Building a Rental Suite or Gutting a Rental: Can You Deduct the Interest and Property Tax While the Work Is Underway?
Section 18(3.1) of the Income Tax Act holds back carrying costs while a building is going up or being rebuilt. It also names four deductions it leaves alone, and tells you where the held-back amounts end up.
Can a landlord deduct mortgage interest and property tax while a rental building is being built or renovated?
Not as ordinary current expenses. Income Tax Act s.18(3.1) blocks a cost that meets three tests. The period: it is attributable to the time a building is under construction, renovation or alteration, a period that ends on the earlier of actual completion or the day all or substantially all of the building is used for its intended purpose (s.18(3.3)). The cost: it relates to that work, or to owning the land during that time, and interest on borrowed money is expressly included (s.18(3.2)). The land: the land under the building, plus contiguous land used for parking, a driveway, a yard or a garden that is necessary for using the building. Blocked amounts are deductible only up to the year’s rental income from that building (s.20(29)); the rest is added to the building’s cost.
Source: Income Tax Act, ss. 18(3.1)–(3.3) and 20(29), Justice Laws Website (Act current to 2026-09-30)
I’m Arthur Zhao, a Toronto real estate Broker. Picture the footings for a garden suite going in at the back of a lot, with the plan of renting it out once it’s finished. Meanwhile the construction draw is accruing interest and the property tax bill keeps arriving, so the obvious question is whether those carrying costs come off this year’s rental income.
The answer sits in subsection 18(3.1) of the Income Tax Act, the rule on costs relating to the construction of a building or the ownership of land. Its wording covers the “construction, renovation or alteration of a building” and does not distinguish a new detached structure from a gut renovation. So if a garden suite is a building in its own right, the same words would appear to apply to it as to an emptied-out duplex. Below I go through what the rule leaves deductible, which land it reaches, when it stops, and where the amounts it holds back end up, followed by two hypothetical sets of numbers.
What the rule itself leaves deductible
Subsection 18(3.1) opens with “Notwithstanding any other provision of this Act,” so it overrides the general rules that would otherwise let you deduct interest and property tax on a rental. Its first paragraph, though, has a bracket listing four deductions it does not touch:
- s.20(1)(a), capital cost allowance. An amount deductible as capital cost allowance is outside the restriction. (Whether a building under construction qualifies for capital cost allowance in a given year is a separate question; s.18(3.1) just doesn’t take it away.)
- s.20(1)(aa), landscaping. An amount paid in the year for landscaping the grounds around a building or other structure that is used primarily to earn income from it or from a business.
- s.20(1)(qq), accessibility work. An amount paid in the year for prescribed renovations or alterations to an income-producing building that let individuals with a mobility impairment get into the building or move around within it.
- s.20(29), the rental-income allowance. Blocked costs can still be deducted in the year up to the lesser of (a) their total and (b) your income for the year from renting the building or the part of it, computed before this subsection and s.20(28).
The fourth item does the heavy lifting. It means the rule never lets construction-period carrying costs push a building’s rental income below zero, but it does let them absorb whatever rental income that building produced in the year. Note that s.20(29)(b) refers to income, meaning rent less the other expenses you can deduct, not gross rent.
⚠️Having someone close to you do the building doesn’t avoid the rule. Subsection 18(3.1) applies whether the work is done by you, by a person you don’t deal with at arm’s length, by a corporation of which you are a specified shareholder, or by a partnership in which your share of income or loss is 10% or more. Under s.18(3.2)(b), interest on money you borrowed to help any of them build, renovate or buy land is also caught, unless the help was a loan on which you charged a reasonable rate of interest.
Which land is caught
The rule reaches costs of owning two kinds of land during the construction period. The first is the land subjacent to (directly under) the building. The second is land that meets all three tests in s.18(3.1)(a)(ii): it is immediately contiguous to that land; it is used, or intended to be used, as a parking area, driveway, yard, garden or similar; and it is necessary for the use or intended use of the building.
For an existing house that is being gutted, this is close to the whole residential lot. For a garden suite at the back of a lot that also carries a main house, the picture is less tidy. The statute does not say how a single property tax bill, or a single mortgage, should be split between land serving the new suite and land serving the house. If the house stays rented throughout, its share would appear to sit outside the rule, but the text gives no allocation method. That split is a question for your accountant, made with the facts of the lot in hand.
When the clock stops
According to the Income Tax Act (s.18(3.3)), the construction, renovation or alteration is completed at the earlier of two days: the day it is actually completed, and the day on which all or substantially all of the building is used for the purpose for which it was constructed, renovated or altered.
That gives two routes to the end of the period. A building can finish the hard way, when the work is genuinely done. Or it can finish by use, when tenants are living in all or substantially all of it even though some finishing remains. Section 18(3.3) does not put a percentage on “substantially all.” Costs attributable to the time after completion are no longer caught by s.18(3.1), and the ordinary deduction rules apply to them again.
ℹ️Reading the statute yourself? Subsections 18(3.4) to 18(3.7) sit right after the completion rule, but they are transitional relief: for outlays made before 1992 by certain real-estate corporations and partnerships, and for buildings already under way or arranged around November 1981 to 1983. They do not change anything for a project today and can be skipped.
Where the blocked amounts end up
Paragraph 18(3.1)(b) is what stops this from being a write-off of the expense. According to the Income Tax Act (s.18(3.1)(b)), to the extent a blocked outlay would otherwise have been deductible, it is included in the cost or capital cost of the building. Two details in that sentence are worth noticing.
