Problem AP $7-1$

$($Interest Deductibility$$Four Cases$)$

Each of the following independent cases involves interest expense and determination of whether the interest is deductible for income tax purposes.

Case A: Liang Chen borrows $$700,000$ using her Toronto condo as collateral security. She uses the amount to purchase high$-$tech common shares that she anticipates will double in value during the coming year. While the general policy of the company is not to make any dividend payments while the company is growing, the board of directors has agreed that dividends could be declared depending on the ever$-$evolving circumstances of the marketplace. However, dividends are not anticipated during the period that Liang intends to hold the shares. Unfortunately, instead of doubling, the stocks lose $60\%$ of their value. They are sold during the year for $$280,000,$ with all the proceeds being used to pay down the loan. The balance of $$420,000($$$700,000$ $$280,000)$ is still outstanding at the end of the year. Liang is uncertain as to when she will be able to pay off this remaining amount. Can she continue to deduct the interest on the amount of the outstanding loan? Explain your conclusion.

Case B: Garner Blake borrows $$850,000$ to purchase a duplex that he intends to rent to arm$$s$-$length tenants. After considerable efforts he was unable to find any tenants willing to rent either side of the property. He subsequently learned that the supply of duplexes was well in excess of the demand. As a result, he was forced to sell the duplex at a loss the following year for $$600,000.$ Recognizing that the market for duplex rentals is weak, he used the sale proceeds to purchase two single family rental properties, the first for $$250,000$ and the second for $$350,000.$ Can Garner continue to deduct the interest expense on the borrowed money after he sold the duplex?

Case C: Habib Nanji purchases a rental property for $$575,000,100\%$ fnanced with a bank loan. Several years later, when the bank loan balance has been reduced to $$500,000,$ he sells the property for $$825,000.$ Habib uses the proceeds to acquire two other rental properties, the first for $$275,000$ and the second for $$550,000.$ None of the proceeds of the sale are used to pay down the original bank loan, which remains at $$500,000.$ Explain how the $$500,000$ balance of the loan can be allocated to the two properties so that the interest may continue to be deductible.

Case D: Thomson Fraser has always dreamed of owning a Rolls Royce SUV, which costs $$525,000.$ His bank has agreed to finance the purchase with a loan at $7\mathrm{.}5\%$ interest.

However, he can borrow the same amount using a margin loan against the investments in his substantial trading account. The interest rate on such a borrowing would only be $4\%.$ He decides to take advantage of the lower interest rate to purchase the Rolls Royce. Since the loan is connected to his income$-$earning investments as collateral, he assumes that he will be able to claim a deduction for any interest. Is he correct? Explain your conclusion. If you conclude that the interest would not be deductible, is there some income tax advice you could provide that would allow the interest to be deductible?