The average debt of Canadians has increased dramatically in recent years fuelled partially by the increasing real estate prices and partially by low interest rates.  So it probably isn’t a surprise to hear that we are asked regularly how to make the interest tax deductible.  According to the Income Tax Act, interest on money borrowed to earn investment income is deductible.  A prime example is interest on money borrowed to purchase a rental property.  Many situations can arise in which an taxpayer may have personal debt but not debt related to investment.  To illustrate, let’s look at an example:
John and Sue own a condominium in Vancouver which they rent out.   They carry a mortgage on the condo with a balance of $50,000.  They recently built a new house for themselves and took out a mortgage for $200,000.  The condo has an appraised value of $375,000 and the house is appraised at $600,000.  Based on the income tax rules, they can deduct the interest on the condo mortgage against the rental income.  However, the interest that they are paying on the house mortgage is much higher and not deductible.  Many people falsely believe that John and Sue could remortgage the condo for $250,000 and pay off their house mortgage making all of the interest deductible against the rental income.  However, it isn’t the source of the security (ie the condo) that determines the interest deductibility.  But rather, it is the use of the cash borrowed (ie to pay off the house mortgage).  In this case, remortgaging the condo to pay off the house mortgage would not make the interest deductible.  It is important to trace the funds to an investment.  In this case the extra $200,000 can only be traced back to the house.
One solution that will help create more interest deductibility is for John and Sue to convert the condo mortgage to a line of credit in which the required payment is interest only.  They could then redirect the savings in the monthly payment toward the house mortgage.  The goal would be to payoff the house mortgage faster and eventually eliminating the non-deductible debt and leaving only the condo mortgage.
Another, but less practical solution, would be for John and Sue sell the condo and use the proceeds to completely payoff the house mortgage.  Now they would be debt free.  They could then purchase a new rental property using a new mortgage making the interest completely deductible from the rental income.  Obviously there are many other tax and investment related considerations to this solution but it is described here to demonstrate a point.
It should be noted that the debt does not have to be secured by the investment in order to make it tax deductible.   John and Sue could mortgage their house and use the proceeds to purchase a rental property.  The interest on that mortgage would be tax deductible since the funds borrowed can be traced to the use of purchasing a rental property.
Many financial institutions today have lines of credit that can be registered against a single property but can be divided into several parts for various uses.  For example, a couple may have a $300,000 line of credit segregated into $50,000 for a renovation to their personal residence, $25,000 for a vehicle, and $225,000 for investments.  The segregation of the account allows them to direct payments toward the non-deductible renovation and vehicle paying these balances off sooner and leaving the deductible debt to be paid off last.
There are many different examples and possibilities for improving the deductibility of interest, however, it is never as easy as it may seem.  It is a deduction that is commonly misunderstood and every financing or refinancing scenario should be closely reviewed prior to taking action.  For professional advice on how you can take advantage of deducting interest on your income tax return, call us today.
The average debt of Canadians has increased dramatically in recent years fuelled partially by the increasing real estate prices and partially by low interest rates.  So it probably isn’t a surprise to hear that we are asked regularly how to make the interest tax deductible.
According to the Income Tax Act, interest on money borrowed to earn investment income is deductible.  A prime example is interest on money borrowed to purchase a rental property.  Many situations can arise in which an taxpayer may have personal debt but not debt related to investment.  To illustrate, let’s look at an example:  John and Sue own a condominium in Vancouver which they rent out.   They carry a mortgage on the condo with a balance of $50,000.  They recently built a new house for themselves and took out a mortgage for $200,000.  The condo has an appraised value of $375,000 and the house is appraised at $600,000.
Based on the income tax rules, they can deduct the interest on the condo mortgage against the rental income.  However, the interest that they are paying on the house mortgage is much higher and not deductible.
Many people falsely believe that John and Sue could remortgage the condo for $250,000 and pay off their house mortgage making all of the interest deductible against the rental income.
However, it is not the source of the security (ie the condo) that determines the interest deductibility, but, rather, it is the use of the cash borrowed (ie to pay off the house mortgage).  In this case, remortgaging the condo to pay off the house mortgage would not make the interest deductible.
It is important to trace the funds to an investment.  In this case the extra $200,000 can only be traced back to the house.
One solution that will help create more interest deductibility is for John and Sue to convert the condo mortgage to a line of credit in which the required payment is interest only.  They could then redirect the savings in the monthly payment toward the house mortgage.  The goal would be to payoff the house mortgage faster and eventually eliminating the non-deductible debt and leaving only the condo mortgage.
Another, but less practical solution, would be for John and Sue sell the condo and use the proceeds to completely payoff the house mortgage.  Now they would be debt free.  They could then purchase a new rental property using a new mortgage making the interest completely deductible from the rental income.  Obviously there are many other tax and investment related considerations to this solution but it is described here to demonstrate a point.
It should be noted that the debt does not have to be secured by the investment in order to make it tax deductible.   John and Sue could mortgage their house and use the proceeds to purchase a rental property.  The interest on that mortgage would be tax deductible since the funds borrowed can be traced to the use of purchasing a rental property.
Many financial institutions today have lines of credit that can be registered against a single property but can be divided into several parts for various uses.
For example, a couple may have a $300,000 line of credit segregated into $50,000 for a renovation to their personal residence, $25,000 for a vehicle, and $225,000 for investments.  The segregation of the account allows them to direct payments toward the non-deductible renovation and vehicle paying these balances off sooner and leaving the deductible debt to be paid off last.
There are many different examples and possibilities for improving the deductibility of interest, however, it is never as easy as it may seem.  It is a deduction that is commonly misunderstood and every financing or refinancing scenario should be closely reviewed prior to taking action.
For professional advice on how you can take advantage of deducting interest on your income tax return, call us today.