Investment Loan Interest Deduction — Make Your Borrowing Costs Tax-Deductible

Do I Qualify?

• You borrowed money specifically to purchase income-producing investments (dividend-paying stocks, bonds, REITs, rental property, or income-producing ETFs/funds)
• The investments pay — or can reasonably be expected to pay — income such as dividends, interest, or rent
• You can trace the borrowed funds directly to the investments (funds went from lender to investment account without being mixed with personal funds)
• You have a statement from your lender showing the total interest paid during the year
• The investment account is non-registered (not RRSP, TFSA, or RESP)

Overview

Under section 20(1)(c) of the Income Tax Act, interest paid on money borrowed for the purpose of earning income from a business or property is fully deductible from taxable income. This means that if you borrow to invest, the CRA effectively subsidizes a portion of your borrowing cost equal to your marginal tax rate.

This rule applies to interest on:

• Margin loans used to buy dividend-paying stocks
• Investment loans used to buy bonds, GICs, REITs, or income-producing ETFs
• Lines of credit where the borrowed funds are used to purchase income-producing investments
• Mortgages and loans on rental properties
• Business loans

The Core Requirement: Income-Earning Purpose

The deduction requires that the borrowed money was used for the purpose of earning income from a business or property. CRA and the courts apply this test at the time of borrowing, not based on actual results.

Eligible uses of borrowed money:

• Buying shares in a corporation that pays (or could reasonably be expected to pay) dividends
• Buying bonds, GICs, or other interest-bearing investments
• Purchasing REITs or income trusts
• Buying units in a fund that holds income-producing assets
• Financing a rental property

The growth-only trap: If the investment produces no income and has no reasonable expectation of producing income (e.g., a speculative stock paying no dividends with no prospect of paying any), CRA may deny the interest deduction. However, the Supreme Court has held that a reasonable expectation of any income — even nominal dividends — is generally enough to satisfy the test.

Practical rule of thumb: If you borrow to buy dividend-paying ETFs, bonds, rental property, or blue-chip dividend stocks, the interest is almost certainly deductible. If you borrow to buy highly speculative growth stocks paying no dividends, consult a tax professional.

How Much You Can Deduct

You can deduct 100% of the interest paid during the year on the borrowed funds, with no dollar cap. There is no ceiling equivalent to the US $10,000 investment interest limitation.

Example: You borrow $200,000 at 6% interest to invest in a diversified dividend-paying ETF. Annual interest: $12,000. At a marginal rate of 46%, your after-tax cost of the loan is $6,480 — roughly half of what you actually paid.

If the investment earns $6,000 in dividends, you report $6,000 in dividend income and deduct $12,000 in interest — producing a net investment loss of $6,000 that reduces your other income.

Tracing the Borrowed Funds

CRA requires a direct link between the borrowed money and the income-producing investment. This is called the “direct use” or “tracing” rule.

How to maintain a clean trace:

• Use a dedicated account for investment loan proceeds — don’t mix borrowed funds with personal funds
• Transfer loan proceeds directly into your brokerage account before purchasing investments
• Keep records showing the loan was drawn and the investment was purchased in sequence

If you redraw on a line of credit, mix borrowed and personal funds, or use borrowed money for personal expenses, the interest deduction can become partially or fully denied.

What Happens When You Sell

If you sell the investments purchased with borrowed money:

• If you repay the loan, the interest deduction stops when the loan is repaid
• If you reinvest the proceeds into other income-producing investments, the deductibility continues — the trace simply follows the new investment
• If you spend the proceeds personally, the interest deduction on any remaining loan balance is denied going forward, even though the loan still exists (the “loss of source” rule from Tennant v. The Queen)

This is the most important planning point: if your investment drops significantly and you sell, the deductibility of ongoing interest may be lost unless you reinvest.

How to Claim

1. Obtain a statement from your lender showing total interest paid during the year
2. Confirm the borrowed funds remained invested in income-producing assets throughout the year
3. Report the interest on Schedule 4 (Statement of Investment Income), line 22100
4. The deduction flows to line 22100 of your T1 return

For rental property interest, report it on Form T776 (Statement of Real Estate Rentals) as a rental expense instead.

What Most People Miss

• You can deduct interest even in a year the investment loses money. The purpose test looks at intent, not results. A down market year does not eliminate the deduction.
• Margin loan interest qualifies if the margin is used to purchase income-producing securities. Keep records of what the margin funds bought.
• The interest rate on the loan doesn’t matter. Whether you’re paying 4% or 8%, the full amount is deductible.
• Capitalizing interest is allowed in some situations. If you are in the construction phase of a rental property, you can add interest to the cost base of the property rather than deducting it immediately.

Frequently Asked Questions

Sources

• Income Tax Act s.20(1)(c) — Interest Deductibility
• CRA — Carrying Charges, Interest Expenses, and Other Expenses (Line 22100)
• Supreme Court of Canada — Ludco Enterprises Ltd. v. Canada, 2001 SCC 62
• CRA — Interest Deductibility — Interpretation Bulletin IT-533