Question about Line 221 - deducting interest expense for dividend investments

It's my understanding that the compound interest arising from some type of loan used to invest/produce income is only deductible in the year that it's paid. The simple interest is deductible in the year it arises, even if you don't actually pay it off.

So in your example and pretending that all of this happened in 2017, you could deduct $12000 right now, and the $682 wouldn't be deductible until next year's taxes, assuming that you paid that part off this year. If you paid off the $682 in 2022, then you could deduct it in 2023.

If you want to look into it further, google S. 20(1)(d) of the Income Tax Act. That's the area that deals with deductibility of compound interest.

Here's the relevant section: http://laws-lois.justice.gc.ca/eng/acts ... on-20.html

Here's some third party links saying what I've already said: http://www.cba.org/cba/cle/PDF/Tax10_Ta ... _paper.pdf
https://www.theglobeandmail.com/globe-i ... cle624511/

And yes, you can take out the dividends and do with them as you please and it won't hurt the deduction.

yupislyr wrote: ↑ It's my understanding that the compound interest arising from some type of loan used to invest/produce income is only deductible in the year that it's paid. The simple interest is deductible in the year it arises, even if you don't actually pay it off.

So in your example and pretending that all of this happened in 2017, you could deduct $12000 right now, and the $682 wouldn't be deductible until next year's taxes, assuming that you paid that part off this year. If you paid off the $682 in 2022, then you could deduct it in 2023.

If you want to look into it further, google S. 20(1)(d) of the Income Tax Act. That's the area that deals with deductibility of compound interest.

Here's the relevant section: http://laws-lois.justice.gc.ca/eng/acts ... on-20.html

Here's some third party links saying what I've already said: http://www.cba.org/cba/cle/PDF/Tax10_Ta ... _paper.pdf
https://www.theglobeandmail.com/globe-i ... cle624511/

And yes, you can take out the dividends and do with them as you please and it won't hurt the deduction.

Thanks, very interesting.

Bulletin here seems to say that compound interest IS deductible in the year it's paid
https://www.canada.ca/en/revenue-agency ... html#p1.69

The implications are not completely clear though.
If I have let's say 4% in dividend income paid out throughout the year I would have $4000 in dividends. So if I take out the dividends let's say on Dec 31, 2017 and put them back in the the account on Dec 31, 2017 then this effectively pays off the compound interest of $682 plus some of the remaining interest or principal, and I could deduct the compound portion (let's assume in one of the tax years) . But if I leave dividends be in the account without taking them out and putting them back in, I can't deduct $682?
If that's the case, it doesn't make much logical sense.

Secondly, seems that calculations of separating base and compound interest would be extremely complicated to do correctly, especially if there are a number of transactions happening throughout the year, eg dividend payments, contributions and interest rates changing multiple times in the year. I'm at a loss about how to do this correctly.

I guess the only way to go here is to deduct 100% and claim that the dividend transactions that were kept in the account were applied as payment against compound interest.

After reading the Income Tax Act closer I agree it's worded in a way that compound interest needs to be "paid". What means "paid" is not clear, however. Does leaving dividends in the account qualify as payment? Does withrawing them and re-depositing them qualify?

Thanks for the references!

the simple answer is yes & the way that you do it is get a statement from your financial institution/brokerage of the TOTAL interest paid in 2017 on that loan/margin account

That's the line 221 entry

its the paper trail the CRA would want to see if & what amount of interest it was that you were charged/paid on your eligible investments that was claimed on line 221

porticoman wrote: ↑ the simple answer is yes & the way that you do it is get a statement from your financial institution/brokerage of the TOTAL interest paid in 2017 on that loan/margin account

That's the line 221 entry

its the paper trail the CRA would want to see if & what amount of interest it was that you were charged/paid on your eligible investments that was claimed on line 221

The eligibility of interest is a lot more complex than that and could depend on potential for interest or dividends in case they're not being paid out.

methyl wrote: ↑ The eligibility of interest is a lot more complex than that and could depend on potential for interest or dividends in case they're not being paid out.

