Mortgage Interest Deductability Scenarios

When filing your annual small business, personal income tax return, expenses incurred to earn income like travel, bank, postage, courier, utility and other charges and expenses are deductions from income. But the item that sometimes has the most impact is deducting a proportion of residential mortgage interest.

Generally speaking, in Canada, interest on residential mortgages is not tax deductible. However, most home businesses can do so because there is a direct link between the borrowed money and earning income.

The mortgage-interest deduction, like other deductions, is based on the square footage of my office divided by the total square footage of the house. Keeping track of all your household expenses is very important. You will then apply the business use percentage to the home office expenses including mortgage interest.

Canadians like to talk about mortgage-interest deductibility because the mortgage on a principal residence is the biggest debt Canadians have. They also like to talk about it because tax laws in the United States have provisions for residential mortgage-interest deductibility. Far fewer realize that Americans must pay a capital gains tax when they sell their home.

Under its most common allowances and interpretations, mortgage-interest deductions can still work as an effective strategy for reducing taxes. In addition to the case of a home business, one can deduct mortgage interest when investing in a residential rental property.

If you are purchasing a property and you take a mortgage to purchase that property and then you rent out that property, then you are getting rental income from it. That interest would be deductible. There always has to be an earning income use of the funds.

A similar mortgage-interest deduction opportunity exists when one is renting out a room in one's principal residence or is earning income from a vacation property for all or part of the year. In both cases, the arrangement must be a legitimate commercial agreement.

If you rented a vacation property out below value to family it would probably be offside. If you rented it out to third parties at a reasonable rate [the Canadian Revenue Agency might] look to see whether there was any commercial reality. At the very least you could deduct it off the rental income for the portion of time it was actually rented.

Mark
http://www.MajecAccounting.com

TFSA or RRSP?

The Tax Free Savings Account (TFSA) is an important investment vehicle for Canadians looking to save money and minimize their taxes

The following are quick facts about the TFSA:

~ Whatever you are saving for, it will help by saving taxes on the investment income.

~ Eligible Canadians can contribute up to $5,000 every year.

~ You don’t require earned income.

~ Unused TFSA contribution room can be carried forward.

~ Contributions are not deductible for income tax purposes

~ Funds can be withdrawn for any purpose at any time (depending on what you invested in).

~ The amount withdrawn will be added to unused contribution room and can be re-contributed starting the following year.

Differences between an RRSP and a TFSA:
~ While an RRSP is primarily intended for retirement, the TFSA is intended for use as needed. Both plans offer tax advantages, but they have key differences:

~ Contributions to an RRSP are deductible and reduce your income for tax purposes. In contrast, TFSA contributions will not be tax deductible.

~ Withdrawals from an RRSP are added to your income and taxed at current rates. TFSA withdrawals and growth within the account will not be taxed.

~ TFSA withdrawals will not result in lost contribution room.

~ With a TFSA you don’t need earned income to accumulate contribution room.

~ There is no requirement to convert the TFSA to an income payment option (i.e. RRIF) at any age.

The TFSA is a perfect complement to an RRSP and we recommend both to minimize taxes. For those not able to maximize RRSP and TFSA contributions, consider contributing to an RRSP and using the tax refund to start a TFSA.

Mark Styranka
www.MajecAccounting.com

RRSP, TFSA, or Mortgage Paydown?

Where to put your extra dollars – RRSP, TFSA, mortgage pay-down?
Gena Katz and Bob Neale, Toronto

The answer is not a simple one. It will vary depending on your personal situation and expectations about rates of return and future tax rates.

There are many issues that will affect your personal choice. Here are some factors to consider and some guidelines to help you with the decision.

RRSP or TFSA?

From a pure "dollar savings" perspective, the choice between RRSP and TFSA depends on your current marginal tax rate compared with the marginal tax rate that will apply when you withdraw amounts in retirement (rates of return should be the same in the TFSA and RRSP).

