This is a guest post from The Canadian Tax Blogger who has taken the time to answer common reader questions regarding leveraged investing and filing income taxes.
The process of saving and investing can be a rewarding experience. However, when it comes to taxes and reporting your savings to the CRA, the experience can be frustrating.
If you have used the Smith Manoeuvre to exchange your mortgage interest for investment interest, you may be wondering how to report the interest expense on your tax return.
When it comes to personal finance, proper record keeping ensures that you can track progress towards your goals. When it comes to income tax, proper record keeping can help avoid the denial of a deduction and incur interest and penalties.
When you file your tax returns, you are not required to submit any documentation to the CRA to prove your claim for interest expenses. However, you must keep adequate records to support your claim in case the CRA asks to see them.
You must be able to show that the funds withdrawn from your line of credit was used to purchase investments. You can show this link by attaching the cancelled cheque from your line of credit to your brokerage statement or attach your bank statement showing the funds transfer from your line of credit to your brokerage account.
You also need to support your interest expense calculations. Attach copies of your line of credit statements along with a coversheet showing your calculations to your income tax return.
Maintaining proper records will ensure that you can quickly access your records and prove your claim at anytime.
Personal Use of Funds
When you borrow to invest in income producing properties, the interest you pay is tax deductible. However, interest used for personal purposes is not tax deductible.
It is important to ensure that when you use your line of credit to invest, that you avoid using it for personal purchases. Using your line of credit for personal purchases could result in your deduction being denied unless you can conclusively link the proportion of the line of credit to your investments.
It can be difficult to determine the proper proportion if there are a number of personal purchases on your line of credit. There is also a greater possibility for error. It is advisable that you use a second line of credit for personal purchases…or better yet, use cash!
Reporting Your Tax Return
You have assembled your bank statements and calculated your interest expense and now you are ready to claim the deductions on your tax return.
The deduction for interest paid on your investment loan is reported as “Interest Expenses” on Schedule 4 Part IV Line 221. The description should be “Investment Loan.” The total amount reported on Line 221 of
Schedule 4 is then recorded on Line 221 of the T1 Income tax and Benefit Return.
And that is it!
If you are unsure of what you can claim or what you can deduct, it is advisable that you speak with a tax professional.
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