Capital Gain - Rental Property & Prepayment charge on Mortgage

Tax Topics
1

I’m calculating the capital gain on a rental property and this is what I have on Schedule 3.

CG = Proceeds - ACB - Outlays

  • Proceeds of disposition: (Sale price)
  • Adjusted cost base: (Purchase price + Land land transfer tax + Legal fees)
  • Outlays and expenses from disposition (Real Estate fees + Legal fees)

(there were no capital cost like renos done)

Is this how others would calculate the gain?

In addition, to the above amounts, the owner had to pay an early payout penalty/prepayment charge on the mortgage which was significant over $4,000.00.

Is the early payout penalty/prepayment charge an expense that can be included in the capital gain calculation? Specifically, as part of the Outlays and expenses?

2

Check out paragraph 1.22 of Income Tax Folio S4-F2-C1 as well as paragraphs 1.30 through 1.38

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3

When you do the disposition it’s part of the Outlays in the disposition transaction, along with lawyers’ fees and real estate fees.

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4

This prepayment penalty was incurred because of the repayment by the taxpayer of all of the principal amount of the debt obligation before its maturity therefore 18(9.1)(d) of the ITA

  • (d) as a penalty or bonus payable by the taxpayer because of the repayment by the taxpayer of all or part of the principal amount of the debt obligation before its maturity,

According to Income Tax Folio S4-F2-C1, this amount is deemed interest:

Computing the deemed interest amount

1.34 For tax purposes, an amount deemed to have been paid as interest under paragraph 18(9.1)(e) will be considered interest for tax years ending after the rate reduction fee or prepayment penalty is paid (such tax years are referred to below as future tax year(s) ).

What I have gathered is this prepayment amount is deemed interest. Are we talking about the interest that is deductible on the T776? Also, paragraph 1.34 mentions the amount will be considered interest for future tax years. What is application on the income tax return?

5

You can’t expense the entire amount if the financial cost is pertinent to a contractual term beyond the year of transaction as per accrual rules. You need to accrue the entire penalty and squeeze it into the assets section of the Balance Sheet. Amortize it for the remainder of the term as interest expense. Note: it is an operating expense as opposed to capital. May use GIFIs 2424 and 2425.

6

I think in your case (where the penalty was imposed because the property was sold and no longer available for rent) the conditions of subsection 18(9.1) would not be met.

1.32 In order for subsection 18(9.1) to apply, a rate reduction fee or prepayment penalty must have been paid:

  • in the course of earning income from property in respect of a debt obligation.

as @fpitre1 has confirmed, I believe your prepayment penalty would be included in the subsection 40(1) calculation of capital gain.

1.22 If a fine or penalty (such as a penalty paid on the prepayment of a mortgage or hypothec) is incurred in connection with the disposition of a capital property, the fine or penalty is taken into account under subsection 40(1) for purposes of calculating any gain or loss on that disposition.