If you are currently taxed at a high marginal tax rate and expect your marginal tax rate will be lower in retirement, the RRSP is generally preferable. The immediate tax savings will be greater than the tax you’ll pay on withdrawal.

However, if you’re currently in a low or middle tax bracket, and you expect a higher marginal tax rate in retirement (perhaps it’s early in your career or you’re starting a new business), the TFSA contribution may make more sense. But you should consider that, unlike RRSP contributions, TFSA contributions do not reduce current income, which could affect your eligibility for the GST credit and the Canada Child Tax Benefit.

If you expect your personal marginal tax rates to be the same in retirement as they are today, there may still be a benefit in using a TFSA. TFSA withdrawals do not increase taxable income, and therefore they do not erode income-tested credits and benefits such as the age credit, Old Age Security, Guaranteed Income Supplement and the GST credit. In addition, TFSAs have added flexibility in that amounts can be withdrawn at any time and used for any purpose. Even if you intend to use your TFSA for retirement, you can also use it as an emergency fund — for example, in the case of job loss — and you can recontribute all withdrawn funds at a later date. RRSPs generally don’t make a good emergency fund, since withdrawals are fully taxable and contribution room cannot be resurrected.

What about paying down your mortgage?

The RRSP versus mortgage debate has been going on for years, and there is still no consensus.

If you’re taxed at a high marginal tax rate and have a low-rate mortgage, and you can earn significant returns in an RRSP, the RRSP is probably the better approach. This is particularly true if you use any tax refund from the RRSP contribution to pay down your mortgage.

On the other hand, if you’re taxed at a lower marginal tax rate, the decision is more complicated.

Comparing paying down a mortgage with a TFSA contribution is a little simpler than the RRSP/mortgage choice. It largely depends on which investment provides the better return. In this case, the return on the mortgage payment is the interest saved. With current low mortgage rates, many believe they can earn a significantly higher rate of return in a balanced investment fund.

But keep in mind that paying down a mortgage provides a risk-free return. If you hold equities in your TFSA, not only is the return not guaranteed, there is a risk of loss.

Even if the TFSA return is the same as your mortgage rate, you might consider making TFSA contributions for a few years and then withdrawing the funds to pay down the mortgage. The benefit here is that you will have grown your TFSA contribution room by the amount of income that was earned in the plan before the withdrawal. Not only can you recontribute the annual contribution amounts, you will be able to recontribute any withdrawn earnings.


Mark
www.MajecAccounting.com

Claiming the HRTC - Home Renovation Tax Credit

The HRTC is a non-refundable tax credit equal to 15% of eligible renovation or alteration expenditures you incur in excess of $1,000, but not more than $10,000. For example, if you incur $7,000 in eligible expenditures, you will be entitled to claim a credit of $900 (i.e., 15% x ($7,000 - $1,000)). If you incur more than $10,000 in eligible expenditures, the credit is capped at $1,350 (i.e., 15% x $9,000).

The renovation or alteration work must be performed after 27 January 2009 and before 1 February 2010. Any renovation or alteration expenditures incurred under an agreement entered into before 28 January 2009 are not eligible.

The credit (including January 2010 expenditures) is to be claimed in your 2009 personal income tax return.

This includes any housing unit located in Canada that is eligible to be your principal residence. This may include, for example, any house, cottage or condominium unit that is owned by you and ordinarily inhabited by you, your spouse or common-law partner, or any of your minor children.

If you own a house and a cottage, both of which are used personally, you can split the credit between both properties by claiming eligible renovation and alteration expenses on both, up to a combined maximum of $10,000.

What renovation or alteration expenditures are eligible?
Specifically excluded from eligible expenditures are the following:

~ Property that can be used independently of the qualifying renovation
~ The cost of annual, recurring or routine repair or maintenance
~ Household appliances
~ Electronic home-entertainment devices
~ Financing costs in respect of the qualifying renovation
~ Costs incurred for the purpose of gaining or producing income from a business or property
~ Goods or services provided by a non-arm’s-length person if that person is not a GST/HST registrant

When planning your home improvement (or reviewing the expenses you have incurred), you’ll find that your improvements include clearly eligible expenditures (for example, painting the exterior of your home), those that are not (like a widescreen TV) and those for which clarification is required.