it is not complicated at all

From Jan 1 - 31 December 2017, what was the interest/carrying charges & only those charges that you were charged by the financial institution/brokerage that you paid or came out of your account? - that's line 221 entry

Let me explain why

The Brokerage/financial institution had income in 2017 from all sources including yourself

For your part of the interest of say $1000 charged by them & paid by you becomes a contra/balance that the institution reports as income to the CRA

As for dividends

a) from Jan 1 - 31 December 2017 lets say that you received in your account $500 in dividends (this is the actual divided received in dollars that went into your account) that amount is entered on the lines where it belongs as income, either Canadian eligible dividends for dividend tax credit or non-eligible dividends from non-Canadian companies (USA/Foreign)

b) then there is the eligible ex-dividend not yet received, such as an ex-dividend in December 2017 payable in the next year (2018). That dividend will be counted as income in 2018.

A dividend is not a dividend for income purposes until its paid to you & is in your account, no different than an ex-dividend in December 2016 paid to you in say January 2017

methyl wrote: ↑ Question about Line 221 - Carrying charges and interest expenses
Is interest paid on interest eligible to deduct on that line?

To explain - let's say for simplicity I have a margin investment account that has $1m in stocks, fully invested. I buy $100,000 of an a dividend-paying stock on margin, so I'm eligible to deduct the margin interest on Line 221.
Let's say interest rate is 1%/month,
At the end of month 1 I have $1000 in interest charges, so I end up owing $101,000 to cover the margin.
At the end of month 2 I have $1010 in interest charges ($1000 on borrowed amount, and $10 in interest on $1000 interest in month 1), so I owe $102,010

At the end of the year I have $112682 owed, out of which $12000 is interest on the amount borrowed (100k), and $682 is interest on interest, since I did not make payments monthly.
It's obvious that I can deduct $12000 as on Line 221.

Is $682 -interest on interest- also deductible? Would appreciate any references for confirmation.

Secondly, if dividends are paid out, can they be taken out of the account without affecting eligibility of being able to deduct interest?

You put on line 221 the amount in interest you paid the lender, that is it. Dividends being paid out to you have nothing to do with this, and will be captured as dividend income elsewhere on your taxes.

Also the stock does not need to pay a dividend to qualify. It just needs to be capable of paying a dividend. All stocks could pay dividends if they wanted to, but many simply decide not to. These stocks are still perfectly eligible to invest in and deduct interest payments.

Thanks all for comments, however seems only yupislyr understands the question.
The question is about compound interest eligibility for deduction when it is not paid but instead rolled into principal.
According to the laws we have, compound interest IS NOT eligible for deductions until it's paid.

For anyone reading in the future about this situation - if you want to be in the clear with CRA - make a payment at the end of the year with an amount sufficient to cover compound interest (not base interest).

methyl wrote: ↑ Thanks all for comments, however seems only yupislyr understands the question.
The question is about compound interest eligibility for deduction when it is not paid but instead rolled into principal.
According to the laws we have, compound interest IS NOT eligible for deductions until it's paid.

For anyone reading in the future about this situation - if you want to be in the clear with CRA - make a payment at the end of the year with an amount sufficient to cover compound interest (not base interest).

I think you are overly complicating it. If you borrow $100K to invest $100K in stocks, then all interest paid on that $100K is tax-deductible. It doesn't matter how often you make payments, or how the lender calculates the interest.

In many cases people simply capitalize their monthly interest payments. i.e. if a $500 interest payment is made, you then immediately withdraw $500 from the same loan and it's as if the payment never happened. The entire amount of the loan is still tax deductable. This forms part of the basis of the Smith Manoeuvre.

All that matters is in a given tax year (Jan 1 to Dec 31), how much in payments did you actually pay in interest on a total original loan amount equal to what you invested in. If interest charges accumulated on your loan but you never actually made a physical payment, then you can't deduct anything in that year.

rob444 wrote: ↑ All that matters is in a given tax year (Jan 1 to Dec 31), how much in payments did you actually pay in interest on a total original loan amount equal to what you invested in. If interest charges accumulated on your loan but you never actually made a physical payment, then you can't deduct anything in that year.

