Buckwold 21e - CH 7 Selected Solutions

Buckwold, Kitunen and Roman, Canadian Income Taxation, 2020-2021 Ed.
CHAPTER 7
INCOME FROM PROPERTY
Review Questions
1. Although the Income Tax Act specifically refers to property income as a separate type of
income, it does not provide a specific definition of the term. Identify the source from which
the definition of property income is derived, briefly explain the term’s meaning, and provide
examples of income from property.
2. Distinguish between income from property and the gains or losses that may occur from
the sale of property.
3. Interest income earned on loans by a financial institution may, for tax purposes, be
classified in a different way from interest income earned on loans by taxpayers who are
investing their savings. Explain why.
4. Briefly explain how income from property is determined for tax purposes.
5. Compare and contrast the taxation year of an individual with that of a corporation with
respect to the determination of business income and property income.
6. “An individual can deduct for tax purposes the interest expense incurred on the mortgage
loan attached to his or her personal residence.” Is this statement true? Explain.
7. A taxpayer has sold property (land) for $200,000 that was originally purchased for
$70,000. The property was sold to an arm’s-length party (not related). The terms of sale
involve a cash payment of $100,000 on closing, with the balance to be paid at $20,000
per year for five years, with no interest charged on the unpaid balance. For tax purposes,
what types of income may result for the vendor from this transaction?
8. An individual invests in a bank term deposit on July 1, 20X0. When does the individual
recognize the interest income for tax purposes if the investment has a term of three years,
with interest compounded annually but paid only at the end of the three-year term? Would
your answer be different if the taxpayer were a corporation? Explain.
9. Can a taxpayer deduct a reserve for unpaid interest on a loan if the interest appears not
to be collectible? Explain. How does the treatment of unpaid interest compare with the
treatment of the loan principal when its repayment is in doubt?
10. Briefly explain why an individual who receives dividends from a Canadian corporation
must include 115% or 138% of the dividend received in income for tax purposes, while a
corporation receiving the same dividend includes only the actual amount of the dividend.
11. “If a loss occurs from the renting of real estate (that is, if annual expenses exceed rental
income), the loss is not recognized in determining a taxpayer’s overall net income for tax
purposes.” Is this statement true? Explain.
Copyright © 2020 McGraw-Hill Education Ltd. 1

Instructor Solutions Manual Chapter Seven
12. A building that costs $200,000 and is rental property will always create a terminal loss or
a recapture of capital cost allowance when it is sold. The same result may not occur if the
building is used directly in a business activity. Explain this.
13. An investor in real estate may achieve a higher rate of return by acquiring a small portion
(part ownership) of several properties, rather than a lesser number of whole properties.
Explain this.
14. Why is the purchase of rental real estate often referred to as a “tax-sheltered” investment?
15. Often, an enterprise conducting an active business will separate its business operations
from its appreciating assets (such as real estate) by establishing a separate corporation
for each. How may this type of structure impair future expansion activities?

Solutions to Review Questions
R7-1. The definition of property income is derived from common law precedents. From this source
income from property can be defined as the return on invested capital where little or no
time, labour or attention is expended by the investor in producing the return. Property
income includes the interest earned on bonds and loans, dividends earned on shares of
corporations and rents earned from real estate [ITA 9(1)].
R7-2. Income from property refers to the regular returns derived from ownership of the property
(such as dividends from shares). The gain or loss which results from the actual sale of the
property is classified either as a capital gain (loss) or business income (loss) depending on
the purpose for acquiring the property [ITA 38, 39(1)].
R7-3. Interest income earned by a financial institution such as a bank or trust company is normally
classified as business income because substantial cost and effort is expended to earn the
interest -- the loaning of money is a part of the entity’s business. A taxpayer who earns
interest from investing their savings earns property income because little effort is required
to generate and maintain the returns.
R7-4. Income from property is determined using the same rules as income from business. It is
the profit determined in accordance with well accepted business principles with the aid of
normal accounting principles. Similar to business income, the determination of profit is
modified by several general limitations and can apply the same exceptions to those
limitations [ITA 9(1)].
R7-5. The taxation year of a corporation is the fiscal period chosen to account for its affairs.
Therefore, both business income and property income are determined annually for the
corporation's fiscal year.
In contrast, property income earned by an individual cannot use a fiscal period and must
be accounted for on a calendar year basis. For individuals carrying on business a calendar
year end is required, however, an election to use an alternative method is available [ITA
34.1].
R7-6. Yes, the statement can be true. Interest expense on a loan is deductible in arriving at
property income provided that the funds obtained from the loan are used to acquire an
investment which in turn can generate taxable income [ITA 20(1)(c)]. Therefore, if an
individual borrows money by mortgaging a home and uses the funds to acquire an income
generating investment (and does not use the funds to buy the home) the interest is
deductible.
R7-7. Because the property is sold to an arm’s length buyer with substantial deferred payments
without interest, it may be construed that the selling price of the property was increased in
exchange for the elimination of interest. In such circumstance, a portion of the price may
be considered to be property income from interest and taxed accordingly.
The gain on the sale of the land (less the imputed interest) may be a capital gain if the land
was originally acquired by the vendor to provide a long-term benefit and was not purchased
for resale at a profit. As the capital gain is only 1/2 taxable, the reduced capital gain and
enhanced interest income results in a greater taxable amount. On the other hand, the gain
on sale of the land may be business income, in which case treating it as property income
(interest) or business income would result in the same taxable amount.
R7-8. The individual must recognize the interest earned to each anniversary day (annual accrual
method) from the issue date of the investment. Therefore, no income would be recognized
in 20X0. But income from July 1, 20X0 to June 30, 20X1 would be included in the 20X1
taxation year [ITA 12(4), (11)]. Income earned from July 1, 20X1 to June 30, 20X2 would
be included in the 20X2 taxation year. And income earned from July 1, 20X2 to June 30,
20X3 would be included in the 20X3 taxation year.
If the taxpayer is a corporation it must use the accrual method at all times. Income from
July 1, 20X0 to December 31, 20X0 (assuming December 31 is the corporation’s year end)
would be recognized in the 20X0 taxation year [ITA 12(3)].
R7-9. Using the same rules for determining income from business it can be ascertained that a
deduction for a reserve for uncollectible interest on a loan can be made. Although the
general limitations prohibit the deduction of reserves, a specific exception is made for
uncollectible amounts which have previously been included in income. Provided that the
uncollected interest has been previously recognized as income, a reserve is permitted [ITA
20(1)(l) & (p)].
However, a reserve is not permitted for the uncollectible principal of the loan because it did
not create income when it was established. If, however, it was part of the taxpayer's normal
course of business to lend money, a reserve for the principal is permitted. [ITA 20(1)(l) &
(p)].
R7-10. Dividends received from a corporation represent corporate earnings that have already been
taxed in the corporation. In order to diminish or eliminate the incidence of double taxation,
a different mechanism exists for shareholders who are individuals and for shareholders who
are corporations. Individuals are taxable on the receipt of dividends, but that tax is reduced
by a dividend tax credit which theoretically is equal to corporate taxes paid (27.5% or 13%).
Therefore, an individual includes 138% of the eligible dividend received and 115% of the
non-eligible dividend received in income, which is supposed to represent the pre-tax income
of the corporation that has been distributed. For example, corporate income of $1,000 less
corporate tax of 13% ($130) leaves $870 available for a dividend distribution. The individual,
on receipt of a $870 non-eligible dividend includes $1,000 in income, calculates personal
tax, and then reduces that tax by the dividend tax credit which is equal to $130 [ITA 82(1)(a),
(b), 121].
If, however, the shareholder is a corporation, double tax is avoided by removing the
dividend from taxable income altogether. As there is no dividend tax credit there is no need
for the gross-up. A corporation simply includes the actual dividend in net income and
removes the full amount when calculating taxable income [ITA 112(1)].
R7-11. The statement is not true. A loss from real estate rentals can be used to offset other types
of income. However, a rental loss cannot be created or increased by a capital cost
allowance (CCA) deduction [Reg. 1100(11)]. Therefore, where expenses before CCA
exceed the revenues an actual loss is recognized but the loss cannot be increased further
by CCA.
R7-12. Each building that is classified as a rental property to its owners and costs more than
$50,000 must be included in a separate capital cost allowance class to which no additions
can be made [Reg. 1101(1ac)]. Therefore, the sale of one building combined with the
purchase of another is not pooled, and the sale will result in a recapture or terminal loss
unless the selling price is equal to the property's undepreciated capital cost.
All buildings owned and used directly by the owner in a business are pooled together in a
single class. Therefore, the sale of one building in a pool of several buildings, or the sale of
a building combined with the replacement of another, may not result in a recapture or
terminal loss. [Note that it is possible to place buildings meeting certain requirements into
a separate Class 1.]
R7-13. If an investor purchases a fewer number of larger real estate properties (each costing over
$50,000), the opportunity to dispose of a lower quality property in order to acquire a better
quality property is diminished, because the cash available on the sale of the first property
may be reduced by tax on the recapture of capital cost allowance. However, if a larger
number of lower cost properties (each costing less than $50,000) are acquired, the sale of
one to acquire a better quality property may defer the tax on recapture due to the fact that,
the properties are pooled in a single capital cost allowance class. Therefore, more cash is
available for replacement.
Of course, one must also consider the marketability of properties that are partly owned
compared to properties that are wholly owned.
R7-14. Real estate is often referred to as a tax-sheltered investment because it permits the
deduction of capital cost allowance even when it is not an actual expense and bears no
relationship to economic reality. Capital cost allowance is an arbitrary allocation of a
building cost, which does not take into account the estimated salvage value of the property.
In many cases, the sale of a building, results in substantial recapture of capital cost
allowance indicating that the previous deductions of capital cost allowance were too high.
Therefore, annual rental income is subject to annual reduced tax in exchange for the
payment of tax, at a later time (recapture). In effect, a portion of the annual rental income
is sheltered from tax until the property is sold and this enhances annual cash flows.
R7-15. By separating the appreciating property from the corporation in which the business is
carried on, the property becomes classified as rental property. Therefore, the normal
transaction of selling a smaller building to replace it with a larger building as part of an
expansion program will result in diminished cash flows from recapture of capital cost
allowance, impairing the expansion capability (each rental property over $50,000 falls into
a separate class).
On the other hand, this diminished cash flow could be avoided if the building were held
directly in the business corporation as a business asset because the sale and replacement
activities are pooled in the same class.
The replacement property rules allow a taxpayer who incurs a capital gains and/or recapture
on the disposition of a former business property to elect to defer the capital gain and/or
recapture to the extent that the taxpayer reinvests the proceeds in a replacement property
within one year or 12 months after the end of the taxation year in which the disposal takes
place [ITA 13(4); 44(1)]. The taxpayer can take advantage of these rules even if the property
is held, separate from the business as long as the person who owns the property is related
to the entity, which uses the property to carry on business. Former business property is
defined in ITA 248(1) as a capital property used by the taxpayer or a related person for the
purposes of earning income from a business. These rules are discussed in Chapters 6 and
8.
______ ___

