Interest on Borrowed Money to Buy Stocks - Tax Deductible?

[Clarky]

I borrowed some money to buy some Canadian stocks. A few different ones, is the interest on my loan to buy the stocks tax deductible?

[angel_wing0]

yes they should be.

[Clarky]

That is what I thought, but I read this from the Can. Rev. website.

"You can claim the following carrying charges and interest you paid to earn income from investments.

Most interest you pay on money you borrow for investment purposes, but generally only as long as you use it to try to earn investment income, including interest and dividends. However, if the only earnings your investment can produce are capital gains, you cannot claim the interest you paid."

This leads me to believe I can't but I ask because I thought it was common practice to claim the interest borrowed for investment. I thought that people doing the Smith Manouevre bought stocks. Am I wrong here?

[Sanchez]

That is what I thought, but I read this from the Can. Rev. website.

"You can claim the following carrying charges and interest you paid to earn income from investments.

Most interest you pay on money you borrow for investment purposes, but generally only as long as you use it to try to earn investment income, including interest and dividends. However, if the only earnings your investment can produce are capital gains, you cannot claim the interest you paid."

This leads me to believe I can't but I ask because I thought it was common practice to claim the interest borrowed for investment. I thought that people doing the Smith Manouevre bought stocks. Am I wrong here?

Why does that make you believe you can't? It is telling you that you can.

[pitz]

If there are actual businesses beneath those stocks, then the money borrowed to buy the stocks is deductible. Its as simple as that.

However, if you just bought, for instance, a trust that holds inventories of metal, in speculation for higher future resale, or a trust that just holds inventories of unimproved land, then interest on the money borrowed is not deductible.

[Clarky]

I guess maybe I am wrong on what I think Stock purchase gains are called. I thought if you buy a stock, and it goes up, these gains are reported as income as capital gains (once you have sold them of course). So, my take on this was since I borrowed money to purchase stock, and the gain from the stock is only capital gains, I would NOT be able to deduct the interest. Am I just stuck in semantics here, is it basic knowledge that all money borrowed to invest in anything like stocks, bonds, whatever is deductible. The CRA clearly separates bonds, Tbills, etc from Stocks. There is no mention of stocks for interest deductability.

I need more clarification on this. Anyone?

[pitz]

I guess maybe I am wrong on what I think Stock purchase gains are called. I thought if you buy a stock, and it goes up, these gains are reported as income as capital gains (once you have sold them of course).

The stock of a business that doesn't eventually provide income, in the form of dividends, is worth exactly $0.

If you hold a stock for a limited amount of time, you may or may not receive a dividend from the underlying business. But the only reason to own stocks, in the long term, is to collect dividends.

So, my take on this was since I borrowed money to purchase stock, and the gain from the stock is only capital gains, I would NOT be able to deduct the interest.

That's not the way it works.

Am I just stuck in semantics here, is it basic knowledge that all money borrowed to invest in anything like stocks, bonds, whatever is deductible.

As long as 'whatever' produces, or can [i]eventually[i] produce income or dividends (and such income/dividends arises from business activities, not merely a reduction in the capitalization of the business).

I used an example earlier -- if your 'stock' is just an ownership of a warehouse full of gold -- then the interest is not deductible. If your stock is an actual, functioning business, then interest is deductible.

[moneytech]

being a newbie at this forum and investing in general, I am also curious regarding index funds, if i follow the classic coach potato index fund investing on say td e-funds, 33% canada bond index, 33% canada index and 33% us index will the interest from the money i borrowed, tax deductible ?
can the tax deduction be applied towards other income not just on the earnings from the investment

[Clarky]

TY Pitz, very helpful. I appreciate you taking the time to elaborate for me.

[Thalo]

being a newbie at this forum and investing in general, I am also curious regarding index funds, if i follow the classic coach potato index fund investing on say td e-funds, 33% canada bond index, 33% canada index and 33% us index will the interest from the money i borrowed, tax deductible ?
can the tax deduction be applied towards other income not just on the earnings from the investment

Yes it's deductible, and yes the deduction is applied against your general income, which makes it all the more beneficial when the investment income you receive is Canadian dividend income.