Thanks for your comments but that's not correct. Base interest payable (not paid) is eligible for deductions.
Compound interest payable (not paid) is not eligible for deductions.

Here's the Income Tax Act law

Deductions permitted
...
Interest
(c) an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer’s income), pursuant to a legal obligation to pay interest on
...
Compound interest
(d) an amount paid in the year pursuant to a legal obligation to pay interest on an amount that would be deductible under paragraph 20(1)(c) if it were paid in the year or payable in respect of the year;

i.e. if a $500 interest payment is made, you then immediately withdraw $500 from the same loan and it's as if the payment never happened. The entire amount of the loan is still tax deductable. This forms part of the basis of the Smith Manoeuvre.

If you borrow an additional $500 for purposes other than what is proscribed as eligible for deductions (ie investment with intent of receiving income) then you can't deduct it.

methyl wrote: ↑ If you borrow an additional $500 for purposes other than what is proscribed as eligible for deductions (ie investment with intent of receiving income) then you can't deduct it.

It's not borrowing an additional amount, it's making a payment to your loan and then borrowing back the identical amount so keeps the loan at the same value as before. It's as if no payment actually happened (though a payment is made which is tax-deductible), and you just accumulated the interest. This is called capitalization of interest, is a fundamental part of the very well established Smith Manoeuvre, and keeps the total interest paid on the loan 100% tax deductible.

I think you are interpreting some of the CRA rules slightly incorrectly.

rob444 wrote: ↑ It's not borrowing an additional amount, it's making a payment to your loan and then borrowing back the identical amount so keeps the loan at the same value as before. It's as if no payment actually happened (though a payment is made which is tax-deductible), and you just accumulated the interest. This is called capitalization of interest, is a fundamental part of the very well established Smith Manoeuvre, and keeps the total interest paid on the loan 100% tax deductible.

I think you are interpreting some of the CRA rules slightly incorrectly.

I agree, if you're using $500 to invest into more dividend paying (or potentially paying) stocks then that's fine.
If you're using the $500 to make mortgage payments or to have a party it's not eligible for a deduction.

methyl wrote: ↑ I agree, if you're using $500 to invest into more dividend paying (or potentially paying) stocks then that's fine.
If you're using the $500 to make mortgage payments or to have a party it's not eligible for a deduction.

No, that is not the purpose of the capitalization payment. The money is not used for anything except capitalizing the loan.

i.e. take a loan of $100K you have taken to invest in stocks, @5% per year interest. In the first month, the lender charges you $416 in interest. So you pay $416 from your bank account into the loan, then immediately withdraw $416 from the loan back to your bank account. The amount of your loan is now $100,416. And the $416 payment you made is tax-deductible. However the $416 withdrawn is not used for anything as your bank account is identical to what is was before, and you still have the original $100K in base investments. Your actual cash flow is net neutral.

Repeat this capitalization process every month. For the next month, the interest payment paid & capitalized will be based on $100,416 as a total loan amount. At the end of the year, 100% of the interest you've paid is tax deductible. No additional stocks were purchased.

rob444 wrote: ↑ No, that is not the purpose of the capitalization payment. The money is not used for anything except capitalizing the loan.

i.e. take a loan of $100K you have taken to invest in stocks, @5% per year interest. In the first month, the lender charges you $416 in interest. So you pay $416 from your bank account into the loan, then immediately withdraw $416 from the loan back to your bank account. The amount of your loan is now $100,416. And the $416 payment you made is tax-deductible. However the $416 withdrawn is not used for anything, you still have the original $100K in base investments. Your actual cash flow is net neutral.

Repeat this capitalization process every month. For the next month, the interest payment paid & capitalized will be based on $100,416 as a total loan amount. At the end of the year, 100% of the interest you've paid is tax deductible. No additional stocks were purchased.

