Making Interest Tax Deductable

 

Just because you borrow to invest doesn’t mean the interest will be tax deductable.  For the interest to be deductible you must take out a loan and invest the proceeds into something that will earn you income; either from a business or property.

Other Conditions Include:

·        You must have paid the interest (or accrued it) in the year you deduct it.

·        There must be a legal obligation to pay the loan back, and

·        The interest rate must be reasonable, based on current rates for loans with similar terms and conditions

Remember your borrowed funds must be invested into something that would reasonably be expected to generate income, this could include; interest, dividends, rents, royalties or business profits.  Capital gains don’t count, they are not considered income.

Two Strategies that make loan interest tax deductable:

1.      Borrow to Earn - Take out a loan and purchase an income-producing asset; like machinery for a business, or a rental property.

2.      Rearrange Existing Debts – Convert your non-deductable mortgage by paying it off and then re-borrowing the money and investing the proceeds.  For example, if you have a $200,000 mortgage and a $500,000 investment portfolio, you can sell the portfolio and pay off the mortgage, then borrow $200,000 and reinvest it into your portfolio.

Points to be aware of when deducting interest:

·        You must be able to trace the direct use of the money.  Keep meticulous records and make sure you don’t combine borrowed funds with personal funds.

·        Be wary of investments that only produce capital gains – as this may not qualify for deduction

·        Compound interest – must be paid in the same year or it does not qualify

·        If your investment loses money – you may still be able to deduct the interest.

·        Selling your eligible investment and spending the money – for personal use will make the interest ineligible

·        Interest to earn tax exempt income – like in a TFSA or RRSP the interest will not be deductible

At the end of the year; remember the qualified interest can be deducted against all income sources, not just the property or business income that was generated from the loan.

As always we should discuss these strategies in detail to ensure they are right for your personal situation before you apply for the loan.  If you want more information or want to discuss further, give me a call.

Have a great weekend,

Tracey

Source:  original article by Stella Gasparro published on Advisor.ca 08-08-13