At the risk of entering the world of investment advice, and please do not take anything within as such advice, from a tax perspective there may be better methods of acquiring investments than others.
Here is the basic premise. Interest expense associated with loans used for personal or operating purposes is not a tax deductible expense, while interest expense associated with loans used for generating taxable earnings generally is.
To offer detail, in addition to the investment having to generate taxable earnings, or have the propensity to do so, qualifying interest to be an allowable expense is subject to having a clear and direct connection between the loan and the investment the loan purportedly acquired, a legal obligation to pay interest although this does not have to be in writing, and the rate of interest being reasonable.
Interest that qualifies as a tax deductible expense is classified as a carrying cost by Canada Revenue Agency (CRA) and is claimed on schedule T1-INV on your tax return.
With the RRSP investment deadline approaching given the looming tax season, I can anticipate your thinking. But wait, before you commit to a loan to invest in your RRSP, as always with CRA there are exceptions. In this case, the interest paid on a loan used to invest in an RRSP is not tax deductible despite RRSP growth eventually taxed when it’s cashed out.
Additionally, and understandably since the growth within a TFSA is not taxed, the interest paid on a loan for investing within a TFSA is not tax deductible.
This detail aside, there is credibility in the premise previously stated.
If you find yourself in a position of having personal loans and also possessing taxable income generating investments then perhaps following the “interest expense shuffle” may be of interest to you for tax purposes.
Cash out investments.
Pay capital gains tax if applicable.
Pay off debt.
Take out a loan.
Acquire taxable income generating investments.
Claim investment loan interest expense as a carrying cost.
Of course if the investment involves large capital gains, serious consideration has to be given to the tax consequence upon disposal. There may clearly be no tax advantage in doing this shuffle.
Noteworthy, if there is a capital loss involved in disposal of the investment, CRA will not allow the loss to be claimed if the same investment is purchased within 30 days prior to the disposal or re-purchased within 31 days after the date of disposal. The special CRA “superficial loss” rule applies during this 61 day period that denies a claim for a capital loss on the investment disposal.
Realizing that there can be viable strategic reasons for re-investing in a losing investment, in general the typical course of action would be to dispose of the losing investment, use the freed up cash to pay off debt, and then take out a new loan to invest in something different. This would yield the ability to claim the capital loss and also expense the new investment loan’s interest.
A final word, before undertaking investment actions, seek advice from a licensed financial advisor.
Ron Clarke has his MBA and is owner of JBS Business Services in Trail, providing accounting and tax services.