To assist you in completing your HRTC claim, we have prepared the accompanying table of eligible expenditures. This information has been gathered from the numerous related technical interpretations from the Canada Revenue Agency (CRA) and from the HRTC page on the CRA’s website.

Some examples of eligible expenses:
~ Renovating a kitchen, bathroom, or basement
~ Windows, exterior and/or interior doors, garage door
~ New carpet, hardwood floors or linoleum floors
~ New furnace, boiler, heat pump, woodstove, fireplace, water softener, water heater, or oil tank
~ Permanent home-ventilation systems
~ Central air conditioner
~ Permanent reverse osmosis systems
~ Septic systems
~ Wells
~ Electrical wiring in the home (e.g., changing from 100 amp to 200 amp service)
~ Home security system (monthly fees do not qualify)
~ Solar panels and solar panel trackers
~ Painting the interior or exterior of a house
~ Replacement of siding, eaves troughs, soffits, and facia
~ Re-shingling or replacing a roof
~ Building an addition, garage, deck, dock, garden/storage shed, or fence
~ A new driveway or resurfacing a driveway
~ Exterior shutters and awnings
~ Permanent swimming pools (in-ground and above ground)
~ Permanent hot tub and installation costs
~ Permanent sauna and installation costs
~ Pool liners
~ Solar heaters and heat pumps for pools (does not include solar blankets)
~ Landscaping: new sod, perennial shrubs and flowers, trees, large rocks, permanent garden lighting, permanent irrigation systems, permanent water fountain, permanent ponds, large permanent garden ornaments.
~ Retaining wall
~ Associated costs such as installation, permits, professional services, equipment rentals, and incidental expenses
~ Fixtures – blinds, shades, shutters, lights, ceiling fans, etc. Window coverings, such as blinds, shutters and shades, that are directly attached to the window frame and whose removal would alter the nature of the dwelling are generally considered to be fixtures (i.e., has become part of the home) and therefore would qualify for the HRTC.

Some examples of expenses that are NOT eligible:
~ Draperies and curtains in most circumstances. In some circumstances, draperies and curtains may qualify for the HRTC, if they would not keep their value or usefulness if installed in another dwelling. If these qualifying criteria are not met, it is likely that draperies and curtains would not qualify for the HRTC.
~ Furniture, appliances, and audio and visual electronics
~ Portable "plug-in" hot tubs
~ Window or portable air conditioners
~ Purchasing of tools
~ Carpet cleaning
~ House cleaning
~ Maintenance contracts (e.g., furnace cleaning, snow removal, lawn care, and pool cleaning)
~ Financing costs

Contact us if you want any additional information on how to claim the tax credit on your 2009 personal income tax return. Make sure that you have your receipts!

Acceptable supporting documentation
Eligible expenses must be supported by acceptable documentation, such as agreements, invoices, and receipts, and must clearly identify the type and quantity of goods purchased or services provided, including, but not limited to the following information:

•information that clearly identifies the vendor/contractor, their business address and, if applicable, the GST/HST registration number;
•a description of the goods and the date when the goods were purchased;
•the date when the goods were delivered (keep your delivery slip as proof) and/or when the work or services were performed;
•a description of the work performed including the address where the work was performed;
•the amount of the invoice;
•proof of payment (receipts and invoices) - invoices must indicate "paid" or be accompanied by other proof of payment, such as a credit card slip or cancelled cheque; and

Mark
http://www.majecaccounting.com/

TFSA Investments

Beware 696-year TFSA investments
Without equities, that’s how long a payoff may take
By Jonathan Chevreau, Financial PostJanuary 24, 2010

While the new tax-free savings accounts are proving to be popular, many Canadians are choosing only interest-bearing TFSA plans that pay so little that the accompanying tax savings are equally negligible.

