Andy owns a small home free and clear. He plans to move to a new larger home soon. He had hoped to rent out his old home to make some rental income. His plan had been to take out a mortgage on the old home and use this money to reduce the size of the mortgage on his new home. A side benefit Andy hoped for was using the interest on the mortgage on the old house once it becomes a rental property as a deduction against the rental income.
Unfortunately, CRA won’t allow this. From CRA’s point of view, the borrowed money wouldn’t be used to purchase an investment, but would be used to buy Andy’s new home. The following Q and A on page 12 of CRA’s Rental Income guide explains CRA’s thinking:
Q. I own and rent a semi-detached house. This year, I refinanced the property to increase the mortgage because I needed money for a down payment on my personal residence. Can I deduct the additional interest on the mortgage against my rental income?If Andy were to go out and find some new rental property and buy it using borrowed money, then the mortgage interest on the rental property would be deductible against his rental income. This situation seems absurd. It’s hard to see any important difference between this scenario and what Andy hoped to do other than the fact that CRA treats them differently.
A. No. You are making personal use of the funds you got from refinancing your rental property. As a result, you cannot deduct the additional interest when you calculate your net income or loss from your rental property.
Perhaps CRA has the current rules in place to prevent clever schemes that skirt the intent of the rules and Andy is collateral damage. The end result is that Andy has to sell his current home and buy some different rental property if he wants to deduct mortgage interest. One solution suggested to Andy was to sell the old home to a family member or friend and then buy it back using a mortgage lump sum. I’d be worried that CRA wouldn’t accept the validity of these transactions.
If there are any readers who know of an easy way to solve Andy’s problems without entering into multiple expensive and pointless real estate transactions, I’m sure Andy would be happy to hear about it.