The difference between good and bad debt often lies in its tax deductibility. Those who leverage their assets as part of their strategic plan to build wealth will often do so more successfully by earning more income and increasing their net worth. However, should you borrow to invest? Claiming tax-deductible interest is often the only consolation for the eroding effect that the costs of debt can have on personal wealth. Here’s what you need to know this tax season:
Charges, such as interest expenses may be deducted when there is a potential for earning income from property. In the case of investments, that means income from property: interest, dividends, rents and royalties. Capital gains are specifically excluded from this list. Interest is not deductible unless you acquire an asset with the potential to earn income from property.
Borrowing to Invest in Registered Accounts. When you incur expenses to invest your money, a tax deduction is only allowed if the potential to earn income is in a non-registered environment. That means interest on loans used for the purposes of investing in an RRSP, TFSA, RESP or RDSP is not deductible. Nor is interest paid on a tax-exempt property, like your principal residence, unless there is an expectation of rental income will be earned.
Tax Form Fact. Eligible carrying charges are all claimed on the “worksheet for the return.”
The total carrying charges are then deducted on Line 22100 and serve to offset all other income of the year, so they can be an important way to reduce overall tax burdens and increase eligibility for social benefits and credits. But for this reason, these expenses are often audited.
Audit Check Point. You must be prepared to trace all interest you have claimed as a carrying charge back to a non-registered investment that has the potential to earn income.
Tax Filer’s Checklist. Consider the following list of deductible amounts carefully to be sure you haven’t missed any. If you have, consider filing Form T1-ADJ T1 Adjustment Request to recover these errors or omissions up to 10 years back.
Checklist of Deductible Carrying Charges
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Excerpted from Essential Tax Facts by Evelyn Jacks.