In general, interest expense which is incurred in order to earn income from business or property is tax deductible. If you have borrowed funds to purchase real estate from which you will be earning income, the interest expense is deductible, but with restrictions if the real estate is vacant land.
Interest on funds borrowed to purchase vacant land is not deductible, unless the land is earning income such as rental income. The deductions for both interest expense and property taxes for vacant land cannot exceed the net rental income earned from the land after all other expenses have been deducted.
When the land is earning rental income, the undeducted portion of interest expense and property taxes can be added to the cost (adjusted cost base, or ACB) of the land, which will reduce the capital gain when the land is sold.
When the land is not earning income, the interest expense and property taxes cannot be deducted, nor can they be added to the cost of the land.
Interest costs related to the construction, renovation or alteration of a rental property are considered "soft costs", for which there are special rules. For more information on this topic, see the Soft Costs topic in the T4036 Rental Income Guide (refer to CRA website).
The principal portion of loan payments is not a deductible expense. When depreciable assets such as buildings or machinery and equipment are purchased, capital cost allowance can be claimed.
Note that there must be a clear paper trail showing that the borrowed funds were directly used to purchase the income-generating property.
Resources
Income Tax Act s. 20(1)(c)
T4036 Rental Income Guide
Soft Costs (costs relating to construction, renovation or alteration
Line 8710 - Interest
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