- The destination is the building. Property tax on the land under or around it is still added to the building’s cost, not the land’s.
- If the work was done by a related party covered by the rule (see the note below), the amount goes into the cost of the building to that person, corporation or partnership, as the case may be.
What the provision does not cover is how that cost shows up on your later returns. That depends on your situation and belongs with your accountant.
Two tax treatments, side by side
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Two hypothetical sets of numbers
Every figure below is invented for illustration. Neither example reflects a CRA assessment or a real property.
Scenario A: a new garden suite that earns nothing this year. Assume the construction-period interest on the suite’s financing is $6,300, and that $1,100 of property tax is treated as attributable to the suite’s land for the period (the statute doesn’t supply an allocation; that number is an assumption). Blocked total: $7,400. The suite isn’t rented until the following year, so its rental income for this year is $0. Under s.20(29) the deduction is the lesser of $7,400 and $0, which is $0, and the full $7,400 is added to the suite’s cost. If the suite is a separate building, the wording of s.20(29)(b) points to income from renting that building, so rent from the main house would not appear to raise the ceiling.
Scenario B: a duplex with one unit gutted and the other still rented. Assume $10,800 of the year’s interest and property tax is attributable to the renovation period. The tenanted lower unit’s rent for the year, less the other expenses you can still deduct, leaves rental income of $2,700 from the building before s.20(29). The deduction is the lesser of $10,800 and $2,700, so $2,700 is deducted and that building’s rental income comes to $0. The other $8,100 is added to the building’s cost.
💡 My own read, stated as a conditional: the s.20(29) ceiling only has room when the building under construction is producing rental income in the same year. If a project can be staged so part of the building keeps earning (one unit at a time, rather than emptying everything at once), the blocked costs have income to absorb them. If the new space is a separate building, as a detached garden suite would be, the main house’s rent would not appear to count, and the ceiling may sit at zero. Staging has its own costs: it can stretch the work out and keep more months of carrying costs inside the rule. So whether to stage is a construction and cash-flow decision first. The tax effect is one input to weigh with your accountant and contractor, not a reason on its own.
Before you file for the construction year
This article sets out what the statute says. How it applies to a particular property, and especially to anything held through a corporation or partnership or partly lived in by the owner, is a question for your accountant.
- ☐Keep loan and line-of-credit statements that show where each draw was spent
- ☐Keep the property tax bills covering every month the work was underway
- ☐Keep landscaping invoices on their own, apart from the builder’s invoices
- ☐Keep invoices and plans for any ramp, lift or doorway work done for mobility access
- ☐Split interest on money borrowed for the construction from interest on borrowing used for anything else
- ☐Separate property tax for the land under and serving the building being worked on from the rest of the lot
- ☐Separate the year’s rental income from the building under construction from income from any other building
- ☐Separate amounts you paid from amounts paid by a related person, corporation or partnership
- ☐Ask how one property tax bill should be split when only part of the lot is subjacent or contiguous land
- ☐Ask whether interest on borrowing against another property is caught by s.18(3.2)(a)
- ☐Ask whether the accessibility work counts as a prescribed renovation under s.20(1)(qq)
- ☐Ask how the capitalized amount will be treated in later years and on a sale
Filing Rental Income Tax with CRA Form T776: What Landlords Can Deduct, and Why Claiming CCA Depreciation Can Backfire →Renting a Home to Your Parents or Adult Children Below Market: The Rent, the Loss and the Principal Residence Question, From Move-In to Sale →Self-Managing a Rental in Ontario: 2026 Tactics and Compliance Lines →First-Time Renter Guide →
Frequently Asked Questions
I paid the builder from a line of credit on my other property. Is that interest caught too?
It can be. Under s.18(3.2)(a) of the Income Tax Act, the costs caught include interest on borrowed money that can’t be identified with a particular building or particular land but that can reasonably be considered, having regard to all the circumstances, as used for the construction or the ownership of the land. If the line of credit funded the suite, the security being another property would not appear to take that interest outside the rule; your accountant can trace the draws with you.
Can I still deduct landscaping while the suite is being built?
Yes, if it qualifies under s.20(1)(aa): an amount paid in the year for landscaping the grounds around a building or other structure used primarily to earn income. Section 18(3.1) names s.20(1)(aa) as an exception, so qualifying landscaping is not pulled into the construction-period restriction. Keep those invoices separate from the builder’s.
Are wheelchair ramps and wider doorways in a rental deductible during a renovation?
They can be, under s.20(1)(qq), which covers amounts paid in the year for prescribed renovations or alterations that let individuals with a mobility impairment get into an income-producing building or move around within it. Section 18(3.1) expressly leaves s.20(1)(qq) untouched. Whether a specific job is on the prescribed list is something to confirm with your accountant.
Only painting and trim are left. Is the construction period over?
Section 18(3.3) ends the period at the earlier of the day the work is actually completed and the day all or substantially all of the building is used for its intended purpose. If tenants are already living in all or substantially all of the building, the second test may be met even with trim unfinished; if nobody is using it yet, the statute points to actual completion. The provision doesn’t define “substantially all” or say whether minor finishing counts, so treat a borderline case as a question for your accountant.
If the interest gets added to the building’s cost, when do I get the benefit?
Under s.18(3.1)(b), blocked costs that would otherwise have been deductible are included in the cost or capital cost of the building, so they are not lost; they just stop being a current-year expense. The Act’s wording here stops at adding them to cost. How and when that cost affects later returns, or the calculation when you sell, depends on your situation and is for your accountant to map out.
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