Key Concept Questions
QUESTION ONE
Determine the amount of interest to be included in income in Years 1, 2, and 3 for each of the
following situations.
• Percel Ltd. has a December 31 year end. In Year 1, Percel purchased a $10,000 bond on
its issue date of November 1. The bond pays interest at 6% compounded annually. Percel
will receive interest when the bond matures on October 31, Year 3.
• Debra Singh purchased a $10,000 bond on its issue date, November 1, Year 1. The bond
pays interest at 6%, compounded annually. Debra will receive the interest when the bond
matures on October 31, Year 3.
CPA Competency 6.2.2 & 6.3.2 Interest income. Income tax reference: ITA 12(1)(c), 12(3), (4),
(11).
QUESTION TWO
Anne Williams received the following dividend income during the current year:
• $1,000 of eligible dividends from taxable Canadian corporations
• $1,000 of non-eligible dividends from taxable Canadian corporations
• $1,000 of foreign dividends. The foreign country withheld $150 in foreign tax and Anne
received the net amount of $850.
Determine the amount of dividend income to be included in Anne’s property income for the current
year.
CPA Competency 6.2.2 & 6.3.2 Dividend income. Income tax reference: ITA 12(1)(j), (k), 82(1).
QUESTION THREE
A Ltd. received the following dividend income during the current year:
• $1,000 of eligible dividends from a taxable Canadian corporation
• $1,000 of non-eligible dividends from a taxable Canadian corporation
Determine the amount of dividend income to be included in A’s property income for the current
year.
CPA Competency 6.2.2 & 6.3.2 Dividend income. Income tax reference: ITA 112(1).

QUESTION FOUR
At the end of the current year, 2020, Fred Hicks owned two residential rental properties. Rental
property #1 cost $125,000 (land $50,000; building $75,000) and at the close of last year had a
UCC of $64,000. Rental property #2 was acquired in the current year for $210,000 (land $80,000;
building $130,000). Revenue and expenses for the rental properties during the year were as
follows:
Property #1 Property #2 Total
Revenue $13,200 $4,500 $17,700

Expenses:
Mortgage interest (0) (3,000) (3,000)
Repairs & maintenance (5,000) (0) (5,000)
Property tax (3,100) (1,000) (4,100)
Insurance (500) (200) (700)
(8,600) (4,200) (12,800)
Income $ 4,600 $ 300 $ 4,900
Determine the maximum CCA deduction for the rental properties for the current year.
CPA Competency 6.2.2 & 6.3.2 Rental income. Income tax reference: Reg. 1100(11),
1101(1ac).

Solutions to Key Concept Questions
KC 7-1
[ITA: 12(1)(c), 12(3), (4), (11) - Interest income]
In both cases $1,236 of interest will be earned and received on the maturity of the bond on
October 31, Year 3.
Nov 1, Year 1 to Oct 31, Year 2 - $10,000 x 6% = $ 600

Nov 1, Year 2 to Oct 31, Year 3 - $10,600 x 6% = 636
$1,236
Timing of income recognition for tax purposes:
Percel Ltd.
Corporations must include interest income as it is earned on a daily basis [ITA 12(3)].
Year 1: Nov 1 to Dec 31 - $10,000 x 6% x 61/365 = $ 100
Year 2: Jan 1 to Oct 31 - $10,000 x 6% x 304/365 = $500

Nov 1 to Dec 31 - $10,600 x 6% x 61/365 = 106 606
Year 3: Jan 1 to Oct 31 - $10,600 x 6% x 304/365 = 530

$1,236
Debra
Individuals must include interest income on an annual accrual basis referred to as an anniversary
day accrual [ITA 12(4)]. Interest earned to the anniversary day must be included. The first
anniversary day in this case is October 31, Year 2 [ITA 12(11)]. The second anniversary day is
October 31, Year 3, the maturity date in this case.
Year 1: No interest income is included as there is no anniversary day $ 0

Year 2: Interest earned Nov 1, Year 1 to Oct 31, Year 2 is included (10000*6%) 600
Year 3: Interest earned Nov 1, Year 2 to Oct 31, Year 3 is included (10600*6%) 636
$1,236
KC 7-2
[ITA: 12(1)(j), (k), 82(1) - Dividend income (Individual)]
Anne will include $3,540 of dividend income in her property income for the current year.
Eligible dividends from Canadian corporations – grossed up ($1,000 x 138%) = $1,380

Other dividends from Canadian corporations – grossed up ($1,000 x 115%) = 1,150
Dividends from foreign corporation 1,000
$3,530

