Tax-Filing Tips: Which carrying charges are deductible, which are not?
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By Knowledge Bureau  | Thursday, April 12, 2018


 

TAX PLANNING FROM THE KNOWLEDGE BUREAU



By Evelyn Jacks

The difference between good and bad debt often lies in its tax deductibility. Carrying charges, such as interest expenses, may be deducted when there is a potential to earn investment income from property, including interest, dividends, rents, and royalties. Here is a checklist of common deductible expenditures.

Accounting fees relating to the preparation of tax schedules for investment income reporting.

Investment counsel fees. These do not include commissions paid on buying or selling investments. These commissions form part of the adjusted cost base of the investment or reduce proceeds of disposition from the investment on Schedule 3.

Taxable benefits reported on the T4 Slip for employer-provided loans that were used for investment purposes. (Again, these are often missed: Ask your tax specialist about this if you have been fortunate enough to receive this perk of employment).

Life insurance policy interest costs if an investment loan was taken against cash values. To justify the claim, complete form T2210 – Verification of Policy Loan Interest by Insurer.

Management or safe custody fees (but not a bank safety deposit box, which is no longer tax deductible after 2013).

Interest paid on investment loans if there is a reasonable expectation of income from the investment, even if the value of the investment has diminished. For this reason, these investment expenses are often audited. You must, therefore, be prepared to trace all interest you have claimed back to a non-registered investment that has the potential to earn income. It makes sense to make all the right tax moves, in other words, but to be audit-proof, too.

Diminished value in assets. Have your assets diminished in value since you acquired them with a loan? Will your interest still be deductible in that case? The answer is yes. You can continue to deduct the interest until the loan is fully repaid, even if you sell the assets. If you did not use the proceeds to pay down the loan, then you can deduct only the portion of interest that would have been paid had you done so.

Carrying charges that aren’t deductible

Loans taken to earn capital gains in non-registered investment accounts. Much to the surprise of many investors, these types of loans are specifically excluded from the list of investments for which interest costs incurred will be deductible. Interest will not deductible unless you acquire an income-producing asset with the potential to earn income from property – interest, dividends, rents or royalties. That’s right: “potential.” That means it doesn’t have to produce income every year.

Borrowing to invest in registered accounts. Interest on loans used for the purposes of investing in a registered asset – an RRSP, TFSA, RESP, or RDSP – is also not deductible. Nor is interest paid on a tax-exempt property, like your principal residence, unless there is an expectation rental income will be earned. This means that you’ll have to divide up the costs if one loan covers all your investing activities.

Should you leverage your assets to invest more?

Many investors wonder if they should leverage existing capital assets in order to invest more into the marketplace. Often, they are approached to consider different leveraged loan arrangements, particularly if they believe they have not saved enough for retirement.

Be sure to crunch the numbers over the life of the loan. The potential for investment income must be present, and you will need to make arrangements to pay off your interest (before tax) and pay back the principal.

This requires cash flow – so where do you find the money? You can turn to your income tax refund for some of it. However, it’s essential to keep in mind that the investment must also be able to pay real dollars on a guaranteed basis before your risk can be properly assessed. Otherwise you will have to dip into other funds to pay off your loans. Make sure that you assess these possibilities with your financial advisor, so that you can sleep at night.

A keen focus on financial planning now will help you ensure that you incorporate tax-efficient strategies for both borrowing and investing in 2018 and avoid the trap of expensive overdue balances to both CRA and your bankers. You don’t want recent interest rate increases to have a negative impact on your financial plans in 2018 and beyond.

© 2018 The Knowledge Bureau, Inc. All rights reserved. Reprinted with permission.

Evelyn Jacks is the founder and President of Knowledge Bureau, which brings continuing financial education in the multiple areas of specialization to advisors and their clients. She is the author of 52 books on tax and wealth planning. This article originally appeared in the Knowledge Bureau Report. Follow Evelyn Jacks on Twitter @EvelynJacks. Visit her blog at www.evelynjacks.com.

Evelyn Jacks’ latest book, NEW ESSENTIAL TAX FACTS: How to Make the Right Tax Moves and Be Audit-Proof, Too is available for pre-order now.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

   
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