We all want to reduce our income taxes and deducting interest payments on mortgages, loans, Lines of Credit or even credit cards can do that.
Canada Revenue Agency (CRA) has set criteria and rules that allow for the deduction of interest under certain situations. The key factor is the money you borrow must be used to generate income.
The three most common situations are:
To Earn Active Income
- The most common example is borrowing funds to buy a rental property.
- Renting a room/suite in your home as an Airbnb also qualifies as a means to deduct some of your mortgage interest, as long as you declare the income.
To Generate Business Income
- Business owners typically borrow funds for hard assets like machinery, warehouse equipment, vehicles, and expensive office items such as computers, printers, and photocopiers.
- Others may use the funds for expansion of the premises or to acquire a competitor.
- Typically, the business secures a loan (or Line of Credit) against other assets for large purchases but carrying a balance on a business only credit card that is used to purchase something like office supplies would also qualify.
To Create Investment Income
- Funds borrowed to generate income such as dividends or interest usually are deductible as they typically generate T3 or T5 tax slips from the financial institution and are recorded as income.
- This includes dividend paying stocks, bonds, royalties and many Mutual or Segregated funds regardless of whether they are Canadian or foreign sourced.
- Investments that generate only capital gains such as the purchase of raw land or non-dividend paying stocks usually do not qualify. CRA has been noted to say if a reasonable expectation of a corporation paying a future dividend exists, the investment qualifies, even if not currently paying a dividend.
Important Tips & Facts to keep in mind
- Proper paperwork is very important. It is always best to have the loan used 100% for business or investment purposes. Mingling of funds is frowned upon by CRA causing many interest payments to be denied.
- Funds borrowed to pay personal or living expenses are strictly prohibited.
- There must be a legal obligation to repay the funds.
- The interest rate used must be reasonable and based on current market rates for similar credit risks.
- If using a Joint Line of Credit be careful of attribution rules and ensure the person borrowing the money is the owner of the investment, and the owner is repaying the loan from his/her own income.
- Borrowing for registered investments such as RRSPs, TFSA, RESPs and RDSPs are not deductible under any circumstances.
- Rearranging debt so that nondeductible loans are repaid, and deductible loans replace them, is a very common strategy. To do so, ensure you are working with a financial team who understand what you wish to accomplish – this would include your mortgage broker or banker, accountant, and investment advisor.
- Taking loans from your life insurance policy can be tax deductible if the proceeds were used for investment or business purposes as discussed above. Borrowing money to buy a life insurance policy is not deductible.
- Should your business or investment become unprofitable, and you lose some or all the capital invested, the loan interest may still be deductible under certain circumstances.