, there is no need to analyze the taxpayer's decisions since there will, by definition, be a source of income whose purpose is to make a profit. In other words, the purpose of this section is to analyze the commercial nature of the taxpayer's activity.
In the event that the taxpayer's activity contains personal or recreational elements, our analysis will need to determine whether the taxpayer has a subjective intention to make a profit. That determination will have to be made in light of a number of objective factors, including the taxpayer's profit and loss history, the taxpayer's background, the path the taxpayer intends to follow, and the ability of the business to earn a profit. It should be noted that these criteria are not exhaustive and will depend on the particular activity carried out by the taxpayer.
In the situation you have presented to us, although the tax treatment to be accorded to the rental income from your daughter can only be established following an analysis of all the relevant facts and circumstances, we are of the view that, in view of the information you have given us, the activity has a personal aspect, so that it must be determined whether the taxpayer's activity is carried on in a sufficiently commercial manner.
Given your objective in purchasing the property, the low annual income received to date from the property and the low future rental cost envisaged and the high annual expenses incurred, it is difficult for us to argue that your rental activity can be a profitable business. Furthermore, although this is a question of fact, it would appear from the information you have provided that the rental business is not being operated in a sufficiently commercial manner. Indeed, you stated, among other things, that the price charged for the rent is below the market price. We are therefore of the view that the rental income should not be included in your income since it is not a source of income for the purposes of the Act.
Finally, we remind you that the Department of Finance had proposed on October 31, 2003 the addition of new section 3.1 in the Act applicable to taxation years beginning after 2004, which could have had an impact on the criteria set out above with respect to the situation you are presenting to us. Following public consultations, the Department of Finance announced in the 2005 Budget Plan, tabled in the House of Commons on February 23, 2005, that it will bring forward another legislative proposal that will take into account the concerns expressed during the consultation period.
Deductibility of expenses
Section 9 of the Act is the starting point for the analysis of the deductibility of expenses incurred by a taxpayer for a taxation year. Section 9(1) reads as follows:
"Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year."
By defining income from a business or property as the profit from that business - that is, the amount of income minus the related expenses - the Act implicitly permits the deduction of expenses incurred for the purpose of earning income from a business or property. Furthermore, under generally accepted business principles, only expenses relating to activities that generate income from a business or property are deductible. Similarly, paragraph 18(1)(a) prohibits the deduction of any expense unless it was incurred for the purpose of earning income from a business or property. In addition, paragraph 18(1)(h) explicitly prevents the deduction of a taxpayer's personal or living expenses in computing business income, except for travel expenses "incurred by the taxpayer while away from home in the course of carrying on the taxpayer’s business". Furthermore, according to section 67, the expense must be reasonable in the circumstances. Finally, the expense must not be of a capital nature.
Consequently, since we have already determined that your rental activity is not a source of income for tax purposes, the expenses you incur in connection with your rental activity are not deductible by virtue of paragraph 18(1)(a).
Eventual disposition of the property
Please note that the Act provides for tax consequences on the eventual transfer of ownership of a property. The transfer of ownership may be, among other things, an arm's length disposition, a non-arm's length inter vivos gift or change of use, or a death.
On a transfer by way of sale to a third party who is an arm's length person, the transaction constitutes a disposition for the purposes of the Act that may result in a taxable capital gain.
In the case of an inter vivos gift, where parties are not dealing at arm's length, the rules in subsection 69(1) apply. Under subparagraph 69(1)(b), where a taxpayer disposes of property to a person by way of an inter vivos gift, the donor is deemed to have received consideration equal to the fair market value ("FMV") of the property at the time of the gift. The donor is deemed to have disposed of the property with the possible consequence of a taxable capital gain. In a gift situation, the cost of the property for your daughter's tax purposes is deemed to be an amount equal to the FMV in light of paragraph 69(1)(c).
Under paragraphs 251(1)(a) and 251(2)(a), there is a non-arm's length relationship between the parties in a transaction involving related persons, such as a father and daughter.
In a situation of a change of use of a property, the rules of subsection 13(7) apply. Thus, where a taxpayer has acquired a property for personal use and begins to use it for another purpose, such as earning income, the taxpayer is deemed to have disposed of the property for proceeds of disposition equal to the FMV at the time of the change in use and to have reacquired it at a cost equal to that FMV. Again, this may result in a taxable capital gain.
Finally, where a taxpayer dies in a taxation year, the rules in subsection 70(5) apply. The taxpayer is deemed to have disposed of all of the taxpayer’s property at FMV immediately before the death. Any person who acquired the property is deemed to have acquired it at the time of death at FMV immediately before death. The person may have acquired the property as part of a succession settlement. For the deceased, a taxable capital gain may result from this deemed disposition.
For your information, when disposing of a rental property, we wish to inform you that you may be able to take advantage of the principal residence exemption when disposing of the residence if the property is used as a principal residence. However, it should be noted that a taxpayer may only designate one residence per family (i.e. you and your spouse) per year if the property meets the principal residence criteria. The term "principal residence" is defined in section 54 and the calculation of the principal residence exemption is set out in paragraph 40(2)(b). The principal residence exemption is intended to reduce or eliminate a gain on the disposition of a principal residence.
We hope you find these comments useful and encourage you to contact us if you require any additional information regarding the content of this document.
Finally, we regret the situation. Please accept our apologies.
Best regards,
Phil Jolie
Business and Partnerships Division
Income Tax Rulings Directorate
Directorate General for Policy and Planning