Tax Deductions: Don’t Get Carried Away

Carrying charges generally represent costs that you incur to manage your investments (and potentially your business). Reported as a deduction on your personal tax return that can be applied against all your sources of income, carrying charges can save you some big dollars this tax filing season. Unfortunately, these costs are often missed by many taxpayers.

The following summarizes some of the more common deductible costs to consider:

• Amounts paid to your personal tax preparer where you have income from business or property (i.e. rental activities, investments, etc.);

• Fees paid to your investment professional to manager your investments and provide advice. Information reporting these costs are not provided to taxpayers in a consistent format: Some institutions issue an annual statement, some mention the cost on your last December reporting statement for the year and some report their fee on your T-slip. As a result, these costs can be missed if you are not diligent in your record keeping;

• Interest paid on money that you borrow for investment purposes. ‘Investment purposes’ generally refers to investment that will yield interest, dividends and rental income. If your investment were to be a (say) a vacant piece of real property and you borrow $100,000 to purchase that property with the anticipation of ‘flipping it’ at a later date for a higher price, that resultant income would constitute a capital gain. As a result, interest on that loan would not be deductible.

While RRSP loans are fairly common this time of year, it is important to note that interest on these loans is not deductible. Similarly, interest paid on a student loan is not deductible (however, it may qualify for a personal tax credit);

• Legal fees paid to collect (or determine the amount of) support payments. Interestingly enough, from the payer’s perspective, legal fees paid to minimize the amount of deductible support payments being provided to the estranged spouse are oddly not deductible; and

• Finally, safety deposit box fees (while fully deductible in prior years) are no longer a valid deduction after 2013.

Perhaps the largest (and most hotly debated) carrying charge deduction is ‘interest.’ Disputes between individuals and the taxing authorities on this topic have resulted in countless court cases. However, if carefully structured, your tax professional may be able to convert interest on your (say) personal mortgage to a deduction on your personal tax return.

Consider the following simple scenario: Bart owns shares of Duff Breweries Inc. that have a value of $100,000. He also has a $90,000 mortgage on his $300,000 house in Springfield. Where Bart ‘cashes’ in his investment, he could utilize the proceeds to pay down the mortgage that is generating non-deductible interest. He could then borrow again (possibly the same amount if he wishes) and this time use the loan proceeds to purchase another investment. While this form of ‘shuffling’ results in debts and assets being the same amount, it converts formerly non-deductible interest to deductible.

In performing a maneuver similar to that as described per the above, the use of a professional tax advisor is strongly recommended. There are a multitude of pitfalls that can occur to the unwary taxpayer who attempts to ‘go it on his own.’

Very generally, there is currently no requirement that your interest ‘income’ exceed your interest ‘expense.’ Regardless, there may be a concern where you are deducting interest on a rental property where you (or another family member) reside in the rental unit.

I hope you found this article ‘interest’ing. In seriousness, the emphasis on attention to detail is critical in structuring your interest deduction. A failure to do so could inadvertently trigger a tax problem at a later date.

Specializing in providing tax and accounting solutions to Northern Ontario business owners, Daryl is partner with MNP LLP, Chartered Accountants.

by Daryl C. Heinsohn, CPA, CA, CFP