There are many examples in income tax where the interest paid on a loan can be deducted from taxable income: mortgage interest on a rental property, loan interest on a business line of credit, and credit card interest on business credit cards, to name a few. You can also borrow money to put into investments and deduct the interest charges, but there are some important rules that must be followed in this case.
The key to deducting interest expense is that the money borrowed must have been invested in something that will generate taxable income. This includes income from a business, rental property, or investment, but only non-registered investments that pay dividends or interest. The interest paid on an RRSP loan (Registered Retirement Savings Plan) or a loan for investing in a TFSA (Tax-Free Savings Account) is NOT deductible.
In addition, if the borrowed money is invested in shares that do not pay dividends – you believe their value will go up and create a capital gain, but the company is unlikely to issue dividends in the future – you cannot deduct the loan interest.
You must keep good records to be able to prove that the proceeds from a loan were invested in the income-producing item. It is permissible to take out a mortgage against your home, for example, and use the money to buy a rental property, but you must be able to show the paper trail.
It is even permissible to continue to deduct the interest paid after an investment has become worthless or is sold for a loss. This is small consolation so invest wisely!
Gwyneth James, Cody & James CPAs
(705) 876-6011 or codyandjames.ca