Which Spouse Should Claim the Investment Loan?
I received an email from Geoff last week regarding which spouse should claim the investment loan when performing a strategy like the Smith Manoeuvre.
Here is the original question:
What I am wondering about is when you are a couple, what is the best strategy or getting the best tax return from the interest paid on the HELOC used to buy investments?
For example:
- Does it matter whose name the investments are purchased under or should they be under both names?
- Does it matter who owns the HELOC or if it is jointly owned?
- If the HELOC is under both names, does the tax deduction for the interest paid get split between the two people?
It really depends on the financial situation of the couple. But lets look at the questions one at a time.
Does it matter whose name the investments are purchased under or should they be under both names?
- Typically, it's whoever funds the investment account is responsible for the taxation on the account. However, investment loans are different. You can have both spouses on the "title" of the investment loan (ie. HELOC), but it's the name (the one who submits their SIN) on the investment account that gets taxed (and obtains the right to claim the tax deduction).
- With that said, providing that you purchase tax efficient investments, it would be optimal to keep the investments in the name of the higher income spouse.
- It makes sense to claim the investment income under both spouses if both spouses are in the same tax bracket. This would help in future years when income splitting is a concern.
- According to Ed Rempel, although you can have both names under one investment account, you can choose who to charge the investment income. As long as you keep consistent through the years, this shouldn't pose a problem.
Does it matter who owns the HELOC or if it is jointly owned?
- As mentioned above, if the HELOC is jointly owed, you can put the money into an investment account of either spouse, or a joint account.
If the HELOC is under both names, does the tax deduction for the interest paid get split between the two people?
- Again, it doesn't matter if the HELOC is under both names, what matters is the name on the account that is investing the money. The owner of the account investing the money, is the owner of the tax deduction and tax liability.
Conclusion:
Be sure to claim the investment income under the spouse with the highest income. If both spouses have similar rates, then invest under both names.
I am not a tax professional, please consult an accountant before following any taxation advice you find here.
18 Comments, Comment or Ping
1. FourPillars
I liked yesterday’s title better :)
This is good information. I think I might have made an error with some of my leveraged buying because some of it ended up getting mixed in with my regular mortgage which is locked in for several years. What happened was that I made a purchase with my LOC at my old bank – then I transferred the mortage + LOC to new financial institution and put it all together in the locked in mortgage (at a good rate). Co-mingling probably doesn’t help if I get audited but I figure that since I have the paper trail I should be ok.
Mike
Sep 25th, 2007 @ 10:00 am
2. FrugalTrader
Hey FP, as you stated, provided that you keep a proper paper trail, everything should work out. Do you do your leveraged buying with a regular LOC?
Sep 25th, 2007 @ 10:44 am
3. FourPillars
Thanks.
I do my leveraged buying with a home equity secured line of credit (FirstLine Matrix) – not sure if that is what you mean by a “regular” LOC.
Sep 25th, 2007 @ 10:54 am
4. Telly
Good post! The only thing I would add is that one should also consider, especially since this is likely a long-term endeavour, potential changes in incomes. For example, if one spouse is currently the lower income earner but is doing a Masters for example, they may in fact, end up the higher income earner over the long run. Also, consider the fact that one spouse may decide to stay at home at some point.
FT, is this hands down always the case? I wonder, if investing in buy-and-hold dividend paying stocks (no cap gains), would it always make sense to invest in the higher income earners name? I’m wondering if dividend gross-up (depending on the province) might make the opposite more appropriate depending on the income levels of each spouse. I don’t have any numerical examples (I’m too lazy ;)) though.
Sep 25th, 2007 @ 12:36 pm
5. FrugalTrader
Perhaps if future income will be variable, then putting the investment loan under both names would be best. Especially if both spouses are close to retirement (income splitting).
Telly, I would need to do an analysis on receiving dividends and the optimal tax solution. But as you stated, it would depend on income of both spouses and the province that they live in. Cannon Fodder’s spreadsheet may help in determining the outcome.
Sep 25th, 2007 @ 2:09 pm
6. Ed Rempel
Telly,
The key in determining who should claim the SM should be in who should best claim the interest deduction.
If your investments are tax-efficient, you should be able to keep your taxable income far below the interest tax deduction for many years.
You are right that you should look at the long term incomes. Once you start claiming the deductions and income on one person’s tax return, you need to continue, unless you sell and claim the taxable gains to date.
FT, the tax ownership of the SM can be different from the names registered for the investements or the investment credit line. This takes some explaining, but the short answer is that we always have both the investments and the investment credit line in joint names, but then claim the deduction and interest wherever it is best.
Ed
Sep 26th, 2007 @ 8:36 pm
7. Man From Atlantis
Hi Ed,
Would you explain your thinking behind putting the investments in Joint name and then claiming the deduction and interest wherever it is best. Are you suggesting that you would change who claims the deduction based on their annual taxable income. If so, would that be an issue with CCRA?
Sep 30th, 2007 @ 10:28 am
8. Ed Rempel
Hi Atlantis,
The reason we usually put the investments in joint name is for estate planning purposes – joint with right of survivorship.
The legal and tax ownership of investments can be different. For example, the entire section on attribution rules is about investments in one person’s name but the income is taxed back to someone else.
So, we can have the investments in joint name and then can have both the loan interest deduction and the tax on the investment income taxed to either or both, whichever is best.
However, you should not change it after that. If for example you have the entire SM taxed to the husband and things change so it would be better to have it all taxed to the wife, the only way to do this is to sell the investments and pay off the loan – and then reborrow and rebuy.
