Is Your Investment Loan Tax Deductible?

If the interest you are paying on your investment loan is tax deductible, then it’s usually considered good debt, as it is the equivalent of paying a lower rate of interest on the loan.  However, not all investment loans qualify.  An investment loan must meet certain specific criteria before the interest payable is tax deductible.

Making Your Investment Loan Tax Deductible: What Is The Criteria?

The income tax rules allow a tax deduction for interest costs incurred for the purpose of earning income – interest, dividends, rent or royalties – or a reasonable expectation of income, from a business or property.  One point that requires special mention is that interest paid on a loan whose sole purpose is to earn capital gains with no expectation of ever earning income does not qualify as a tax deduction.

How Much Can You Deduct?

If you buy an investment with a fixed interest payment you can deduct interest costs on the loan only if the loan interest is less than or equal to the fixed rate of return the investment will pay.  If you buy an investment with a fixed dividend you can deduct the loan interest up to the amount of the dividend that is included in your tax return, which is generally 144% of the actual dividend you received.

Types Of Investment Loans

1. Student loans

Education is an investment in the future earning potential of the student, which supposedly will increase once the education is completed.

The interest on a student loan is eligible for a 15% non-refundable tax credit.  The credit is available only to the student, even if a parent actually makes the loan payments.  The interest paid can be carried forward for up to five years if it is more beneficial to wait until earnings have increased.

Related: Student Loan Repayment – How Quickly Should You Pay It Off?

Only loans received under the Canada Student Loans Act or similar provincial loans are eligible for a non-refundable tax credit.  That means that other personal loans and Student Lines of Credit do not qualify.

2.  RRSPs

If you procrastinate and wait until the last minute to make your RRSP contributions you may not have the funds for a lump sum deposit.  The only solution may be to borrow and financial institutions have a variety of loan options for this purpose.

However, even though the loan is being used to purchase an investment, the interest on the loan is not tax deductible.  The reason is that any investments made to a tax-deferred account are not taxed in the regular way.  RRSPs are taxed as ordinary income not investment income.

Don’t borrow if you can’t repay the entire RRSP loan within one year.

3.  Rental property

Mortgage interest payments (as well as other eligible expenses) can be deducted against the rental income.  Problems can occur if you start using the rental property as your own primary residence or if you rent to a family member even if you switch houses to do this.

Canadian income tax rules are quite specific and can be complex.  The Canada Revenue Agency can come down hard on people who try to bend the rules.  If in doubt, it’s best to consult a tax professional.

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  1. youngandthrifty on December 20, 2011 at 3:09 am

    I hear financial advisors often recommending taking out an RRSP loan- I suppose it would depend on the loan interest and the marginal rate you would be taxed at in order to figure out whether it’s “worth” it to take out a loan?

    • Boomer on December 20, 2011 at 12:29 pm

      @youngandthrifty: If you take out a loan I recommend paying it off as soon as possible. Here’s a formula you can use:
      Take the amount of cash you have on hand to contribute and divide it by (1/marginal tax rate -1). This will give you an amount you can borrow, which in most cases will give you a tax refund for that exact amount.
      I hope that makes sense.

  2. Juan on December 20, 2011 at 11:33 am

    Hey is good to know that the interest on student loans is deductible. Thanks for putting that in the article.

  3. My University Money on December 20, 2011 at 10:34 pm

    Thank goodness for the rules on investment loans. It makes things like my soon-to-be-pursued Smith Manoeuvre possible. Reward debt-for-assets, not consumer debt with bailouts etc.

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