How to Make Canadian Interest Tax Deductible - dummies

How to Make Canadian Interest Tax Deductible

Many tax payers in Canada pay interest on personal borrowing, such as mortgage interest, car loans, lines of credit, and credit cards, but few Canadians can deduct that interest on their tax returns. A way exists, however, for some tax payers to convert that non-deductible interest into a tax deduction. This strategy is commonly known as debt-swapping. Get the lowdown on how to implement debt-swapping here.

[Credit: © 2008]
Credit: © 2008

Debt-swapping is possible if you have both non-deductible interest and non-RRSP investments such as shares, bonds, or mutual funds. Here’s how you do it:

  1. Sell your investments, ideally choosing those that have not greatly appreciated in value since you purchased them (because you are responsible for paying tax on any capital gains you trigger on the sale).

  2. Use the proceeds from the sale to pay down your non-deductible debt.

  3. Take out a new loan with the bank and use it to repurchase the investments you sold.

At the end of the day, you have the same amount of debt and the same amount in investments as before the sale (assuming you didn’t have tax to pay on any capital gains), but because a direct trace occurs between the borrowing and the investments, the interest you pay each year can be deducted on your tax return!

Just because the initial purpose of your borrowing is to invest, this does not mean you’re guaranteed a tax deduction for the interest paid in the future. To ensure your interest remains tax deductible, avoid withdrawing any capital from your investment account (which includes both the growth and any reinvested distributions) for personal purposes. Doing so will result in losing a portion of your interest deduction, unless you’re withdrawing the funds to put into another investment.

If you’ve borrowed to invest but later sell your investment at a loss, and use all the proceeds you have to pay down the loan, the interest on the remaining loan is still tax deductible.