Investing

Borrowing to invest - proving funds used solely for income generating

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  • Jan 10th, 2021 11:27 am
[OP]
Jr. Member
Jun 20, 2012
144 posts
15 upvotes
Toronto, Ontario

Borrowing to invest - proving funds used solely for income generating

Hi All,

Quick question for my situation here. I recently refinanced my rental mortgage to obtain 100k cash because I thought I needed the extra funds to close a pre-construction property. However, at the end I was able to qualify for the mortgage amount I needed for the pre-con.

At this point, can I invest the 100k and deduct the mortgage interest? Would the CRA be critical because I also purchased a property in the same tax year? What can I do to avoid potential challenges? Thank you in advance!
11 replies
Deal Addict
Mar 3, 2018
1831 posts
1828 upvotes
GTA
Yes if the funds are used for investment purposes the interest will be deductible. You will need an allocation though between the interest claimed as a rental expense and the interest claimed for investment. They are entered in different parts of the tax return.
[OP]
Jr. Member
Jun 20, 2012
144 posts
15 upvotes
Toronto, Ontario
Thank you. For record keeping, is the bank statement (showing the funds obtained from the refinance) and the brokerage statement (showing funds deposited) sufficient?
Deal Addict
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May 11, 2014
4397 posts
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Iqaluit, NU
btcoma wrote: Thank you. For record keeping, is the bank statement (showing the funds obtained from the refinance) and the brokerage statement (showing funds deposited) sufficient?
Yes. Clear transaction showing this is more than sufficient.
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Member
May 2, 2019
429 posts
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Vancouver
btcoma wrote: the brokerage statement (showing funds deposited) sufficient?
No, I have to disagree with @xgbsSS . Depositing funds does not constitute an investment that allows claiming the interest. The funds need to be actually invested into something that generates income/dividends or at least expected to do so.

This appears to be one of heavily audited areas. The CRA document on interest deductibility mentions lots of court decisions and fine details.
Where money is borrowed, the use of the money must be established and the purpose of that use must be to earn income.
...
1.32 In determining what borrowed money has been used for, the onus is on a taxpayer to trace or link the borrowed money to a specific eligible use, giving effect to the existing legal relationships.
...
1.69 Based on Ludco, where an investment carries a stated interest or dividend rate, the income-earning test will be met "absent a sham or window dressing or similar vitiating circumstances"...
...
1.70 Where an investment does not carry a stated interest or dividend rate, such as some common shares, it is necessary to consider whether the purpose test is met. Generally, the CRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that at the time the shares are acquired there is a reasonable expectation that the common shareholder will receive dividends. However, it is conceivable that in certain fact situations, such reasonable expectation would not be present. If a corporation has asserted that it does not pay dividends and that dividends are not expected to be paid in the foreseeable future such that shareholders are required to sell their shares in order to realize their value, the purpose test will not be met. However, if a corporation is silent with respect to its dividend policy, or its policy is that dividends will be paid when operational circumstances permit, the purpose test will likely be met. 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 funds.
Deal Addict
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May 11, 2014
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yvrbanker wrote: No, I have to disagree with @xgbsSS . Depositing funds does not constitute an investment that allows claiming the interest. The funds need to be actually invested into something that generates income/dividends or at least expected to do so.

This appears to be one of heavily audited areas. The CRA document on interest deductibility mentions lots of court decisions and fine details.
Sorry, my post was just referring to the record keeping requirement for CRA. You are correct that it needs to be a qualifying investment.
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[OP]
Jr. Member
Jun 20, 2012
144 posts
15 upvotes
Toronto, Ontario
Understood, thank you for clarifying. I intend on investing the money in a mix of Canadian dividend payers for income.

However, my TFSA is not maxed...but knowing that interest from the borrowed money invested in a TFSA is not tax-deductible, would you invest the borrowed money in a taxable account and then use the potential tax-return and dividends to fund the TFSA? Or is the advice here always max out the TFSA first?
Member
May 2, 2019
429 posts
486 upvotes
Vancouver
xgbsSS wrote: Sorry, my post was just referring to the record keeping requirement for CRA.
Sorry for calling you out. You have a reputation for giving a detailed and accurate advice, so I thought it's important to clarify this one. Broker statements should be indeed enough, just not the way OP asked. The statements should cover not only the deposit, but also the subsequent transactions. The interest expense can be claimed only since the purchase of qualifying investments, on the invested amount only.
Member
May 2, 2019
429 posts
486 upvotes
Vancouver
btcoma wrote: but knowing that interest from the borrowed money invested in a TFSA is not tax-deductible, would you invest the borrowed money in a taxable account and then use the potential tax-return and dividends to fund the TFSA? Or is the advice here always max out the TFSA first?
TFSA will be better. You get the same return as non-registered and pay no tax, while in non-registered you still pay some tax. You are growing your TFSA space, as a perk.
That's assuming you get a better return than your borrowing rate, which is a prerequisite for even doing this. There may be some exceptional situation when a taxable investment pays a negative tax rate (on eligible dividends), but I'm guessing you have more taxable income than that case.


Check out the Smith Manoeuvre page on milliondollarjourney, that's where I learned of the concept the first time.

Edit: I stand corrected on TFSA, other than growing your TFSA space helps. It's best to calculate for your own tax situation and assumptions about profitability.
Say Ontario, employment income $99,000 and other income $1,000 , year 2020. https://www.wealthsimple.com/en-ca/tool/tax-calculator/ gives the total tax of 27,133.
Now assume we invested $10,000 taxable, and expect $300 in eligible dividends and no capital gains or new other income. That raises the tax bill by $76. However, we get to deduct the interest expense on the $10,000, say $200. So we are changing $1000 other income to $800, and get a refund of $11 - better than TFSA. But if the $300 were in ineligible dividends, you'd owe $21, making TFSA definitely a better choice.
Last edited by yvrbanker on Jan 9th, 2021 11:42 pm, edited 2 times in total.
Deal Addict
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May 11, 2014
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Iqaluit, NU
yvrbanker wrote: Sorry for calling you out. You have a reputation for giving a detailed and accurate advice, so I thought it's important to clarify this one. Broker statements should be indeed enough, just not the way OP asked. The statements should cover not only the deposit, but also the subsequent transactions. The interest expense can be claimed only since the purchase of qualifying investments, on the invested amount only.
No need to apologize :) I gave a short answer that could be taken incorrectly! Thanks for providing a thorough and detailed answer!
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[OP]
Jr. Member
Jun 20, 2012
144 posts
15 upvotes
Toronto, Ontario
Thank you so much for the responses, I'll give it some more thought. I think I have to revisit my overall investment goals versus being tax-efficient.
Deal Addict
Mar 10, 2010
1403 posts
384 upvotes
I know it's OT, but I had to laugh reading this thread as it's very Canadian. I'm terribly sorry to correct you but... Oh, thank you for correcting me..

It's great to see such polite discourse when so many other threads turn into name calling (bulls/bears etc.)

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