If you have a home equity line of credit (HELOC) joint with your spouse and you have used to invest be aware that deducting the interest on your investment loan can be a mine field.
Consider the case of Bill and Judy. They have a joint HELOC secured to their family home. Bill withdrew $50,000 from the line of credit and deposited the funds in his joint brokerage account with Judy.
Since Bill makes considerably more than Judy, he pays all of the family expenses, including the interest payments on the line of credit. When tax time comes around Bill and Judy allocate the investment income and interest deductions 50/50. However, the CRA disagrees with this allocation and taxes all of the investment income to Bill and denies half of the interest deduction.
What Went Wrong?
The only way Bill and Judy could split their investment income and the HELOC interest would have been for them to make equal payments on the HELOC. Because Bill made all of the payments meant that the investment loan was for him and the CRA taxed all of the income in his hands.
Since the account was held joint and the apparent intent was that the investments were equally owned, Bill would not be able to deduct half of the interest because it really belonged to Judy.
Confusing? Yes. But let’s look at this a little closer.
Bill Pays For Judy’s Investment Loan
If Judy had borrowed from the line of credit directly but Bill had made the HELOC payments, the investment income would be taxed in Bills hands and the interest expense would be disallowed.
The CRA looks at this way:
Bill is paying the investment loan and is the real contributor to Judy’s account. Bill is taxed However, the investments belong to Judy so Bill cannot deduct the interest despite paying it.
How To Do It Right
The best way to use a joint HELOC to split income and the interest deduction is to ensure you and your spouse make equal payments to the HELOC.
Separate accounts works better but make sure you still make equal payments to the HELOC!
Related Articles
- Personal Audit Trail With Multiple Accounts
- Deducting Automobile Expenses For Work
- The Benefits And Dangers Of Joint Accounts
- Drawing Income From Your Home
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Thanks for the reply.
Do you know what the law with regards to deducting interest paid on a loan taken out for investing in stocks, which you have now sold at loss, but the loan is unpaid yet.
@Kevin – If you have borrowed to invest and then have disposed of the investments for less than the loan, you can continue to deduct the interest on the excess, provided you used the proceeds of the sale to pay down the loan. The excess being the difference between the loan and the proceeds of the sale. This is permitted under s.20.1 of the Income Tax Act – Here is an alternate link. You can also read a better version of this at paragraph 19 of CRA Document IT533.
I am trying to do the Smith manoeuvre. I have invested the Heloc amount into stocks. some of them are for long term (dividend) and some are short term trading. I started in Sept. this year. Now I have some taxable capitol gains + losses(after buying and selling) and some dividends. After withdrawing the amount, the book value of my portfolio will still be higher than my Heloc amount. My question is can I withdraw the amount equal to my capitol gains and dividends to pay the mortgage down, while still keeping my Heloc fully tax deductable.
Thanks
Javed,
When you buy a stock, it’s cost plus any commissions are added to the cost base. When you sell the proceeds, less any commissions are deducted from the cost and the difference is a capital gain or which 1/2 is taxable. You cannot withdraw the “cost” or “book value”.
Second, you can deduct the interest on borrowed money if the investment is used to gain or produce income from property. This includes interest, dividends, rents, royalties. It does not include capital gains. If you are a heave trader and most of your gains are capital, your interest deductibility may be compromised because the CRA may tell you that your investing is only for capital gains.
Finally, the source of funds must be traceable to the use of funds. If you borrow to invest, then cash out some investments and pay the mortgage (not the HELOC) you may taint your structure and face a denial of deductions.
You should hire someone to advise you.
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