Really, a lot of the tax code on this is kind of "gray area" and you kind of got to interpret the CRA explanation mentioned earlier at face value and cross your fingers that your interpretation is right or that you don't get audited. I agree with Pitz though, any stock of a business is purchased for an eventual dividend stream, and as a shareholder you have a "right" to a portion of the businesses profits (the EPS), even if it's not paid out to you by dividend and is reinvested into the business instead.

[X360]

That is what I thought, but I read this from the Can. Rev. website.

"You can claim the following carrying charges and interest you paid to earn income from investments.

Most interest you pay on money you borrow for investment purposes, but generally only as long as you use it to try to earn investment income, including interest and dividends. However, if the only earnings your investment can produce are capital gains, you cannot claim the interest you paid."

This leads me to believe I can't but I ask because I thought it was common practice to claim the interest borrowed for investment. I thought that people doing the Smith Manouevre bought stocks. Am I wrong here?

What I interprete from this is...

There are stocks you can earn dividend income + capital gains. For example, TD, RY, CM, BMO, BCE, T, RCI.B, MFC, GWO, etc... If you buy these stocks and wait until the ex-dividend day, you will get the dividend payment and you will be able to deduct your borrow interest

There are stocks which behave as income like income trust stocks... For example, PWT.UN, BTE.UN, COS.UN, etc... If you have gain on these stocks, you can deduct your borrow interest...

There are stocks you can only earn capital gains. For example, RIM, DML, WTN, HOU, HOD, HNU, HND, etc... If you only buys these stocks and have no other interest income then you won't be able to deduct your borrow interest...

[rfdn00b]

Interesting, i'm also thinking about borrowing from my LOC and buy investments... but was unsure about what qualifies as a valid investment that will generate revenue...

So as long as the investment pay dividends it is eligible whether they pay dividend every year or not? Otherwise I do not understand how i will pay taxes on the revenue generated on capital gains when I a capital gain , as far as i know if only when you actually sell the investment, right?


ALso, since we're at it may be someone can confirm if i get this straight on how this whole thing works...

i'd like to use my LOC at 4% and invest and have the interest tax deductible.
Assuming im in a Marginal Tax Rate of 35%, If I paid $1000 in Interest, Does this mean, I will get a return of $650 back ? SO in the end, as long as my investment get me a return of more than $350, I am ahead?

If the Interest Rate goes up for the LOC, because it looks like if it go up at for example 6%, the Interest paid , lets say is $1500, and the return from the govt will be ( 1 - 0.35) * 1500 = $975, so again all i have to make sure is my investment return me more than $525, right?

[Clarky]

I found an interpretation bulletin that discusses this. Here is some of it.


OTHER INTEREST DEDUCTIBILITY AND RELATED ISSUES

Borrowing for investments including common shares

� 31. Where an investment (e.g., interest-bearing instrument or preferred shares) carries a stated interest or dividend rate, the purpose of earning income test will be met "absent a sham or window dressing or similar vitiating circumstances" (Ludco). Further, assuming all of the other requisite tests are met, interest will neither be denied in full nor restricted to the amount of income from the investment where the income does not exceed the interest expense, given the meaning of the term income as discussed in � 10.
Where an investment does not carry a stated interest or dividend rate such as some common shares, the determination of the reasonable expectation of income at the time the investment is made is less clear. Normally, however, the CCRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends. Nonetheless, each situation must be dealt with on the basis of the particular facts involved.
These comments are also generally applicable to investments in mutual fund trusts and mutual fund corporations.

Example 8
R Corp. is an investment vehicle designed to provide a capital return only to the investors in its common shares. The corporate policy with respect to R Corp. is that dividends will not be paid, that corporate earnings will be reinvested to increase the value of the shares and that shareholders are required to sell their shares to a third-party purchaser in a fixed number of years in order to realize their value. In this situation, it is not reasonable to expect income from such shareholdings and any interest expense on money borrowed to acquire R Corp. shares would not be deductible.