It doesn't work like that, which is the whole point of this thread. The interest on additional $416 (at 5% = $20.80) that you borrow is a portion that is not deductible, unless you use that portion to invest. That's the law.
Latest we hear is CRA is going even after waitresses that under-reported their tips, with massive fines in tens of thousands of dollars. Good luck with CRA if you claim this interest.

methyl wrote: ↑ It doesn't work like that, which is the whole point of this thread. The interest on additional $416 (at 5% = $20.80) that you borrow is a portion that is not deductible, unless you use that portion to invest. That's the law.
Latest we hear is CRA is going even after waitresses that under-reported their tips, with massive fines in tens of thousands of dollars. Good luck with CRA if you claim this interest.

Seems to contradict everything that professional accountants and financial advisers have said on doing the Smith Manoeuvre and in reporting to the CRA.

Just look up "capitalizing interest" when it comes to using the SM.

I'm pretty sure you are not interpreting the CRA rules entirely correctly here.

rob444 wrote: ↑ Seems to contradict everything that professional accountants and financial advisers have said on doing the Smith Manoeuvre and in reporting to the CRA.

Just look up "capitalizing interest" when it comes to using the SM.

I'm pretty sure you are not interpreting the CRA rules entirely correctly here.

Perhaps I am interpreting the rules correctly/incorrectly, but now I understand also that we are talking about slightly different things, and there's a distinction there, I believe.

If you, as you say, pay interest periodically when it's due, that's fine, I agree it's deductible and you can re-capitalize it by borrowing more to pay it off.

What the original question was about is a margin account - where interest payments are not required and no payments made. When payments are not made then compound interest is not deductible, according to tax law I quoted.

methyl wrote: ↑ Perhaps I am interpreting the rules correctly/incorrectly, but now I understand also that we are talking about slightly different things, and there's a distinction there, I believe.

If you, as you say, pay interest periodically when it's due, that's fine, I agree it's deductible and you can re-capitalize it by borrowing more to pay it off.

What the original question was about is a margin account - where interest payments are not required and no payments made. When payments are not made then compound interest is not deductible, according to tax law I quoted.

Not sure what the difference is, since each month after the interest amount is posted to your account (assuming it's done monthly) you could have simply put in a cash payment to the margin account then immediately withdrawn it again. This would be pretty much the same as the situation I was describing. The only difference is in your case it would be voluntary, in my case it's a mandatory payment. Does this step suddenly make all the compound interest tax deductible?

rob444 wrote: ↑ Does this step suddenly make all the compound interest tax deductible?

Apparently so, in spite of how ridiculous it sounds. Not sure how much of a stickler CRA is about this.

But here's another confirmation of this:
https://www.theglobeandmail.com/globe-i ... cle624511/
"Your interest costs don't have to be actually paid in the year to be deductible, but the interest must be legally payable in respect of the year in which you're claiming the deduction. I should mention that compound interest (that is, interest on your interest), however, is not deductible until the year it's actually paid."

I guess to be safe one could withdraw (re-advancing the loan) an amount equal to or greater than compound interest on Dec 31 and re-deposit it the next minute.

methyl wrote: ↑ Apparently so, in spite of how ridiculous it sounds. Not sure how much of a stickler CRA is about this.

But here's another confirmation of this:
https://www.theglobeandmail.com/globe-i ... cle624511/
"Your interest costs don't have to be actually paid in the year to be deductible, but the interest must be legally payable in respect of the year in which you're claiming the deduction. I should mention that compound interest (that is, interest on your interest), however, is not deductible until the year it's actually paid

The way it's worded, the compound interest accumulated simply can't be deducted until the year you actually pay it. But once you do pay it, you can then start claiming it back to the beginning. So you don't actually lose anything it's just deferred.

So say you started with your margin account in 2017 and then paid it off in 2020 (so just letting all the interest compound and accumulate on the original amount with no payments). Each year you could deduct the interest accumulated before compounding. And in 2020 you could deduct the 2020 regular interest plus ALL the compound interest portion going back to 2017. Making yearly payments for the entire interest amount, just allows you to claim the compound interest portion in that year.