KC 7-3
[ITA: 12(1)(j), 112(1) - Dividend income (Corporation)]
A Ltd. will include $2,000 of dividend income in property income for the current year. The
corporation includes the amount received [ITA 12(1)(j)]. In computing its taxable income the
corporation will deduct the $2,000 of dividends received from taxable Canadian corporations [ITA
112(1)].
KC 7-4
[Reg. 1100(11), 1101(1ac) - Rental income]
Two special rules apply to rental properties with respect to CCA:
• Each rental building costing $50,000 or more must be held in a separate CCA class. They
cannot be pooled [Reg. 1101(1ac)].
• CCA can be deducted only to the extent that it does not create or increase a net loss from
all rental properties combined [Reg. 1100(11)].
Class 1 Class 1
#1 #2 Total
UCC, beginning of year $64,000 $ 0
Purchases 130,000
Maximum CCA available:
$64,000 x 4% $(2,560)
$130,000 x 4% x 1.5 $ (7,800) $10,360
Since these are residential buildings the CCA rate is 4%. Although a maximum of $10,360 CCA
is available, the maximum CCA that can be claimed is limited to $4,900, being the net rental
income before CCA for the two properties, combined. The $4,900 of CCA can be claimed partly
from property #1 and partly from property #2, in any proportion up to the maximum available for
each class.
Net rental income before CCA $4,900
CCA (4,900)
Net rental income for tax purposes $ 0

Problems
PROBLEM ONE
[ITA: 12(1)(c); 12(3), (4), (11)]
On April 1, 2020, a corporation with a December 31 taxation year purchased a three-year

investment certificate for $20,000. The certificate pays interest only at the end of the three-year
term but interest is compounded annually at the rate of 10%. Currently, the corporation’s marginal
tax rate is 28%. However, in 2021, the marginal tax rate will decrease to 25%.
An individual makes the identical investment on April 1, 2020.The individual’s marginal tax rate in
2020 is also 28% and is expected to decrease to 25% in 2021.
Required:
Calculate and compare the tax on the interest income for the three-year period for the individual
and the corporation.

Solution to P 7-1
The actual interest income earned on the investment certificate is:
Year 1 10% x $20,000 $2,000

Year 2 10% x $22,000 2,200
Year 3 10% x $24,200 2,420
$6,620
The Individual:
The individual can use the cash method or the receivable method, subject to the overriding
anniversary day accrual rules. The receivable method would normally recognize the interest when
it is due and payable at the end of the three year term. Similarly, the cash method (if paid on time)
would require recognition at the end of three years. However, both the receivable and cash
method are constrained by the anniversary day accrual method which requires that interest on an
investment must be recognized at least every year from the date of issue [ITA 12(4), 12(1)(c),
12(11)].
The actual payment of interest occurs at the same time under each alternative however, the
amount and timing of tax payments are different.
Tax payments under the anniversary day accrual method:
Income Tax Rate Tax
2020 0 28% 0
2021 2,000 25% 500
2022 2,200 25% 550
2023 2,420 25% 605
TOTAL TAX $1,655

The Corporation:
The corporation must use the standard accrual method to recognize interest income [ITA 12(3)].
Tax payments under the accrual method:
Income Tax Rate Tax
2020 275/365 x $2,000 = $1,507 28% $ 422
2021 90/365 x $2,000 = $ 493

275/365 x $2,200 = 1,658
$2,151 25% 538
2022 90/365 x $2,200 = $ 542

275/365 x $2,420 = 1,823
$2,365 25% 591
2023 90/365 x $2,420 = $597 25% 149
TOTAL TAX $1,700

The timing and amounts of tax payments are compared below:
Corporation Individual
2020 $ 422 $ 0
2021 538 500
2022 591 550
2023 149 605
$1,700 $1,655

PROBLEM TWO
[ITA: 5(1); 8(1)(m); 12(1)(c), (j), (k), (l); 12(4), (11); 13(1), (21); 20(1)(a), (c), (e), (e.1),
(bb);74.1(2); 82(1)(a), (b); Reg 1101(1ac)]
Ken Potman is the sole shareholder in Brickbase Enterprises Ltd., a Regina-based construction
company. In addition, Ken is a 25% partner in a retail kitchenware store, although he does not
actively participate in its management. The following information relates to Ken’s financial affairs
for the year 2020:
1. Brickbase was organized three years ago. For its year ending May 31, 2020, the company
earned a profit of $88,000. Ken originally contributed $200,000 to the corporation, using
$50,000 of his own savings and funding the balance with a bank loan. In return, the
corporation issued Ken $1,000 worth of common shares and $199,000 of preferred
shares. In 2020, the company paid a dividend of $12,000 on the preferred shares. All of
Brickbase’s income is subject to the small business deduction.
2. During the year, Ken sold a warehouse property for $180,000 (land $15,000, building
$165,000). The building was used by Brickbase to store construction equipment, and the
company paid Ken a fair rental for use of the property. The property was originally
purchased at a cost of $140,000 (land $10,000, building $130,000). At the end of 2019
the building had an undepreciated capital cost of $110,000. Simultaneously with the sale,
Ken purchased a larger warehouse property (constructed after March 18, 2007), which
was also rented to Brickbase. The new property cost $400,000 (land $50,000, building
$350,000). During the year, the company paid Ken net rents of $30,000 for both
properties. The new property was financed with the proceeds from the sale of the old
building as well as mortgage financing.
3. The retail store partnership earned $40,000 for its year ending December 31, 2020.
The profit consisted of a $32,000 profit from operations and $8,000 of interest income
earned on excess undistributed cash deposits.
4. Ken’s other cash receipts and disbursements for 2020 are shown in the table below.
5. On July 1 of the previous year, Ken purchased a four-year guaranteed investment

certificate for $30,000 that bears interest at 10%. The interest compounds annually but is
not payable until the end of the four-year term. Ken did not include any amount of interest
in his previous year’s income.
6. During the year, one of the Canadian public corporations of which Ken is a shareholder
issued him 100 additional shares as a stock dividend. The shares had a stated value of
$40 per share. Ken placed the shares in his safety deposit box along with his other
securities.

Receipts:
Salary from Brickbase $62,000
Dividends from Canadian public corporations 6,000
Dividends from foreign public corporations (net of 10% foreign

withholding tax) 9,000
Winnings from provincial lottery 2,000
Interest on a loan to his daughter 1,000
Disbursements:
Contribution to Brickbase employee pension plan 3,000
Investment counsel fees 1,000
Legal fees for registering mortgage on new warehouse 5,000
Life insurance premium on policy required as collateral for the

bank loan used to purchase Brickbase shares 1,000
Interest on warehouse building mortgage 21,000
Interest paid on house mortgage (The house mortgage is $100,000,

of which $70,000 was used to acquire the house. The balance
was used to purchase public corporation shares.) 10,000
Interest on bank loan (re: Brickbase shares) 15,000
Donations to local charity 4,000
Safety deposit box fees 100
Required:
Determine separately, for the year 2020, Ken’s income for tax purposes from employment,
business, and property.