Example 9
S Corp. is raising capital by selling common shares. Its business plans indicate that its cash flow will be required to be reinvested for the foreseeable future and S Corp. discloses to shareholders that dividends will only be paid when operational circumstances permit (i.e., when cash flow exceeds requirements) or when it believes that shareholders could make better use of the cash. In this situation, the purpose of earning income test will generally be met and any interest on borrowed money to acquired S Corp. shares would be deductible.

Anyone want to interpret the interpretation?

[rfdn00b]

The stock of a business that doesn't eventually provide income, in the form of dividends, is worth exactly $0.

What does this mean... in this this case if i hold 50% of my loan on this stock, then 50% of my interest i paid does not qualify to be tax deductible?

As long as 'whatever' produces, or can [i]eventually[i] produce income or dividends (and such income/dividends arises from business activities, not merely a reduction in the capitalization of the business).

What if in a particular year no dividends were paid but the stocks is worth more than what I paid but I do not sell any of the stocks... Can I still deduct the interest and also will have have to pay taxes on the gain i did not realise yet?

If your stock is an actual, functioning business, then interest is deductible.

How about when will i have to pay on the income generated by the business, whether as capital gains or dividends? I can understand when dividends are paid, the amount paid out to me is taxable but what if I didnt sell the stocks to make the capital gain.. if it is on paper, am i still liable and need to pay taxes on the increase in value?

What I interprete from this is...

There are stocks you can earn dividend income + capital gains. For example, TD, RY, CM, BMO, BCE, T, RCI.B, MFC, GWO, etc... If you buy these stocks and wait until the ex-dividend day, you will get the dividend payment and you will be able to deduct your borrow interest

Do you mean ONLY then ( when the year it pays the dividend) I can deduct the borrowed interest ?
ALso, regarding the dividend paid out to me, is this amount added to my income and taxed at my marginal tax rate?

How about he capital gain portion, what if I do not sell the stock? DO I still have to pay taxes on the increase in value?

There are stocks which behave as income like income trust stocks... For example, PWT.UN, BTE.UN, COS.UN, etc... If you have gain on these stocks, you can deduct your borrow interest...

Sorry for asking again, but im trying to understand this correctly... especially the capital gain... i thought the only way to have a capital gain, is when i actually sell the stock... what if i buy it for a longer term but there is an increase in value... so although i have deducted the borrowed interest, on the other hand, the stock hasnt paid any dividend but has increased in value but to which I did not sell... do I have to declare anything in my taxes that will add it to my taxable income?

There are stocks you can only earn capital gains. For example, RIM, DML, WTN, HOU, HOD, HNU, HND, etc... If you only buys these stocks and have no other interest income then you won't be able to deduct your borrow interest...

I know you have listed examples of stocks that qualifies and those that do not qualify... but how will i know which one , say if i go by the morning star and try to pick a stock there?

Someone mentioned about index funds... does this really qualify, since it is a bunch of stocks together, how do i know the funds together are all qualified

[X360]

I have a test by using QuickTax...

1) Have no salary income...

2) Have $1000000 capital gain only... so 50% will be reported as income = $500000...

3) Have $500000 borrow interest expense...


As you see,

Net income = $500000 (capital gain) - $500000 (interest expense) = $0...

So you expect to pay $0 tax for $0 income... but from the QuickTax calculation,

have to pay $62920 (31,362.60 federal tax + 31,557.00 Quebec tax)...

============

Same example, this time

2) Have $500000 as interest income (for example, interest from saving account, etc...)

Net income = $0

have to pay $0 tax...


============

Same example, this time

2) Have $1000000 as dividend only

Net income = $0

have to pay $62920 (31,362.60 federal tax + 31,557.00 Quebec tax)...


============

Same example, this time

2) Have $500000 as salary employment income...

Federal net income = $0
Quebec net income = $499,000.00

have to pay $112,654.00 (-$887.52 federal tax + 113,541.30 Quebec tax)...

Federal allows deduct the borrow interest expense from the employment income...
Quebec not allow and we have to carry the unused borrow interest expense any subsequent taxation year...