Last updated: Mar. 23, 2023
At tax time, we’re consumed with finding every deduction we can to lower our final tax bill. One that is commonly missed (and misused) is interest expense deductions.
As a small business owner or farmer, you are entitled to deduct certain types of interest payments related to your business or farming operation.
That’s why FBC spends time sifting through all your information and financial backups – like loan statements, banking information, and annual reports. We’re finding as many deductions as we can, along with the supporting paperwork, to make sure you get the maximum deduction to which you’re entitled.
After all, there’s no point in deducting an expense only to have that be audited and, eventually, denied.
With that in mind, lets answer that age-old tax question: to deduct or not to deduct?
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- Are you self-employed?
- If so, do you have a business loan (with monthly interest), a specific bank account (with monthly interest), or a home office (in a home in which you make mortgage payments with interest). If so, a portion of the related interest may be a tax deduction.
- Do you have a rental property?
- If so, and there is a mortgage or other lending attached that is used only for the rental property, you can include these amounts as a deduction from your rental income (Form T776).
- Do you have a farm?
- If so, does your farm operation include a loan? Related interest expense can be included as a deduction.
- Do you have a non-registered investment loan used to earn income on investments that pay interest or dividends such as stocks, bonds, or mutual funds?
- If your annual statement confirms that the loan was only used for purchasing investments, the annual interest paid is a deduction.
- Please note, only non-capital gain income qualifies as deductible interest.
- Do you have a financed vehicle that you use as part of your employment (supported by Form T2200)?
- If so, check the loan document to calculate the total interest paid in the year (generally limited to a max deduction of $10/day).
- Reminder: only the business use portion of the expenses may be deducted.
Or not to deduct…
- Does the loan relate to registered investment income such as Registered Retirement Savings Plan (RRSP), Registered Education Savings Plan (RESP) or Tax Free Savings Account (TFSA) investments?
- This interest is not
- Does the business loan or eligible mortgage include amounts that have been used for personal expenses (i.e., paying down credit cards or other personal debt and purchases)?
- The interest may need to be prorated to carve out the personal portion which is not
- Do you have a loan for a vehicle used in your employment or business with daily interest that exceeds $10/day?
- The portion of the interest exceeding that $10/day limit is not
- Are you an employee that works from home?
- Mortgage interest for your home office is not deductible from employment income.
- Do you have a government-issued student loan?
- Interest paid on a student loan is not deductible but may be eligible for a non-refundable personal tax credit (see line 31900).
- Unused student loan interest amounts may be carried forward 5 years.
When claiming interest deductions, your records need to show that the interest you paid was used to generate income.
In other words, when preparing your tax filing, your tax specialist must be able to trace the purpose of the loan and the use of the loaned funds to ensure the interest is treated correctly.
For example, if you refinance a home and the funds were used to pay down personal debt, the interest needs to be adjusted to remove that portion from potentially deductible mortgage interest.
To avoid these kinds of paperwork headaches, it’s best to keep your personal and tax-deductible debts separate. If you can’t, then see what you can do to simplify your record keeping.
Let’s say you have a line of credit that you use for personal expenses and income generating investments. You could ask your lender to break the personal and investment portions into separate accounts to make it easier to track interest payments.
It’s good to be cautious when using a loan for dual purposes, however, as the Canada Revenue Agency may reallocate payments to your tax-deductible debt first, rather than your personal debt.
If you have some extra cash, you may also want to consider using that cash to pay down personal debt (i.e., personal credit card) and then borrowing the equivalent amount as an investment loan (i.e., a loan to buy stocks). Done correctly, the interest payments are lower on your personal debt because you’ve paid a portion off, and the interest payments on your investment loan becomes a tax deduction.
As this scenario depends on interest rates of your personal debts and your investment loan, the expected income from your investment as well as your personal financial and tax situation, it’s best to get financial planning and tax advice before proceeding.
If you have any additional questions about interest deductions or what kind of supporting paperwork you need to provide your tax specialist please reach out to us. We’re always happy to help you pay less tax.
Free Guide: Tax Preparation Toolkit for Small Business Owners
We know you’re dreading it, but with a little preparation, you can fulfill your tax obligations without any stress. Our comprehensive tax preparation toolkit will help you get organized for tax time.
Learn what information and key documents you need to prepare so you’re ready for the tax filing deadline. There’s even a printable checklist that includes important small business tax deductions.
Let’s help you get the prep out of the way so you can get back to running your business!
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