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