Therefore, our choice of which spouse to tax to (or joint) is based on which we expect will be best for most of their financial future. It is a many year decision – not a one year decision.
Ed
Sep 30th, 2007 @ 7:15 pm
10. Steps
My husband and I have a joint investment loan. I have been claiming the interest from the loan on my tax returns since getting the loan in 2003 and I have also been claiming all the capital gains, dividends, etc. (all the funds are jointly owned as well), except for last year. I was told by an accountant that we could switch it around to our benefit so I put the gains from two of our funds onto my husband’s tax return last year. I have called the CRA several times regarding this matter and each person I speak with tells me something different. One said I should put it back onto my return this year and do a T1 adjustment for 2006, one said I should go back to when we got the loan and investments and do a T1 adjustment for every year and split everything according to who invested what percentage, one said to just switch it back to me this year and the latest person ( I told her that I get a different answer each time I call) told me that if it is in both names, either one of us can claim any gains and we can switch it around each year, but it was better to be consistent. What is the correct answer.
Mar 27th, 2008 @ 1:13 am
11. Iced
My wife stays home with our 1yr old son. My total income was 120K and hers was 30K. We have 200K of leverage loan so an investment income and interest expense. Can I (should I) claim the interest expense and she claim the investment income? Optimally, the higher salary person claims the interest expense and lower salary reports the investment income? I will most likely always have the higher salary now and in future.
May 1st, 2008 @ 4:20 am
12. elman
@Iced
Someone correct me if I am wrong but I am sure the person who deducts the investment loan interest must also claim the investment income. You cant deduct the loan interest + expenses for yourself and have your spouse claim the investment income.
Jan 8th, 2009 @ 9:01 pm
13. Scare
I am in a similar situation as Iced, anyone have any further updates for the 08 tax season
Apr 17th, 2009 @ 6:41 pm
14. Ed Rempel
Hi Iced, Elman & Scare,
I just noticed this post. Elman is correct – whoever claims the interest deduction must also claim any investment income/profit.
Since you are in the higher tax bracket and assuming you plan to invest tax-effiiciently, you should expect tax refunds most years. Therefore, you would want to claim both the interest deduction and the investment income/profit.
Your position is that you borrowed money and invested it, which is why you claim all the tax consequences. Your investment credit line is probably in both your names, but that does not matter. You can also buy the investments in joint names with your wife for estate planning purposes, but still have claim everything yourself.
Ed
Jul 19th, 2009 @ 4:00 am
15. Dave D
I found a post that it is based on the percentage of payment for interest.
ei If one spouse paids all the interest on the HELOC that is the person must claim 100%. If the payments are 50/50 then it can be split.
Is this correct?
http://blog.taxresource.ca/deducting-interest-and-joint-heloc/
Aug 14th, 2009 @ 1:41 pm
16. Ed Rempel
Dave,
I just noticed your post. That is partly right. Whoever borrowed to invest should claim both the interest deduction and the investment capital gains. That is normally designated when you first borrow to invest (or the first time you prepare your tax return).
In general, once you designate who borrowed to invest, that should remain as long as you have the investment loan.
You should then consider that person paid the interest. That is normally a reasonable assumption, as long as he/she made at least that much. If you decide to claim it 50/50, then both need to earn at least that amount of income each year.
The example in the article was not a smart tax strategy anyway. If she has no income and he has a high income, it would be much smarter for them to claim everything on his return only.
Ed
Dec 14th, 2009 @ 3:23 am
17. Dwight N
Hi all,
We live in BC. I work overseas, thus take advantage of the”overseas tax credit “. Currently my wife owns a small business { in BC } that grosses approx $50,000- 60,000 /yr and my employment income is between $100,000 – 140,000 /yr.
We used our loc { joint acc } to buy dividend paying Canadian stocks in the amount of $100,000. Things are looking fine to date.
So far our accountant has everything going into my wifes name. My tax knowledge is limited… does this seem to be the correct action.
Also when my wife sells her business later this fall how will this change things.
Dwight.
Jul 15th, 2010 @ 9:01 am
18. Ed Rempel
Hi Dwight,
Your situation sounds complicated, but most likely the SM is better claimed in your wife’s name only, because you are getting dividends.
With the tax-efficient version of the SM, you would claim it on your return to get the refunds. With the dividend version of the SM, you would normally claim it under your wife’s name in order to pay less tax on the investment income. This depends on how much you receive in dividends vs. the loan interest.
With the dividend version of the SM, you normally don’t get the refunds that you get with the tax-efficient version.
By “overseas tax credit”, I assume you mean you are taxed in a different country – is that right? Which country?
It may sound complicated, but essentially you claim your foreign income in that country and pay tax there. Then you also claim it on your Canadian return, but claim a tax credit for the tax you paid in the other country.
This mean you essentially pay the highest rate of the 2 countries, which is probably Canada.
Without know the details of your situation, if your employment income is fully taxed in Canada, then your tax bracket is much higher than your wife’s. Her gross may be $50-60,000, but what is the income she actually shows on her tax return after business expenses? She is probably in the low tax bracket, while you are probably in a high tax bracket.
Your accountant may be claiming the SM under your wife, because you are using a dividend method. Dividends are taxed at negative tax rates (no tax) for the lowest tax bracket (taxable income under $41K).
Both the investment income and the interest deduction need to be claimed by the same person(s).
The SM is usually best claimed on the person with the highest income. If you invest in a tax-efficient investment (one with minimal taxable investment income), you should be getting tax refunds every year. The interest deduction should be more than the investment income almost every year, so you get tax refunds. In that case, you would claim the SM on your tax return.
Ed
Aug 13th, 2010 @ 3:50 am
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