Solution to P 7-2
Property income:
Interest
Share of interest earned by partnership
(25% of $8,000) [ITA 12(1)(l)] $ 2,000
Interest from daughter [ITA 12(1)(c)] 1,000
Investment certificate [note 1] 3,000
6,000
Dividends [ITA 12(1)(j), (k), 82(1)]
Stock dividend ($40 x 100 = $4,000 x 138%) $ 5,520
Brickbase Enterprises ($12,000 x 115%) 13,800
Canadian public corporations ($6,000 x 138%) 8,280
Foreign dividends ($9,000 + tax of $1,000) 10,000
37,600
Less:
Interest on bank loan [ITA 20(1)(c)] (15,000)
Interest on house mortgage [ITA 20(1)(c)]
$100,000 x $30,000/$100,000 (3,000)
Life insurance – collateral on Brickbase shares
fully deductible [ITA 20(1)(e.2)] (1,000) 18,600
Rental
Rental Income $30,000
Recapture on sale of warehouse
($130,000 - $110,000) [Note 3] 20,000
50,000
Deduct:
Interest on mortgage (21,000)
Legal fees to register mortgage (cost of arranging
financing 1/5 of $5,000) [ITA 20(1)(e)] (1,000)
Rental income before CCA 28,000
CCA ($350,000 x .06 x 1.5 = $31,500; limited to $28,000) 1 (28,000) (0)
24,600
Deduct
Investment counsel fees [ITA 20(1)(bb)] (1,000)
NET INCOME FROM PROPERTY $23,600
1 Non-residential buildings built after March 18, 2007, qualify for an additional allowance of 2% increasing the CCA
rate to 6%. To receive the additional allowance the taxpayer must elect to place the building in a separate Class 1.
CCA is limited to net rental income before CCA $28,000.
Note 1
Investment certificate - No interest is paid until the end of four years. The annual accrual method
requires that interest be recognized on each one-year anniversary date. In this case one year of
interest must be recognized by June 30, 2020 -10% of $30,000 = $3,000 [ITA 12(4)].
Note 2
Safety deposit box fees are specifically denied as a tax deduction [ITA 18(1)(l.1)].
Note 3
Sale of Building and CCA - The warehouse building although used by Brickbase Enterprises to
conduct its business is, nevertheless, a rental property to Ken who rents it to the corporation. The
building falls into a separate CCA class [Reg. 1101(1ac)] and therefore results in a recapture on
sale even though another building was acquired in the same year.
Old building:
UCC $110,000
Sale ($165,000 - credit pool
With original cost of $130,000) (130,000)
Recapture [ITA 13(1)] $ (20,000)
New building:
Addition [ITA 13(21)] $350,000

CCA 2020 ($350,000 x .06 x 1.5) (31,500)
UCC $318,500
In addition, the sale of the property will result in capital gains on the land and building to the extent
the selling price exceeds the cost. These gains are not part of property income.
The replacement property rules allow a taxpayer who incurs a capital gains and/or recapture on
the disposition of a former business property to elect to defer the capital gain and/or recapture to
the extent that the taxpayer reinvests the proceeds in a replacement property within one year or
12 months after the end of the taxation year in which the disposal takes place [ITA 13(4); 44(1)].
The taxpayer can take advantage of these rules even if the property is held separate from the
business as long as the person who owns the property is related to the entity which uses the
property to carry on business. Former business property is defined in ITA 248(1) as a capital
property used by the taxpayer or a related person for the purposes of earning income from a
business.
In this case, the credit to the UCC for the disposal of the old building would be reduced by the
lesser of the recapture ($20,000) and the cost of the new building ($350,000). Thus, $110,000 -
$110,000 = Nil recapture. The capital cost of the new building is reduced the by the $20,000 of
deferred recapture.
These rules are discussed in Chapters 6 and 8.

Employment income:
Salary [ITA 5(1)] $62,000

Less: Contribution to pension plan [ITA 8(1)(m)] (3,000)
Net employment income $59,000
Business income:
Share of partnership profits [ITA 12(1)(l)]

Total profits $40,000
Business income 32,000
Ken's share -- 25% of $32,000 $8,000

PROBLEM THREE
[ITA: 13(1); 20(1)(a); 45(1); Reg. 1100(11); 1101(1ac)]
Anna Osinski acquired a townhouse unit in 2017 for $120,000 (land $10,000, building $110,000).
She bought the unit in order to rent it. By the end of 2019, the undepreciated capital cost of the
building was $103,500. In August 2020, Anna decided to live in the unit herself. At that time,
similar townhouses were selling for $136,000 (land $12,000, building $124,000). Prior to August,
her 2020 net rental income before capital cost allowance was $1,000.
In September 2020, Anna purchased, for rental purposes, a residential condominium unit for
$145,000 (land $15,000, building $130,000). Between September and the end of the taxation
year, the condo earned net rentals of $900 before capital cost allowance.
Required:
Determine the change to Anna’s 2020 net income for tax purposes as a result of the above activity.

Solution to P 7-3
The change in use of the townhouse from investment to personal use, results in a deemed
disposition at fair market value [ITA 45(1)].
Anna’s net income for tax purposes is:
Rental income:
Rents – townhouse $ 1,000
Rents – condo 900
Recapture of CCA on deemed disposition of

the townhouse ($110,000 - $103,500) [ITA 13(1)] 6,500
Less CCA on condo (Class 1) $130,000 x 4% x 1.5 (7,800)
Net rental income 600
Taxable Capital gains:
Building ($124,000 - $110,000) ½ $7,000
Land ($12,000 - $10,000) ½ 1,000 8,000
Net Income $8,600
Note:
The new condo falls into a separate CCA class because its cost is greater than $50,000 [Reg.
1101(1ac)]. It does not qualify for the additional 2% CCA since it is a residential building. Also,
note that the recapture is considered to be rental income and its inclusion increases the rental
income to a level that permits the CCA to be claimed [Reg. 1100(11)].

PROBLEM FOUR
[ITA: 13(1); 20(1)(a); Reg. 1100(11); 1101(1ac)]
After receiving an inheritance, Sandra Yaworski decided to invest her newly acquired funds in
real estate. In 2019, she purchased the following properties:
Land Building Total

Property 1 $10,000 $ 40,000 $ 50,000
2 12,000 45,000 57,000
3 20,000 80,000 100,000
4 30,000 100,000 130,000
Each of the properties is a residential condominium unit, and each unit is part of a separate
condominium high-rise project. Not all of the units were fully rented during the year of acquisition,
and Sandra determined that her net rental position (before capital cost allowance) for each of the
properties was as follows for 2019:
Property 1 2 3 4 Total
Rent revenue $4,000 $5,000 $7,000 $12,000 $28,000
Expenses* (6,000) (3,000) (6,000) (9,000) (24,000)
Income (loss) ($2,000) $2,000 $1,000 $ 3,000 $ 4,000
* Property taxes, insurance, interest, maintenance.
In 2020, one of Sandra’s close relatives ran into financial difficulty, and she was forced to sell two
of the properties in order to provide financial assistance. She sold property 1 for $52,000 (land
$12,000, building $40,000) and property 3 for $110,000 (land $24,000, building $86,000). In 2020,
the four properties (including the two sold properties to the date of sale) earned net rental income
of $7,000.
Required:
Determine Sandra’s net income from property from the rental properties for 2019 and 2020.

Solution to P 7-4
For capital cost allowance purposes buildings 1 and 2 are pooled together because their cost is
less than $50,000. Buildings #3 and #4 fall into separate pools [Reg. 1101(1ac)].
The maximum available capital cost allowance in 2019 is as follows:
Class 1 Pool A B C
Building 1 $40,000
2 45,000
3 $80,000
4 . . $100,000
$85,000 $80,000 $100,000
CCA available - 4% x 1.5 $5,100 $ 4,800 $6,000

TOTAL $15,900
The 2019 rental income for tax purposes is as follows:
Net rentals before CCA from all

four properties ($28,000 - $24,000) $4,000
Less capital cost allowance
Available -- $15,900
Maximum permitted [Reg. 1100(11)] (4,000)
Net rental income $ 0
Note that these buildings do not qualify for the additional 2% allowance for buildings acquired
after March 18, 2007 since they are residential buildings.
The limited capital cost allowance of $4,000 must be allocated among the pools, subject to the
maximum available to each pool. The taxpayer must choose the allocation. Without the benefit of
hindsight (i.e., knowing when and which properties may be sold) it is difficult to plan the best
strategy. One possible option is to claim the maximum CCA from a pool which holds several
assets (e.g., Pool A) because a sale of one property would not likely create a recapture whereas
single asset pools always create recapture.
Using this principle, CCA is applied to Pool A.

