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It's smart to try and get every tax break possible to reduce what you owe to the government. For some Canadians, that could means claiming the interest paid on mortgage payments. But your eligibility for a mortgage interest tax deduction depends on a number of circumstances. Find out whether this tax-saving strategy will work for you.

If you follow any U.S.-based personal finance content, you may have heard that our neighbours to the south can claim a mortgage interest tax deduction on any property, including a primary residence. This might leave you wondering: is mortgage interest tax-deductible in Canada? The answer is an unequivocal maybe since the mortgage tax deduction in Canada applies only to properties used for generating income, which can include a primary residence.

In general, you can deduct mortgage interest paid on a house, condo, vacation home, commercial space, or any other real estate you rent out (fully or partially), or where you operate a business. Even then, you can only deduct the business-use portion of your interest payments. Still confused? Below we break down the rules for deducting mortgage interest in each scenario.

Mortgage Interest Tax Deduction on Rental Income

When you’re a landlord, there are a number of expenses you can deduct from your rental income to lower the tax hit on those earnings. These eligible expenses include anything from site maintenance and repair costs to property taxes—as well as the interest charges paid on the mortgage.

In some cases, you can deduct 100% of the mortgage interest. In other cases, you can only deduct a portion of the interest you paid. The percentage deduction depends on how much of the property is rented out and for what timeframe, as explained below:

Entire property rented out for the full year

If, for example, you have a tenant on an annual lease in a condo you purchased for investment purposes, you can deduct 100% of the mortgage interest paid on that property from your rental income.

Entire property rented out for part of the year

Assuming the property is for your own personal use the rest of the time, you must adjust the mortgage interest tax deduction based on the portion of the tax year that the property was rented out. So, for example, if you had a short-term Airbnb tenant in your primary residence (or cottage) for a month while you were out of the country, you could deduct 1/12th (8.3%) of the annual mortgage interest paid on that property from your rental income.

A portion of property rented out for the full year

Say you own and live in a two-bedroom condo where you rent out the second bedroom to a roommate, or you have a tenant in the basement of your house. In these situations, your mortgage interest tax deduction must be adjusted to reflect the area of the rental space as compared to the total area of the property. So, for example, if you rent out a 600-sq.-ft. basement apartment in your 1,800-sq.-ft. primary residence, you would be allowed to deduct a third (33.33%) of the mortgage interest you paid.

A portion of property rented out for part of the year

Here, the percentage of mortgage interest eligible for the deduction becomes even smaller. For example, perhaps you decided it was best not to have a roommate in your condo’s second bedroom during the pandemic and so you re-occupied that space as of April 1, 2020. In that case, you would first calculate the size of the second bedroom (and shared spaces, divided by two) as a proportion of the total condo suite, and then divide that percentage by four, since the rental took place for just one-quarter of the year (three months).

Note that in all cases, it is only the interest payments on the mortgage that are included in the deduction calculations. The portion of your mortgage payment that goes toward paying down the original debt (also called the principal), is not an eligible expense. If you’re not sure what your mortgage interest payments are, refer to your annual mortgage statement. 

Mortgage Interest Tax Deduction on Business or Professional Income

The mortgage tax deduction in Canada also applies to properties where you operate a business or earn professional income. And, just like with rental income, in some cases, 100% of the mortgage interest can be deducted, while in other cases it will just be a portion of the interest paid. Again, this depends on how much of the property area is used for business, and whether that space is also used for personal activities, as explained below:

Entire property used for business exclusively

An example here could be a commercial property where you operate a bike shop. The space is used solely for business; when the business is closed the space is idle. In such cases, the mortgage interest paid on the property can be deducted, in full, as a business expense.

A portion of property is used for business exclusively

If you own a property, whether it be your principal residence or not, where part of the space is used to operate a business and part of the space is for personal use, you can deduct only a portion of the mortgage interest paid. Say, for example, an accountant has a home-based practice. He converted one of the home’s bedrooms into an office, and it is used for business purposes only (i.e., when he’s not working in there, the room is empty). The area of the office is 10% of the home’s total area, so he can then deduct 10% of his annual mortgage interest payments as a business-use-of-home expense.

A portion of the property is used for business, but not exclusively

Say we tweak the above example slightly so that the accountant allows his teenage child to do homework in the office in the evenings and on weekends. The space is no longer used for business exclusively, it is being used for both personal and business activities. Here, the accountant would have to calculate how many hours per week the space is used for business vs. personal activities and reduce his business-use-of-home expense claims accordingly.

It’s worth noting that there are a number of other deductions self-employed individuals who work out of their home can claim as business-use-of-home expenses, including heat, electricity, insurance, maintenance and property taxes. And while some of these expenses are also eligible deductions, under certain circumstances, for employees who work from home, mortgage interest is not among them. (To find out more about when and how employees can deduct home-office expenses, check out Work-From-Home Tax Deductions for 2021.)

What About Mortgage Interest on a Primary Residence?

Unless you operate a business from your primary residence or rent out a portion of it to tenants, as explained above, you cannot claim a deduction for the mortgage interest paid.

Some experts suggest a complicated workaround, sometimes referred to as the Smith Maneuver, in which borrowers use the equity in their home to take out interest-deductible investment loans. But this tactic doesn’t make the mortgage interest on your primary residence tax-deductible. It simply has you borrowing more money, which you then use to invest in dividend-paying equities in non-registered accounts, because the interest payments on loans taken out for the purposes of such investments are tax-deductible.

Proponents of the strategy say you can use the dividend payments to pay down the mortgage on your primary residence, and you can later sell off your investment holdings (at a profit) to pay off the extra money you’ve borrowed. But there are some major potential pitfalls with this approach.

First, you have to be comfortable with huge sums of debt. If your original mortgage was $500,000, by the end of the process your home is paid off, but you still have $500,000 in investment loans. Having that much debt for years on end, without seeing the needle move at all, may be a hard pill to swallow.

Second, while the expectation is that your investment portfolio will cover your debt, you can’t be sure. Borrowing to invest is risky, and it’s possible your investments won’t perform as well as you hope. In that case, you could end up in the red.

Finally, earnings on non-registered investments are taxable. Depending on your situation, these additional taxes may end up costing you more than whatever tax savings you enjoyed by writing off the interest payments on your investment loan.

How to Claim the Mortgage Tax Deduction in Canada

Rental expenses, including mortgage interest, are deducted from the rental income you report on Form T766, Statement of Real Estate Rentals.

Business and business-use-of-home expenses, including mortgage interest, are deducted from the business or professional income you report on Form T2125, Statement of Business or Professional Activities.

If you’re DIYing your taxes, the easiest way to claim mortgage interest is to use online tax filing software, like Wealthsimple Tax. It’s free to use (!) and makes tax filing simple with features such as auto-filling your return, express notice of assessment, and refiling. There’s also a smart search and tutorial mode to help you determine which forms apply to your tax situation, and a team of human experts available to help if you get tripped up on something.

Learn more about Wealthsimple Tax

Final Word

Mortgage interest is tax-deductible in Canada only when the property is used for the purposes of generating rental, business or professional income. In terms of primary residences, you can deduct a portion of mortgage interest from the rental income you receive from a short- or long-term tenant in your home, or from the business or professional income you earn while working from home as a self-employed individual.  The bottom line? At tax-time, use CRA-certified online tax filing software or an accountant to file your taxes so you don’t miss out on any tax-saving opportunities.

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