Line of Credit interest is tax-deductible in Canada under certain circumstances.
In general, the interest you pay on money you borrow to earn income from an investment is tax-deductible.
Personal Line of Credit
There are scenarios where the interest you pay on a personal line of credit is tax-deductible in Canada and others where it’s not.
Suppose you used the line of credit for personal expenditure, like a home theatre system.
In that case, the Canada Revenue Agency (CRA) doesn’t allow you to claim any resulting interest charges as a tax deduction.
However, if you used the funds to purchase an investment that produces income, such as a bond or dividend-paying stock, the CRA will permit you to write off the interest against your taxable income if it is held in a non-registered savings account
Student Line of Credit
Like a personal line of credit, a student line of credit must be used to pay for post-secondary expenses, like textbooks and tuition.
However, unlike a personal line of credit, there are no circumstances where the interest of a student line of credit is tax-deductible in Canada.
Business Line of Credit
You can generally deduct interest payments originating from a business line of credit if the borrowed funds were used specifically for business purposes.
Acceptable uses include the purchase of inventory, office expenses, and factory equipment.
Interest originating from a business line of credit purchase for a personal item is prohibited from being used as a tax deduction.
To ensure you’re claiming only legitimate interest charges, it’s essential to keep detailed records that separate funds used for business operations from those used for personal expenditures.
You can only deduct interest charges (in the form of a tax credit) on student loans issued by the federal government, never on student lines of credit.
What Types of Interest Payments are Tax Deductible?
In general, you can write off interest on a line of credit if the borrowed funds were used to invest and generate income.
Two prominent examples of investment income would be the interest paid on a bond or a share that pays dividends.
In both cases, you can claim the interest charges you incurred as a deduction against your taxable income.
Mutual funds and exchange-traded funds (ETF) that distribute earnings as interest or dividends also qualify.
Assume you purchase shares that currently pay no dividends, but you anticipate they will soon.
Can you deduct your interest costs in this case?
The answer is yes.
If there’s a reasonable expectation that dividends will be paid out in the future, the interest is tax-deductible.
However, if you’re purchasing shares solely to realize a capital gain, the interest expense you incur from borrowed money is not deductible.
From the CRA’s perspective, capital gains don’t qualify as income.
The same rule applies to land, artwork, and other assets that don’t generate income.
One crucial aspect to keep in mind is that the deductibility of interest charges related to purchasing income-producing investments pertains only to those held in a non-registered account.
Interest charges resulting from borrowed funds used to buy financial assets held in a government-registered account, like an RRSP or Tax-Free Savings Account (TFSA), are not tax-deductible.
Any interest you pay on a mortgage for a property used to generate rental income is tax-deductible, even if you live in the same property.
However, the interest you pay on a property that functions solely as your personal residence can’t be claimed as a deduction.
If you’re drawing money from a line of credit to finance business operations, any associated interest charges are tax-deductible.
Did You Know?
If you’re self-employed and work from home, you can deduct a portion of the interest you pay on your mortgage against your taxable income.
How Do I Know if Something is Tax Deductible?
Unless you possess a comprehensive knowledge of the Canadian Income Tax Act, you should consult with your accountant to determine if your line of credit interest is tax deductible.
Alternatively, you can conduct your research using CRA resources on the Government of Canada website.
Here, you can find a detailed overview of all the deductions, credits, and expenses you can claim on your tax return.
Frequently Asked Questions
- Can you write off margin interest?
Yes, provided the margin interest originates from funds borrowed to purchase financial assets that earn you an income.
- How can I maximize deductible interest?
How can I maximize deductible interest?
Another tax deduction strategy you can employ is debt swapping, which works as follows:
- Sell a portion of your investments
- Use the proceeds to pay down your non-deductible interest
- Take out a loan to repurchase your assets.
While you end up with the same level of debt, the interest will now be tax-deductible since you used the funds to purchase income-producing investments.