This results in the following effect on the CCA pools in 2019 and 2020:
A B C Total
2019
Opening UCC $85,000 $80,000 $100,000
2019 CCA (4,000) (0) (0) $(4,000)
UCC 81,000 80,000 100,000
2020
Sales (40,000) (80,000) -
41,000 (0) 100,000
Recapture 00
CCA 4% (1,640) (4,000) $(,5,640)
$39,360 $ 0 $ 96,000
2020 net rental:
Net rentals before CCA $7,000

Recapture of capital cost allowance 0
INCOME BEFORE CCA 7,000
2020 CCA (5,640)
NET RENTAL INCOME $1,360

PROBLEM FIVE
[ITA: 20(1)(c)]
Toshiaki Minamiyama is a successful business executive. Over the years, he has allocated a
portion of his large salary to the building of an investment portfolio. He currently has a net worth
of $800,000 (exclusive of retirement plans), as follows:
Personal assets:
Automobiles $ 30,000
Sailboat 29,000
House 220,000
Investment assets:
Corporate and government bonds (average interest return—10%) 200,000
Common shares of public corporations 306,000
Rental real estate 360,000
1,145,000
Liabilities:
First mortgage on house (interest at 9%) (150,000)
Term financing on sailboat (12%) (15,000)
First mortgage on rental real estate (10%) (180,000)
Net worth $ 800,000
Toshiaki seldom trades his investments, as his strategy is to hold various types of investments
for a long time in order to delay any tax that may occur on their disposition. (He is in the 45% tax
bracket.) In fact, he chose not to dispose of any investments when he needed money to purchase
his house and sailboat.
Required:
From a tax planning perspective, what would you recommend he do in order to enhance his wealth
accumulation? If possible, quantify how he would benefit from your recommendations, assuming
a five-year time period.

Solution to P 7-5
Toshiaki has a substantial amount of investment income and is subject to high marginal tax rates.
In addition, he has outstanding debt, from which a large portion of the interest is not deductible
because the loans were made to acquire personal property and are not for the purpose of earning
income.
If, for example, the bond investment which earns taxable interest income is compared to the
personal debt which incurs non-deductible interest the following analysis can be made:
Investment in Bonds $200,000

Less interest bearing debt
House mortgage $(150,000)
Sailboat debt ( 15,000) 165,000
Net equity $ 35,000
The net equity results in the following annual cash flow:
Interest income ($200,000 @ 10%) $20,000

Less tax @ 45% (9,000)
Net cash inflow 11,000
Interest expense (not deductible)

House $150,000 @ 9% $(13,500)
Boat $15,000 @ 12% ( 1,800) (15,300)
NET CASH COST $ (4,300)
Therefore, equity of $35,000 actually results in an annual after-tax cash loss of $4,300.
If $165,000 of bonds were liquidated (leaving bonds of 35,000) and used to pay off the personal
debt, the annual after-tax cash flow would be a positive amount of $1,925 as follows:
Interest income $35,000 @ 10% $3,500

less tax @ 45% (1,575)
1,925
Interest expense 0
NET CASH INFLOW $1,925
Annual cash flow, after tax, would increase by $6,225 (i.e., from a loss of $4,300 to a gain of
$1,925 = $6,225). If this annual income is reinvested in corporate bonds yielding 10% (5.5%
after-tax; 10% - 45% tax = 5.5%) the series of annual payments would compound to $36,653 after
five years ($6,225 for 5y @ 5.5%).

In addition, a further wealth enhancement could be achieved if, shortly after the house mortgage
was paid off, a new mortgage of $165,000 was taken out at the same rate of 9% but used to
purchase new bonds yielding 10%. Because the mortgage funds are now used to generate
income, the interest would be deductible and a further annual cash gain of $908 could be achieved
as follows:
New bond interest income:

10% of $165,000 $16,500
Less deductible interest expense
9% of $165,000 (14,850)
1,650
Less tax @ 45% (742)
NET CASH GAIN $ 908
After five years the $908 annual cash flow would accumulate to an additional $5,436, resulting in
a total wealth enhancement of $42,089 ($36,653 + $5,436).

PROBLEM SIX
[ITA: 13(1); 20(1)(a); Reg. 1101(1ac)]
Quantro Enterprises Ltd. and Baizley Holdings Ltd. (BHL) are both 100% owned by Harold
Baizley. Both companies are Canadian-controlled private corporations. Quantro operates a
wholesale business and pays rent to BHL for the use of a warehouse property.
BHL owns only one asset—the warehouse building and related land that is rented by Quantro for
$36,000 per year. The property was originally owned by Quantro but was sold to BHL several
years ago as a means to reduce the risk exposure of this appreciating asset.
On December 31, 2020 (the year end of both companies), BHL sold the warehouse property to a
third party for $370,000 (land $40,000, building $330,000). The property originally cost $320,000
(land $25,000, building $295,000). The undepreciated capital cost of the building at December
31, 2019, was $254,000.
One month before selling the warehouse property, BHL purchased a newly constructed
warehouse property for $480,000 (land $50,000, building $430,000).
Required:
Determine BHL’s net income for tax purposes for 2020.

Solution to P 7- 6
The warehouse is considered a rental property. Therefore, the new property acquired must be
placed in a separate Class 1, since it cost more than $50,000 [ITA 1101(lac)].
Income:
Rent $36,000
Recapture of CCA ($295,000 - $254,000) 41,000
77,000
Less CCA on new warehouse
$430,000 x 6% x 1.5 * (38,700)
38,300
Taxable capital gains:
Building ($330,000 - $295,000) x ½ $17,500
Land ($40,000 - $25,000) x ½ 7,500 25,000
$63,300
* Non-residential buildings acquired after March 18, 2007 and placed in a separate class have
a CCA rate of 6% (other than buildings that were used by any person or partnership prior to
March 19, 2007).
Former business property is defined in ITA 248(1) as a capital property used by the taxpayer or
a related person for the purposes of earning income from a business. Since the warehouse
owned by BHL is used by Quantro (a related person) in its wholesale business, it qualifies as a
former business property. Thus, BHL can elect under ITA 44(1) and ITA 13(4) to defer recognition
of the capital gain and recapture on the sale of the old warehouse.

PROBLEM SEVEN
[ITA: 9(1); 12(1)(c), (j), (k), (l), ;18(1)(a), (b); 20(1)(a), (e), (n), (aa); Reg. 1100(11)]
Lia Wright is the sole shareholder of Newgardens Ltd. (NGL), a Canadian-controlled private
corporation. The corporation holds investments in shares, bonds, and real estate. You have been
retained to complete NGL’s tax return for the year ended December 31, 2020, and provide certain
other tax advice.
It is now February 15, 2021, and you have gathered the information outlined below.
1. The draft income statement for the year ended December 31, 2020, is as follows:
Income
Interest on bonds and certificates $ 78,000
Dividend income 32,000

Net loss from real estate rentals (19,000)
Gain on sale of land (Stoney Lake) 170,000
Share of profits of Rare Products Ltd. 120,000
381,000
Expenses
Legal fees for general corporate affairs $ 1,000
Director’s fees 21,000
Donations—charitable 8,000 (30,000)
Income before income tax $351,000
2. NGL owns a 40% interest in Sharlet (a partnership), which has a June 30, 2020, year end.
The partnership’s profit for the year was $200,000, which consisted of dividends from
taxable Canadian corporations of $80,000 and royalties from mineral rights of $120,000.
On December 31, 2020, NGL received $100,000 as its share of a partnership cash
distribution. The partnership’s results are not reflected in the above income statement.
3. On September 30, 2020, NGL purchased a $100,000 guaranteed investment certificate

bearing 9% interest. The company intends to record the interest of $9,000 on September
30, 2021, its one-year anniversary date.
4. The dividend income of $34,000 consists of the following:
Canadian Public corporations $16,000
Turner Inc.—an American corporation—net of a 10% U.S.

