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Lecture

3520-3- updated JF-revised.doc

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Department
Administrative Studies
Course
ADMS 3520
Professor
All Professors
Semester
Fall

Description
3520-3: 9/25/2008 1 1 Lecture 3: Income from Property, Capital gains and Capital Losses 1.1 Topics Covered This weeks lecture looks at the basics of how investments are taxed, i.e. the taxation of interest, dividend and rental income (earned while the investment is held) and the taxation of capital gains and losses (generally earned when an investment is sold). CTP ch. 6 covers property income and expenses, i.e. how dividend income, interest income, rental income and other types of property income are taxed and the expenses that can be deducted against this income. CTP ch. 7 covers capital gains and losses, i.e. how the gain on the sale of an investment (including your home) is taxed during your lifetime. As before, urls to background materials are included for those who are interested. 1.2 Designated problems Exercises 6-3, 6-6 to 6-8, self-study problem 6-3 Exercises 7-2, 3, 21, 22 and 25. 2 Property Income [6-2 to 6-4] passive income from investments (investment income) most interest, dividends, rental income (minus expenses) and royalties In some cases, a corporation's activity of earning property income can be considered an active business, e.g. a corporation earning investment income because of the number of employees (more than 5 full-time employees throughout the year) Most of the rules in subdivision b of Division B of Part I of the ITA apply to both income from business and property 2.1 A few significant differences between business and property income: You cannot generally create or increase a property loss with CCA e.g. a rental loss with CCA For a background note on CCA, see http://www.parl.gc.ca/information/library/PRBpubs/prb0606-e.htm You cannot deduct cumulative eligible capital amount (CECA) and convention expenses against property income (only business income) Attribution rules apply to property income (and capital gains, in the case of spousal loans and transfers) but not business income. Jason Fleming [[email protected]] 3520-3: 9/25/2008 2 You cannot deduct home office expenses against property income according to the case law 2.2 Interest Expense [6-5 to 6-9] The general rule allowing the deduction of interest expense is ITA 20(1)(c). The conditions are as follows: The interest expense must be pursuant to a legal obligation, e.g. a signed agreement meet a purpose test = to produce income from business or property (not capital gains) relate to funds directly used for that income-earning activity Read 6-6, 6-8 and 6-9 2.2.1 Deemed Interest Expense [ITA 80.5] The deemed interest benefit on employee loans is deemed to be interest paid for purposes of ITA 20(1)(c) and 8(1)(j) 2.2.1.1 Examples The imputed interest benefit on a loan made to an employee to buy company shares is typically deductible (since the shares (can) earn dividend, i.e., property, income) The interest benefit is reported as employment income. The interest (deemed paid) can be deducted as an investment expense under ITA 20(1)(c) The imputed interest benefit on a loan to buy a car for employment use is typically partially deductible All of the interest benefit is reported 100% as employment income. The interest (deemed paid) can be deducted partially (i.e., the % used for employment purposes) as employment expense under s. 8(1)(j) 2.2.2Frequently asked questions Is home mortgage interest deductible? Home mortgage interest may be deductible if the funds from the mortgage are used directly to earn income from business or property. The term mortgage means that real estate = collateral for the loan. Funds from most home mortgages are used to buy a house to live in. But if part of the house is rented or used for a business, then a portion of the interest may be tax deductible. Jason Fleming [[email protected]] 3520-3: 9/25/2008 3 Alternatively if the house is purchased with cash (or the mortgage is paid off) and the house is re-mortgaged and the cash from the bank is invested directly to produce income from a business (see Singleton case at 6-12 to 6-14) or property (mutual funds, shares), the interest will be deductible. Is interest on money borrowed to buy investments deductible? The interest may be deductible if the funds are used directly to earn income from business or property. 2.2.3Examples of interest expense which is deductible are cases where the money is used to buy: Common shares because of potential to pay unlimited dividends. Real estate rental property as long as there is a reasonable expectation of profit (excluding capital gains) from the rental property Preference shares or interest-bearing investments but the deduction is limited to income earned (grossed-up dividends or interest) because the related income stream is fixed Gold bars/commodities/foreign exchange interest is deductible if profits reported as business income interest is not deductible if profit is reported as a capital gain because capital gains are not "income from business or property" 2.2.4 Examples of non-deductible interest expense include cases where the money is used to Make interest-free loans to family members because not incurred to earn income Make an RRSP contribution because ITA 18(11) denies the deduction Buy a cottage since a personal use property [ITA 18(l)(h)] Interest paid on late payments under the ITA is not deductible [ITA 18(l)(t)] 2.3 Interest Income [6-46 to 6-53] Any interest earned and received during the year is taxed Interest earned during a year but not received until after the end of the year is also taxed using an "accrual" method Jason Fleming [[email protected]]
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