Cash Damning - mortgage interest as a deduction -

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."

  A couple of cases on expectation of profit were won by the taxpayers but OParliament plugged the wins for the future with the issuing of Bulletin IT-533 which essentially says that to deduct the interest in any one year, you must have an expectation of a rental profit sometime in the future.  This expectation of a rental profit is easy to produce by projecting an increase in rents, taxes, repairs, etc and a future decrease in interest as you eventually start paying off the mrtgage.  Thousands of MURBS (Multiple Unit Rental buildings) were sold with the actaul rental profits starting in the tenth or eleventh year.

You can read the bulletin here.

http://www.ccra-adrc.gc.ca/E/pub/tp/it533/it533-e.html#P138_15186

With regard to why teh interest on interest is dedcutible, I want you to pretend that the rental sat empty for three months.   If you had to borrow money to pay the payments, it is clear that the interest would be dedcutible.  It was a situation like this in 1974 that first tipped me off on how you coyuld make a mortgage deductible in Canada.  You could also get hold of Fraser Smith's Book the Smith Manouver.

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