withholding tax 18,000
Not included in the above is a dividend received from Rare Products Ltd. of $25,000. NGL
owns 50% of its voting shares and records the investment using the equity method of
accounting. Rare earned business income of $240,000 in the current year.
5. During the year, NGL received 100 shares of Herford Ltd. (a public corporation) as a stock
dividend. Herford increased its paid-up capital by $30 for each stock dividend share
issued. NGL did not record the receipt of the stock dividend.
6. In January 2020, NGL purchased three hectares of land on Stoney Lake for $130,000.
The land was then rezoned and subdivided into six building lots. The entire subdivision
was immediately sold to a building contractor for $300,000. The payment terms called for
no cash down, but payments of $50,000 are required as the contractor completes
construction on each lot. By December 31, 2020, one payment of $50,000 had been
received.
7. In 2019, NGL had purchased two rental properties as follows:
Land Building Total

Fourplex $50,000 $150,000 $200,000
Townhouse #1 20,000 40,000 60,000
$70,000 $190,000 $260,000
Maximum capital cost allowance was claimed in 2019. In 2020, townhouse 1 was sold for
$75,000 (land $25,000, building $50,000). On December 1, 2020, NGL purchased
townhouse #2 for $50,000 (land $11,000, building $39,000). Also, in 2020, NGL
constructed a six-plex rental unit for $437,000, as follows:
Land $ 80,000
Permanent landscaping 8,000
Labour and materials 300,000
Air-conditioning and heating equipment 49,000
$437,000
All of the properties resulted in a net rental loss of $19,000 (as shown on the financial
statement). The following items are included in the net loss calculation:
Cost of surveying land (new six plex) $ 2,400

Amortization/depreciation 28,000
Legal fees for mortgage (new six plex) 2,000
Advertising for new tenants 4,000
Required:
Determine NGL’s net income for tax purposes for 2020. Assume all rental properties are
residential properties.

Solution to P 7-7
Net income for tax purposes for Newgardens Ltd. (2020):
Net income per financial statements [ITA 9(1)] $351,000

Donations [ITA 18(1)(a)] 8,000
Accounting Gain on sale of land (Stoney Lake) [ITA 18(1)(b)] (170,000)
Sale of subdivided land is business income:
Gain (300,000 - 130,000) $170,000
Reserve 250,000/300,000 x 170,000 [ITA 20(1)(n)] (141,667) 28,333
Share of profits of Rare Products Ltd.
- separate corporation (120,000)
Dividend from Rare [ITA 12(1)(j)] 25,000
Share of partnership profit [ITA 12(1)(l)]
(80,000 x 40%) - dividend income 32,000
(120,000 x 40%) - royalty income 48,000
Interest on GIC (9,000 x 3/12) [ITA 12(1)(c)] 2,250
Additional dividend on US shares [ITA 12(1)(k)]
- foreign tax withheld 2,000
Stock dividend (100 @ $30) [ITA 248(1)] 3,000
Rental loss (accounting loss) 19,000
(tax loss) (see note 1 below) 0
Taxable capital gain on Townhouse #1:
land and building (75,000 – 60,000)½ 7,500
Net income for tax purposes $236,083
Note 1 - Rental properties:

Rental loss reported $(19,000)
Landscaping included in capital costs [ITA 20(1)(aa)] (8,000)
Cost of surveying land (add to land cost) [ITA 18(1)(b)] 2,400
Amortization [ITA 18(1)(b)] 28,000
Cost of financing mortgage (legal) [ITA 20(1)(e)]
(1/5 deductible annually) 4/5 x 2,000 1,600
Income before CCA 5,000
CCA limited to net rental income [Reg.1100(11)] (5,000)
Rental income $0
CCA Schedule:
Class 1 1 1
2019 $150,000 $40,000
2019 CCA @ 4% x 1.5 (9,000) (2,400)
141,000 37,600
2020 Purchase Townhouse #2 39,000
2020 Constructed simplex *349,000
2020 Sale: townhouse #1 . (40,000) .
141,000 36,600 *349,000
2020 Maximum CCA (4%)* (5,640) (1,464) (20,940)
* Cost includes labour and materials of $300,000 plus the cost of air conditioning and heating
equipment. CCA is - $349,000 x 4% x 1.5 = $20,940. Residential properties are not eligible
for the 6% CCA rate.

Note that where costs of surveying land are incurred as part of the investigation of a site to
determine whether the land is physically suited for the planned building and the building is
intended for use in a business carried on by the taxpayer, the surveying costs are deductible
in the year paid [ITA 20(1)(dd); IT-350R].
Net income for tax purposes:
The property income is as follows:
Net income for tax purposes $236,083

Deduct:
Business income - land sale (28,333)
Taxable capital gain (7,500)
Property income $200,250
The breakdown of net income for tax purposes is:
Business income:
Land sale $ 28,333
Property income:
Above 200,250
Taxable capital gain 7,500
$236,083

PROBLEM EIGHT
[ITA: 3; 5(1); 6(1)(b), (f); 8(1)(h.1), (j); 12(1)(c), (l), 12(4); 13(7)(g); 20(1)(a), (bb); 60(i); 82(1);
Reg. 1100(2.5); 1100(11); 1101(1af); 7307]
Margaret Lykaios is the president and major shareholder of Measureup Ltd., a Canadian-
controlled private corporation that operates a construction business in Regina, Saskatchewan.
Measureup earns only business income, which is all subject to the small business deduction.
In 2020, she had a number of financial transactions. She has asked you to help her prepare her
2020 tax return and provide advice on other tax matters. The following additional financial
information is provided for 2020:
1. Margaret’s gross salary was $90,000, from which Measureup deducted the following
amounts:
Income tax $30,000

EI premiums 856
CPP (includes enhanced contributions of $166) 2,898
Private health insurance premiums 600
Group sickness and accident insurance premiums 400
In addition to her salary, Measureup paid $2,000 to a deferred profit-sharing plan, $600 of
private health insurance premiums, and $400 of group sickness and accident insurance
premiums on Margaret’s behalf.
2. Margaret is required to use her own automobile for company business. For this,
Measureup pays her an annual allowance of $3,600. She purchased a new automobile
for $34,000 plus HST, and received $18,000 as a trade on her old car. At the end of the
previous year, the old car had an undepreciated capital cost allowance balance of $20,000
(Class 10). Of the 20,000 kilometres driven in 2020, 12,000 were for employment
purposes. Margaret incurred automobile operating costs of $5,200.
3. For three months during the year, Margaret was sick and could not attend work. She
received $9,000 from the company’s group sickness and accident insurance plan. Since
the plan’s inception, Margaret had paid premiums totalling $2,000.
4. Margaret purchased a warehouse property and leased it to Measureup to store

construction equipment. The property cost $250,000 (land 30,000, building 220,000). The
building was constructed after March 18, 2007. The price for the land includes $2,000 of
permanent landscaping completed just after acquisition. The 2020 rental income is
summarized below.
Rent received $20,000

Expenses:
Insurance 1,200
Property taxes 4,000
Interest 10,000
Repairs:
General maintenance 800
Storage shed addition 3,000 (19,000)
Income $ 1,000
5. Margaret is a 30% partner in a computer software business but is not active in its
management. The partnership financial statement shows a profit of $40,000 for the year
ended December 31, 2020. The profit consists of $32,000 from software sales and $8,000
from interest earned.
6. On July 1, 2019, Margaret purchased a three-year guaranteed investment certificate for

$20,000 with interest at 10%. The interest compounds annually but is not payable until
July 1, 2022.
7. Margaret received (made) the following additional receipts (disbursements):
Receipts:
Dividends (Eligible) from Canadian public corporations $2,000
Dividends (Non-eligible) from Measureup 3,000
Dividends from foreign corporations (net of 10% foreign tax) 900
Winnings from a provincial lottery 12,000
Disbursements:
Contribution to RRSP (within allowable limits) 10,000
Dental expenses for children 3,500
Donation to a charity 2,000
Safety deposit box 100
Life insurance premium used as collateral for personal bank loan 800
Investment counsel fees 1,000
Required:
Determine Margaret’s minimum net income for tax purposes in accordance with the aggregating
formula of section 3 of the Income Tax Act for 2020.

