Q: Why is the mortgage interest on a home or condo not deductible when it’s our principal residence?
— Brendan A., St. Albert, Alta.
Answer from Frank Wiginton, CFP and financial wellness expert:
It should be pointed out that U.S. citizens only pay tax on the capital gains of their home if they downsize or sell out of the market. Also, if they purchase a more expensive property they aren’t required to pay tax on the less expensive property they just sold as the book value of the property carries through.
Keep in mind, however, that any time a Canadian wants to invest and create a tax-deduction from a property investment that property needs to earn an income. If the property does not earn an income the interest on the mortgage cannot be deducted as an investment expense (and, at no time, can the principal part of the mortgage payment be used as a tax deduction).
Those opting to deduct the business portion of home-office expenses should also keep in mind that any deduction in capital cost allowance expenses could exempt the portion of your home dedicated as your home office from the principal residence exemption, which could create a potential future tax liability when you sell your home.
It’s important to realize that while we are talking generalities there are always transactional costs. For example, there will be trading costs and a potential tax hit that will arise from the sale of the original (non-registered) investments. There will also be penalties if you need to break the $150,000 mortgage, as well as additional trading costs to reacquire the investment portfolio.
Finally, if the investor only bought stocks or assets that appreciated in value and never realized the capital gains, then you couldn’t claim the interest expense. A few examples of such investments would be shares in mining companies with no revenue, physical gold or metals contracts, as well as start-up tech companies. They key is if you don’t generate taxable income you can’t deduct the carrying costs.
Frank Wiginton is a Certified Financial Planner and a financial wellness expert. He is CEO of Employee Financial Well-Being and author of “How to Eat an Elephant – Achieving Financial Success One Bite at a Time.”
Robert McLister, mortgage planner at intelliMortgage and founder of RateSpy:
In Canada, interest can be deducted only if the purpose of the borrowing is to earn business or investment income. If a property is your principal residence and not rented out, it does not produce income, and therefore does not meet Canada Revenue Agency’s interest deductibility requirements.
If, however, you mortgaged your home and invested the proceeds in income producing assets, you may be able to write off the mortgage interest. One such strategy is called the “Smith Manoeuvre,” a leveraged investing strategy that’s not without risk. Before attempting to write off mortgage interest, it pays to chat with a licensed tax/financial planner first.
Nawar Naji, mortgage broker with Mortgage Architects:
Good question for the Minister of Finance!
In Canada primary residences are not tax deductible, whereas the interest on the mortgage payments of investment properties are. However, if you are self-employed and operate a business out of your home you can also gain some tax advantage on portions of the mortgage interest, property taxes, condo fees and utilities as these are considered tax deductible expenses. An accountant can provide further details on these tax deductions.
Nawar Naji is a licensed mortgage broker with Mortgage Architects in Toronto, Ontario. He has been brokering since 2007, helping clients finance homes and investment properties.
Romana King, senior editor and real estate specialist with MoneySense:
Look at the monthly mortgage payment you make. Notice how a big chunk of that is interest? Well, that’s not a tax-deductible expense. Which is why more than a few Canadian homeowners get a wee bit jealous when we hear about how our American neighbours can deduct their mortgage interest off their income each year for a great income tax deduction.
But you can actually mimic that effect. Say you have a home with only $150,000 left on the mortgage and you have investments worth at least $150,000 in unregistered accounts (so no RRSPs, RDSPs or RESPs). Sell the investments and use the money to pay off your mortgage. Yep. Now, get go to a bank and apply for a Home Equity Line of Credit (known in bank speak as a HELOC). This HELOC is secured against the value of your home. Now, go back and buy back all those investments (just remember there are holding limits so talk to a tax expert about minimizing these charges).
After all that you still have the same amount of debt but the great thing is that loans on investments are tax-deductible, so you can write off the interest from this HELOC each year on your tax return. For instance, if you’re paying 3.5% on the HELOC and in a 30% tax bracket, you could deduct $5,250 of interest on your tax return and save just over $1,700 in taxes. Better yet, each year the loan is held, you can claim a deduction.
Just make sure your investments provide you a return that exceeds the cost of your loan. Also, keep in mind that almost no lender will give you a HELOC that’s worth more than 65% of the fair market value of your home. So, if your home is worth $500,000, the maximum a lender will give you is $325,000.
Romana King is the senior editor and real estate specialist at MoneySense. She is also a licensed real estate sales agent. Follow her on Twitter (@RKHomeowner) or on Facebook. If you have real estate concerns or questions, please email Romana directly at firstname.lastname@example.org or call her on her direct line at 416-764-1382.
Correction: This copy was updated with additional information on Monday June 27, 2016, to help clarify how U.S. property is taxed.