How to Deduct Mortgage Interest in Canada

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The interest you currently pay on your mortgage is not tax deductible in Canada the way it is in the United States. Canadian tax law, however, does allow an interest deduction for borrowed money that is then directed to an investment with the purpose of generating taxable income. If you currently own your own home and have funds in non-registered investments generating taxable income, you can take advantage of this feature in the Canadian tax law.

Things You'll Need

  • Funds in non-registered investments
  • Home with existing mortgage
  • Check whether your existing mortgage can be paid off without penalties. This is usually allowed on open mortgages.

  • Verify your outstanding mortgage balance with your lender.

  • Identify a source of funds in your investments that is readily available. The investment should be non-registered and free of withdrawal penalties.

  • Withdraw an amount of funds equal to your mortgage balance. Deposit the funds to your bank account.

  • Pay off your existing mortgage balance.

  • Apply for a loan at an institution of your choice a day or two after paying off your mortgage. Give as a reason for the loan that you wish to use the funds to invest. Use your home as collateral for the loan.

  • Deposit the funds into non-registered investments. Do not invest in a Registered Retirement Savings Plan (RRSP) or Tax Free Savings Account (TFSA). You must direct the funds to an investment that is deemed to generate taxable income, such as mutual funds. The purchase of a rental property, or investment in a business, also qualifies as long as they will produce taxable income.

  • Keep track of your interest payments and deduct them from your taxes up to and including the amount of taxable income the related investment generates. Use line 221 and also complete Schedule 4 on your Federal T1 form.

Tips & Warnings

  • Read the Canada Revenue Agency regulations regarding the deductibility of interest. Learn which investments qualify and which ones don't.
  • Talk to a qualified tax specialist before undertaking this venture. It is worth it as you will be moving a lot of assets around.
  • Although this procedure is entirely legal and supported by precedent, you should prepare yourself for the Canada Revenue Agency to question your deductions. The best defense against an audit or a rejection of your claim is to keep detailed records of all transactions and keep to the guidelines with regard to which investments allow you to deduct the loan interest.

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