Negligible is an understatement. Consider that in 2009, the median one-year yield for Canadian money-market mutual funds was 0.3%, according to Morningstar Canada. That would mean you’d double your money in 232 years, says Morningstar investment funds editor Rudy Luukko. Or, if you calculate it based on the 0.1% six-month yield, you’d double your investment in 696 years.

This is not quite as bad as in the United States, where the top 100 money-market funds have an average yield of 0.05%, which would take 1,000 years to double.

Three-month federal paper yields 0.20% in Canada, versus 0.05% in the United States, says Dan Hallett, a director with HighView Asset Management Inc. “It would only take just south of 350 years to double your money invested at 0.2% annually, but I’d guess yields would creep up a few years before that time frame is up.”

Now consider the tax savings on these paltry yields. We’ll be generous and juice the yield up to the 0.4% paid by Canada Savings bonds. A $5,000 TFSA investment in a CSB pays a grand total of $20 in interest after a year. Meanwhile, more adventuresome investors who put their TFSA contribution last March in stocks, equity funds or exchange-traded funds could easily be up 50% or more on the year.

Perhaps because the “S” in TFSA stands for “savings,” many TFSA newcomers don’t realize they can also serve as supercharged tax-free investment accounts. A study by BMO Financial in 2009 found a whopping 94% of TFSA accounts are in savings accounts or term deposits. Even by mid-January 2010, TFSAs are still 90% in such accounts, says director of retirement strategies Tina Di Vito.

People seem unaware they can invest their TFSA contributions in stocks, bonds and other financial assets, as well as in short-term deposits and GICs.

In this respect, average investors are repeating the mistake made when they first opened up registered retirement savings plans through bank-offered GIC RRSPs that severely limited their investment options. In either case, it makes more sense to choose self-directed RRSPs or TFSAs that let you invest in stocks, bonds, mutual funds and ETFs, as well as interest-bearing securities.

As of Jan. 1, Canadians could put a second $5,000 contribution into their TFSAs, assuming they put in their first $5,000 in 2009. If they did and later withdrew funds — perhaps to pay for a project to generate the soon-to-expire Home Renovation Tax Credit — they can repay that withdrawal back into their TFSA now that we’re in the new year.

So, for example, if you put in $5,000 early in 2009, then withdrew $3,000 in August, now that it is a new calendar year you can contribute $8,000: $3,000 to replace what you withdrew and $5,000 more in a “new contribution.”

The question remains how to invest it. Most financial advisors make emergency funds a priority, so it’s logical that families with few financial resources might keep at least some of their TFSA in short-term, liquid, interest-bearing vehicles, such as high-interest savings accounts, money-market funds or GICs.

The problem is the gap between short-term and long-term interest rates — the yield curve — has seldom been greater. So, if you want to be paid a decent rate of interest, you must commit the funds for a longer period.

Cashable one-year GICs are one possibility. You lose some yield for the privilege of being able to cash out. A similar dynamic exists between cashable CSBs and locked-in Canada premium bonds. Other alternatives include strip bonds and bond ETFs, which may pay more, but can be cashed out if necessary, possibly sustaining a loss.

The threat of an imminent rise in interest rates is why some investors are buying high-yielding dividend paying stocks, income trusts or preferred shares. These can be sold when you want but, as with bond ETFs, there’s no guarantee you won’t experience a short-term loss.

Since TFSAs are extremely versatile, so should the investments you want to hold in them. Limiting them to interest-bearing investments when rates are so low is unwise. So switch to a self-directed TFSA: It can still own interest-bearing vehicles, but you’ll have the best of all worlds.

Unless, of course, you’re content to double your money every few centuries.

Mark
www.MajecAccounting.com

Home Reno Tax Credit News

By MARKUS ERMISCH, Calgary Sun
Tuesday Jan 19

With the deadline of the home renovation tax credit approaching in less than two weeks, it’s still unclear whether Ottawa plans to extend the hugely popular program.

