How do taxes work with leveraged investing?
In previous articles, we’ve discussed the ins and outs of leveraged investing, including what it is, how you can smartly use leverage to grow your portfolio, and the risks of over-leveraging yourself. What we have left to cover is the potential tax implications of using leverage in your portfolio. The good news is that while the CRA always wants its cut of income, there are actually a few ways that using leverage may help to reduce your tax burden.
Recommended reading: An introductory guide to leveraged investing.
How is real estate taxed in Canada?
First off, let’s do a quick refresher on how real estate is taxed.
The main factor distinguishing how the sale of your home is taxed comes down to whether the home was your principal residence or not. If you bought a home and lived in it for the full duration of your ownership, you won’t be taxed on the sale of the property. However, if you purchased the home as a rental and generated income, you’ll need to pay capital gains tax on the profit made from the sale. Check out our capital gains tax calculator for an in depth explanation of capital gains.
If you purchased a home as an investment property to rent out, you’ll also need to pay regular income tax on the revenue you made, however there are a whole host of expenses which you can deduct including the interest on your mortgage, which is highly relevant to the context of using leverage.
Recommended reading: How real estate taxes work
How does using leverage affect your tax bill?
When it comes to using leverage, whether it’s in the form of a mortgage, a Home Equity Line of Credit or a private loan, you won’t be incurring any additional taxes by borrowing money regardless of how you use it.
With that being said, there is a way that you can potentially reduce your current tax burden through the use of leverage.
How using leverage can reduce your taxes
As we discussed earlier, when you own an investment property, the interest portion of the loan can be deducted from your income as it’s considered an expense incurred in the operation of your rental business. This is the case for most forms of leveraged investing. In general, interest you pay on a loan to help finance a business or investment expense is tax deductible. Whether this means the mortgage on your rental property, or taking out a HELOC on your current property to fund the purchase of other investments; it’s all tax deductible.
This isn’t limited to only real estate either. You could for example borrow against the equity of your home to fund other investments such as purchasing shares of a mortgage investment fund to generate income. This makes a HELOC an even more attractive opportunity for investors, who will often find that borrowing against home equity is the cheapest and most convenient form of lending they have access to.
One thing to note however is that only the interest on the portion of the loan that is used for the investment is tax deductible. If for example you took out a $50,000 HELOC, put $10,000 into the stock market and used the other $40,000 to buy a car, only the interest on the $10,000 would be tax deductible.
If you want to tap into your home equity to leverage your property value, sign-up to Perch today and our mortgage advisors can help you plan your strategy.
This article should not be taken as legal, tax or investment advice. Please consult your wealth advisor, tax or legal professional before making any investment decisions.