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TaxRobin, Senior Tax Advisor
Category: Canada Tax
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Experience:  More than 20 years tax expertise
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I own a rental property (A) with $X equity on it. Recently

Customer Question

I own a rental property (A) with $X equity on it. Recently we purchased a new property (B) as our primary residential property with $Y mortgage on it.
My question is if we borrow $X equity from property A to partially pay off property B mortgage ( $Y is greater than $X), the interest on borrowing $X equity on rental property (A) is tax deductible?
The Canada Revenue Agency [Line 8710 - Interest] reads: …You can deduct interest on money you borrow to buy or improve your rental property…
Submitted: 1 year ago.
Category: Canada Tax
Expert:  Rick Martin replied 1 year ago.

Hi, I'm happy to help. Please tell me the business purpose of obtaining financing on the rental property to pay down the mortgage on the primary residence. For example, is it to secure a lower interest rate?

Expert:  Rick Martin replied 1 year ago.

I would like more information to answer you more completely, but based on what you have provided, no the interest would not be deductible because the proceeds from the loan are not being used to buy or improve. I kindly ask that you provide a positive rating on my response, and I am available for any follow up questions you may have.

Expert:  Rick Martin replied 1 year ago.

If you plan on deducting the interest, you should keep documentation to support that the amount of loan proceeds from financing the rental property were used dollar-for-dollar to pay down the mortgage on the primary residence. The "buy or improve" rule is not tied to the rental property and can be applied to the primary residential property. In that regard, the position taken might be that loan proceeds were used to "buy" the primary residence, albeit after the original purchase date. The tax rule is meant to ensure that funds are channeled back into the property. Whether it is via improvements or via loan pay down should make no difference.

Customer: replied 1 year ago.
Thanks for the reply. When we signed the mortgage contract for the new residential property (B), we then managed to rent out our old property (A). Some one then brought up the fact that we could have asked for a mortgage on the rental property (A) instead of new residential property (B) just because that way the interest on the mortgage could be written off as an expense for the rental property. but this is after the fact.Yes, my main plan is deducting the interest. I then called the bank and requested switching our mortgage from property (B) to rental property (A). They said it cannot be done BUT I can advance my $X equity on rental property (A) to pay off partial amount for mortgage payment on residential property (B). They didn't recommend this because they weren't familiar with tax rules and whether or not this way we achieve our goal to write off interest on equity loan on property (A). They recommended consulting with an accountant or tax expert.From your last statement, I understand that " yes, we can do that and the interest on the equity loan to pay the mortgage can be written off as expenses". Could you please clearly confirm this.thanks
Expert:  Rick Martin replied 1 year ago.

Please give me a moment to review your response and I will clarify my answer. I understand your situation.

Expert:  Rick Martin replied 1 year ago.

The advantages of deducting mortgage interest expense against a rental property income vs. deducting it against ordinary income are debatable, so don't think you automatically missed out on something by not taking out a loan on the rental property. For example, if the interest had been tied to the rental property, and you didn't have any rental income in a given year, you might be in a different place than if you were deducting the interest as ordinary mortgage interest against ordinary income.

Expert:  Rick Martin replied 1 year ago.

Based on what you have clarified, it all depends on whether property A is characterized in your tax filings as a rental property or as a second home. If it has already been characterized as a rental property, the interest is not deductible. If property A were a first or second home, the answer would be different. The debt must be secured by a qualified home in order to be deductible, meaning first or second home but not a rental property. I hope this helps answer your question, although it is not the answer you were hoping for.

Expert:  Rick Martin replied 1 year ago.

Is it an electric vehicle, passenger vehicle, truck or van?

Expert:  Rick Martin replied 1 year ago.

Please disregard that last response. And please feel free to ask me any follow up questions on your tax matter. -Rick

Expert:  TaxRobin replied 1 year ago.


Totally different expert.

I am not sure if the first expert to respond to you realized your are asking under Canadian Tax Law.

CRA will argue that the actual use of the money that was borrowed was to pay off a mortgage on a new principal residence (Property B), and therefore the borrowed money was not used for the purpose of earning income.

Even if the bank had allowed you to switch the loan you still used the money to buy a new home not a rental property. Your intention or purpose for borrowing money is irrelevant when it comes to deducting interest. The assets you pledge as security for the debt are also irrelevant. All that matters is direct use of the borrowed money.

I sincerely ***** ***** could tell you differently.