Just before Christmas, Premier Stephen Harper had vaguely hinted he’d like to extend the program as part of the government’s plan to stimulate the economy.

But then Harper suspended Parliament. And any added clarity about the fate of the home reno tax credit was suspended along with it.

“We have no word on (the future of the home reno tax credit). As it stands now, it’s running out at the end of the month,” said Finance spokesman David Barnabe when asked about a possible extension, and whether Parliament would be needed to do so.

“It wouldn’t really be proper for me to speculate on something hypothetical.”

Calgary’s city hall, however, would like to see the program continue beyond the Jan. 31 deadline.
“I think it’s a great program,” said David Watson, general manager of planning, development and assessment at city hall. “So sure — I think it would be a great idea if they could extend it,”

The home reno tax credit was introduced last year to infuse Canada’s ailing economy with cash during the recession. Eligible renovation expenses could be deducted from taxes, leading to savings of up to $1,350.

In Calgary, the program has bolstered the residential construction sector during one of the worst recessions in recent memory. City hall issued building permits worth $3.66 billion last year, down 9% from 2008. But the tax credit has helped support the construction sector last year, Watson said, and helped prevent it from dipping further. Watson pointed out that low interest rates were also an important factor.

Linda Duncan, an Edmonton NDP MP, said her party is still discussing whether it would support an extension of the home reno tax credit should Finance Minister Jim Flaherty include it in his next budget. “This is, obviously, not the biggest item on the agenda for the budget,” she said. “The biggest is unemployment. But it’s an aspect of employment. So it will be one of many items that we’ll take a look at, and chances are a lot of people will be supportive of it.”

Mark
www.MajecAccounting.com

Interest Expense and Debt Management

For financial planning purposes, there are two kinds of debt; good debt, and bad debt. When money is borrowed with the purpose of earning income and the interest is tax deductible this is good debt. Borrowing money to pay for purchases such as vacations, vehicles, recreational items where the interest is not tax deductible is bad debt. Please note that this is a discussion on good debt versus bad debt and not on the appropriateness of any particular investment or purchase.

In our accounting business, I had a client very pleased that the $100,000 debt he incurred to purchase his business was paid off. On the surface, this may be a good thing, but in the background were over $60,000 of outstanding personal loans for recreational vehicles. The $4,200 (at a 7% interest rate) interest that this individual will continue to pay on his personal loans is not tax deductible. If he had paid off his personal loans and had $60,000 remaining on his business debt, the $4,200 would have been tax deductible. Assuming a marginal tax rate is 25%, the tax savings would have been $1,050! This tax savings could then be used in any way the individual sees fit.

A similar situation would exist where a person was investing in real estate, the stock market, or other types of passive income potential. It is a better tax and wealth building strategy to use whatever funds are available to pay off personal debt where the interest is not tax deductible. Then you can borrow money for the investment you were going to make anyway and then be able to use the interest expense as a deduction from your income. The tax savings to you can be substantial.

Your banker should have no problem with what you are doing and many are likely doing this sort of arrangement themselves already. For tax write off purposes, it doesn't matter what the loan collateral is, it does matter what the actual item purchased is. So if you put up your personal debt-free car as collateral, the interest can still be deductible if used for appropriate business or other investments.

As we can see from this example, it is important to consider the tax consequences of our debt related decisions. Simply put, personal debt where the interest is not tax deductible should be paid off first. Then, a decision to pay off business or investment debt must include consideration for alternate uses of the money. This can only be done on an individualized basis and a financial advisor or accountant should be brought into your team.

Debt management for tax purposes is only a portion of what should be examined. Other considerations, not discussed include this like debt servicing abilities, ratios, cash flows, debt vehicles, and perhaps most important is the individuals attitude toward debt.

The benefits of including tax planning with your debt planning is one indication of the importance of paying attention to all aspects of a home business, even the so-called mundane tasks. If you are not an expert yourself or don't have time to become an expert, then hire an advisor to your business team and focus on making the profits.

Mark
www.MajecAccounting.com