The deductibility of interest and taxes on vacant land is a topic that invariably causes confusion for many people, myself included. So, since I felt the need to brush up on the issue, I thought I’d subject you to the same torture.
To quote Maria von-Trapp, let’s start at the very beginning. That would be subsection 18(2), a very fine place to start. In its simplest application, it provides that interest and taxes on vacant land are not deductible. That’s a pretty well-known concept.
Income tax rules: Someday there will be a musical
OK, let’s jump ahead now to paragraph 53(1)(h). That’s the provision that allows us to add these disallowed expenses to the adjusted cost base of the land. Again, a simple concept.
So why the whole Tax Issue treatment? Well, for one thing, I’ve got space to fill; for another, it gets a bit more complicated.
Let’s jump back for a minute to 18(2). There are a few exceptions to the rule, whereby the expenses will be deductible. The provision does not apply at all, if the land was used in the course of a business at any time during the year. So, for example, if a piece of land was used at any time to store inventory, such as scrap metal, as part of a business, 18(2) would not apply and the expenses would be fully deductible. Note that the rule applies to a business. This means that rental use is not likely to qualify. Further, the exception does not apply to developers, who are subject to their own set of rules.
In the case of rental use, a second exception allows a deduction of interest and taxes to the extent of income for the year from the land; income may be offset, but no loss can be generated by these expenses.
Lets go back now to paragraph 53(1)(h) because the ACB adjustment may not be so clear cut. What many practitioners are surprised to discover (and often only find out during an audit) is that the non-deductible interest and taxes on vacant land is not automatically added to the ACB. In order for the ACB adjustment to apply, the expenses must have been disallowed by virtue of subsection 18(2). Flipping back there, we find that the expenses are disallowed in the calculation of net income from business or property. Therefore, the land must be part of a business or property income earning endeavour. If not, there is no ACB adjustment.
Typically this problem comes up in cases such as Bauerle v. MNR, where the taxpayer purchased a parcel of land in 1957, held it until 1981, and reported a capital gain on disposition. In calculating the ACB of the property, he added the interest and taxes for all the years he owned it. The tax court held that paragraph 53(1)(h) did not apply to increase the ACB because the land was not used or held in connection with the earning of income from a business or property. In such cases, the expenses are simply non-deductible capital expenses, and are lost.
Alternatively, an adjustment to the cost of land inventory may be available under subsection 10(1.1). The owner must hold the land as inventory, either as a developer or dealer. Any gain or loss on the sale of the land would, of course, be treated as ordinary income of the taxpayer.
This begs the question as to the treatment of an isolated purchase of land as an adventure or concern in the nature of trade. Such a purchase would classify the land as inventory and the disallowed expenses would be available as addition to the cost of inventory under 10(1.1). Again, any gain would be fully taxable as business income. Furthermore, whether a purchase of land is an adventure or concern in the nature of trade is a question of fact, and must be analyzed based on the circumstances. These factors include: (a) the taxpayer’s conduct; (b) the nature of the property; and (c) the taxpayer’s intention.
So the problem with vacant land is not as easy as A-B-C or even Do Re Mi. Blindly assuming that interest and taxes may be added to ACB could become a costly trap in the end