Solution to P 7-8
Net income for tax purposes:
Employment income:
Salary [ITA 5(1)] $ 90,000

Group sickness benefit ($9,000 - $2,000) [ITA 6(1)(f)] 7,000
Automobile allowance (unreasonably low) [ITA 6(1)(b)] 3,600
100,600
Operating costs $5,200 x 12,000/20,000 km [ITA 8(1)(h.1)] (3,120)
Terminal loss on Class 10 car traded in $ 0
CCA Class 10.1 new car ($30,000 x 1.13 x 30% x 1.5)
[ITA 8(1)(j), 13(7)(g), Reg. 1101(1af)]] 15,255
$15,255
12,000/20,000 km x $15,255 (9,153)
88,327
Business income:
Partnership (30% x $32,000) [ITA 2(1)(l)] 9,600
Property income:
Partnership (30% x $8,000) [ITA 12(1)(l)] 2,400

Rental property:
Income reported $1,000
Storage shed addition to building) 3,000
Landscaping (from land cost) (2,000)
CCA class 1 - ($220,000 + $3,000) x
6% x 1.5 = 20,070 - limit to rental income (2,000) 0
Interest – GIC (10% x 20,000) [ITA 12(4)] 2,000
Dividends: [ITA 12(1)(j), (k), 82(1)]
Public (2,000 x 138%) 2,760
Measureup (3,000 x 115%) 3,450
Foreign ($900 + $100) 1,000 7,210
11,610
Property deductions:
Investment counsel fees [ITA 20(1)(bb)] (1,000) 10,610
108,537
Other deductions:
CPP enhanced contributions [ITA 60(e.1)] (166)
RRSP [ITA 60(i)] (10,000)
Net income for tax purposes $ 98,371
CRA disallows the deduction of a terminal loss in computing employment income [Income Tax
Folio S3-F4-C1]. ITA 8(2) prohibits deductions to employees except as specifically allowed by
ITA 8(1). Terminal losses are deducted in computing business and property income under ITA
20(16).

PROBLEM NINE
[ITA: 9(1); 12(1)(d); 13(1); 20(1)(a), (l), (m); 39(1)(b); Reg. 1100(11), 1101(1ac)]
Kawartha Ltd. is a Canadian-controlled private corporation owning a portfolio of investments

including stocks, bonds, and rental properties. The financial statements for the year ended June
30, 2020, show a profit of $104,300, summarized as follows:
Bond interest $ 50,000

Taxable dividends from Canadian corporations 20,000
Gain on sale of assets 40,000
Rental loss (5,700)
Income before income taxes $104,300
Additional financial information is outlined below.
1. The previous year’s corporation tax return includes the following tax account balances:
Undepreciated capital cost:

Class 1—building A $126,000
Class 1—building B 35,000
Class 1—building C 46,000
2. Taxable Canadian dividends totalling $20,000 include $8,000 from public corporations and
$12,000 from X Ltd., a Canadian-controlled private corporation. Kawartha owns 30% of X
Ltd.’s common shares.
3. The rental properties were purchased prior to March 18, 2007. The details are as follows:
A B C
Land cost $ 20,000 $35,000 $21,000
Building cost 130,000 40,000 49,000
$150,000 $75,000 $70,000
On February 28, 2020, property A was sold for $170,000 (land 30,000, building 40,000)
and property B was sold for $77,000 (land 40,000, building 37,000). The combined rentals
resulted in a loss of $5,700 after deducting amortization/depreciation of $3,000 for the
year ended June 30, 2020.The rental revenue includes a $1,000 rental deposit applying
to the last two months’ rent on a lease expiring December 31, 2021. For the year ended
June 30, 2019, Kawartha deducted a reserve for unpaid rents of $2,000. In January 2020,
$1,000 of the unpaid rents was received and credited to the rent receivable account. No
reserve has been claimed at June 30, 2020; however, $1,200 of the current year’s rent
remains unpaid.
Required:
Determine Kawartha’s minimum net income for tax purposes for the 2020 taxation year.

Solution to P 7-9
Net income per financial statement (2020) [ITA 9(1)] $104,300

Gain on sale of assets [ITA 18(1)(b)] (40,000)
Taxable capital gains: [ITA 38]
Property A - ½(170,000 – 150,000) land and building 10,000
Property B - ½ (40,000 - 35,000) land only 2,500
Capital loss on depreciable property (building) is denied [ITA 39(1)(b)] 0
Rental loss (included in financial statement income) 5,700
Rental income (see note 1) 0
Net income for tax purposes $ 82,500
Note 1:
First determine maximum CCA that is available. Then determine rental income before CCA to
establish CCA limit.
Rental Property A is in a separate Class 1 pool since the capital cost is $50,000 or more [Reg.
1100(11)].
UCC beginning of year $126,000

Sale of property (credit to pool limited to capital cost) (130,000)
Recapture [ITA 13(1)] $ (4,000)
Rental Property B & C are pooled - Class 1

UCC beginning of year (35,000 + 46,000) $81,000
Sale of property B (37,000)
$44,000
Available CCA - 4% x 44,000 $ 1,760
Maximum CCA cannot exceed net rental income before CCA [Reg. 1100(11)] calculated as
follows:
Rental Income:
Loss for the year $(5,700)
Recapture of CCA 4,000
Amortization [ITA 18(1)(b)] 3,000
2019 bad debt reserve [ITA 12(1)(d)] 2,000
2020 bad debt reserve [ITA 20(1)(l)] (1,200)
Rental deposit [ITA 20(1)(m)] (1,000)
CCA - Available $1,760, limited to $1,100 (1,100)
Net rental income $ 0

CASE
Helen Chapman
[ITA: 13(1); 20(1)(a), (c), (e), (aa); 38; 39; 40(1); Reg. 1100(11)]
Helen Chapman is 56 years old and intends to retire in four years. Most of her investment funds
are tied up in her employer’s pension plan and in her personal registered retirement savings plan.
In addition, she has managed to accumulate a personal investment fund of $100,000, which
currently is invested in government treasury bills earning interest at 9%.
Immediately before retirement, Helen intends to use her personal investments and her pension
plans to acquire a life annuity that will provide her with a guaranteed monthly income. She is
looking for an investment for the $100,000 currently invested in treasury bills that will maximize
the value of the annuity. Her investment counsellor has proposed two secure investment options,
as follows:
• Option 1 is a corporate bond yielding annual interest of 13%. The counsellor has advised that
Helen could fund a purchase of $200,000 of the bonds with $100,000 of cash (from the treasury
bills) and $100,000 of borrowed funds. Because her house is debt-free, her bank has offered to
provide her with a term loan secured by a mortgage on the house. The loan interest rate would
be 10%, and no principal payments would be required until the end of the term of the loan.
• Option 2 is a real estate investment. A small, single-tenant commercial building is currently under
construction and will be completed in six weeks. A prospective tenant has already agreed to a 12-
year lease. The lease calls for rent payments of $40,000 annually for four years, at which time
the annual rent will increase by 12% and then remain fixed for the remaining eight years of the
lease. The tenant will be responsible for all costs associated with the property, including property
taxes and insurance.
The developer is prepared to finance up to $300,000 of the project with a 10-year first mortgage
that includes a requirement to pay only interest (no principal) at the rate of 9% per annum. The
full principal balance is due at the end of 10 years. At the closing date, the property will be ready
for tenant occupation, except that the landscaping will have to be arranged and paid for separately
by Helen. The total cost of the investment and the related funding is as follows:
Cost:
Land $ 40,000
Building 350,000
Landscaping 8,000
Legal fees to register first mortgage 2,000
$ 400,000
Funding:
Cash $ 100,000
Mortgage (9%) 300,000
$ 400,000

Whichever investment she chooses, Helen intends to liquidate the investment at the end of four
years and use the funds to acquire a life annuity for retirement. Her marginal tax rate is 45%.
Required:
Advise Helen on which investment will best meet her objectives.

Solution to Case - Helen Chapman
In comparing the two investments, it is assumed that Helen can reinvest the after-tax annual
returns in treasury bills similar to her current investment, and earn 9% annually (or 5% after tax;
9% - 45% tax = 5% rounded).
Option 1 - Corporate Bond
Annual cash flow:

Interest income ($200,000 x 13%) $26,000
Interest expense on loan ($100,000 x 10%) [ITA 20(1)(c)] (10,000)
16,000
Less tax @ 45% (7,200)
$ 8,800
Value of investment after four years:

Sale of bonds $200,000
Less bond loan (100,000)
100,000
Net interest return for four years ($8,800)
Reinvested and compounded at 5% 37,929
Total available for annuity $137,929
Option 2 - Real Estate
Before determining the cumulative position of this option, a number of separate items must be
examined:
A. Resale Value of Property: The value of the property to the owner is based upon the net
rentals which can be achieved. Assuming that the property will be sold to an investor after
four years who will also hold the property to earn rental income, the value of the property
should increase in proportion to the increase in net rentals. After four years the net rentals
increase by 12%. Therefore, it is assumed that the property value will increase from
$398,000 to $445,760 (land cost $40,000 + landscaping $8,000 = $48,000 x 1.12 =
$53,760; building cost $350,000 x 1.12 = $392,000).
B. Deductions for Tax Purposes:

In addition to the annual interest expense the following amounts are deductible in particular
years:
• Landscaping of $8,000 is fully deductible in year 1 [ITA 20(1)(aa)].

• Legal fees of $2,000 to register the mortgage is a cost of borrowing money and can be
deducted at 1/5 per year [ITA 20(1)(e)]. However, because the term is for four years
the remaining balance is deductible in year 4.
Year 1 1/5 ($2,000) $ 400

Year 2 1/5 ($2,000) 400
Year 3 1/5 ($2,000) 400
Year 4 Balance 800
$2,000

• Capital cost allowance is limited to the net rental income in any year as follows [ITA
20(1)(a), Reg. 1100(11)]:
Year 1 2 3 4
Rent income $40,000 $40,000 $40,000 $40,000
Interest expense (27,000) (27,000) (27,000) (27,000)
Landscaping (8,000)
Legal cost (400) (400) (400) (800)
$ 4,600 $12,600 $12,600 $12,200
CCA
Cost $350,000
Year 1 6% x 1.5 to maximum of $4,600 (4,600)
345,400
Year 2 6% to maximum of $12,600 (12,600)
332,800
Year 3 6% to maximum of $12,600 (12,600)
Sold in year 4 $320,200
C. Gain on sale of property
Recapture of CCA [ITA 13(1)]

UCC $320,200
Proceeds limited to cost (350,000)
$ 29,800
Capital Gain [ITA 39, 40(1)]

Land Building Total
Proceeds $53,760 $392,000 $445,760
Cost (40,000) (350,000) 390,000
$13,760 $ 42,000 $ 55,760
Taxable 1/2 of $55,760 [ITA 38] = $ 27,880
D. Taxable Incomes and taxes payable in cash year
1 2 3 4
Net rents $4,600 $12,600 $12,600 $12,200
Recapture 29,800
Taxable capital gains 27,880
CCA (4,600) (12,600) (12,600) --
Taxable Income $ 0 $ 0 $ 0 $69,880
Tax @ 45% $ 0 $ 0 $ 0 $31,446
E. Cash flows excluding sale of property
Year 1 Net rents ($40,000 - $27,000) $13,000

2 Net rents 13,000
3 Net rents 13,000
4 Net rents 13,000
$52,000

F. Value after four years
Sale of property $445,760

Less mortgage (300,000)
145,760
Net annual rents of $13,000
reinvested at 5% after-tax 56,031
201,791
Less tax in year four (31,446)
Total available for annuity $170,345
The real estate investment provides a total of $170,435 after four years compared to $137,929
from the bond investment.
Students may also include points in the discussion such as:
• the inclusion of a real estate commission on the sale.

• a different assumption about the value of real estate after four years.
• the fact that real estate may not be easy to liquidate when desired.


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Buckwold, Kitunen and Roman, Canadian Income Taxation, 2020-2021 Ed.

INCOME FROM PROPERTY

Copyright © 2020 McGraw-Hill Education Ltd. 1

Copyright © 2020 McGraw-Hill Education Ltd. 2

Solutions to Review Questions

Copyright © 2020 McGraw-Hill Education Ltd. 5

Key Concept Questions

• $1,000 of eligible dividends from taxable Canadian corporations

• $1,000 of non-eligible dividends from taxable Canadian corporations

• $1,000 of eligible dividends from a taxable Canadian corporation

• $1,000 of non-eligible dividends from a taxable Canadian corporation

Copyright © 2020 McGraw-Hill Education Ltd. 6

Property #1 Property #2 Total

Revenue $13,200 $4,500 $17,700

Income $ 4,600 $ 300 $ 4,900

Copyright © 2020 McGraw-Hill Education Ltd. 7

Solutions to Key Concept Questions

[ITA: 12(1)(c), 12(3), (4), (11) - Interest income]

Nov 1, Year 1 to Oct 31, Year 2 - $10,000 x 6% = $ 600

Year 1: Nov 1 to Dec 31 - $10,000 x 6% x 61/365 = $ 100

Year 2: Jan 1 to Oct 31 - $10,000 x 6% x 304/365 = $500

Year 3: Jan 1 to Oct 31 - $10,600 x 6% x 304/365 = 530

Year 1: No interest income is included as there is no anniversary day $ 0

[ITA: 12(1)(j), (k), 82(1) - Dividend income (Individual)]

Eligible dividends from Canadian corporations – grossed up ($1,000 x 138%) = $1,380

Copyright © 2020 McGraw-Hill Education Ltd. 8

[ITA: 12(1)(j), 112(1) - Dividend income (Corporation)]

[Reg. 1100(11), 1101(1ac) - Rental income]

Two special rules apply to rental properties with respect to CCA:

Copyright © 2020 McGraw-Hill Education Ltd. 9

[ITA: 12(1)(c); 12(3), (4), (11)]

On April 1, 2020, a corporation with a December 31 taxation year purchased a three-year

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The actual interest income earned on the investment certificate is:

Year 1 10% x $20,000 $2,000

Tax payments under the anniversary day accrual method:

Income Tax Rate Tax

TOTAL TAX $1,655

Income Tax Rate Tax

2020 275/365 x $2,000 = $1,507 28% $ 422

2021 90/365 x $2,000 = $ 493

2022 90/365 x $2,200 = $ 542

2023 90/365 x $2,420 = $597 25% 149

TOTAL TAX $1,700

The timing and amounts of tax payments are compared below:

Copyright © 2020 McGraw-Hill Education Ltd. 12

5. On July 1 of the previous year, Ken purchased a four-year guaranteed investment

Copyright © 2020 McGraw-Hill Education Ltd. 13

Salary from Brickbase $62,000

Dividends from Canadian public corporations 6,000

Dividends from foreign public corporations (net of 10% foreign

Winnings from provincial lottery 2,000

Interest on a loan to his daughter 1,000

Contribution to Brickbase employee pension plan 3,000

Investment counsel fees 1,000

Legal fees for registering mortgage on new warehouse 5,000

Life insurance premium on policy required as collateral for the

Interest on warehouse building mortgage 21,000

Interest paid on house mortgage (The house mortgage is $100,000,

Interest on bank loan (re: Brickbase shares) 15,000

Donations to local charity 4,000

Safety deposit box fees 100

Copyright © 2020 McGraw-Hill Education Ltd. 14