Is Mortgage Interest Tax Deductible in Canada?

Understanding tax deductions for mortgage interest is a common concern for homeowners. In Canada, the tax system generally links deductions to expenses incurred to earn income. While the rules can appear complex, grasping the fundamental principles helps clarify when and how mortgage interest can reduce your taxable income.

The General Rule for Personal Residences

In Canada, mortgage interest paid on a principal residence is generally not tax-deductible. The Canada Revenue Agency (CRA) views the costs associated with owning a primary home as personal expenses rather than expenses incurred to generate income. Therefore, the interest portion of your mortgage payments on your home does not qualify for a tax write-off. This policy reflects that tax deductions are generally intended for expenses directly related to earning business or property income. Since a personal residence does not generate income, its associated costs, including mortgage interest, are not considered deductible under the Income Tax Act. Homeowners make mortgage payments with after-tax dollars.

Deductible Mortgage Interest in Specific Scenarios

While mortgage interest on a principal residence is not generally deductible, specific situations allow for its deduction if the borrowed funds are used for income-generating purposes. The Canada Revenue Agency (CRA) permits these deductions when there is a clear link between the loan and the pursuit of income. This distinction is important for Canadians seeking to understand their tax obligations and potential benefits.

Rental Properties

Interest on a mortgage or loan used to acquire, maintain, or improve a rental property is deductible against the rental income generated. This deduction applies if the property is rented out with a reasonable expectation of profit. The CRA scrutinizes rental properties that consistently report losses to ensure they are not merely hobbies. If only a portion of the property is rented, or it is rented for only part of the year, the mortgage interest deduction must be prorated based on the area rented and the period of rental.

Business Use of Home

A proportionate amount of mortgage interest can be deducted if a part of your home is used exclusively and regularly for a business. To qualify, the home office must be the principal place of business, or it must be used regularly to meet clients, customers, or patients. The deductible portion is calculated based on a reasonable method, such as the square footage of the business space relative to the total area of the home. This deduction, along with other eligible home office expenses like utilities and property taxes, cannot be used to create or increase a business loss.

Borrowing to Invest

Interest on money borrowed to purchase investments that are expected to generate income, such as dividends or interest, is tax-deductible. This is often referred to as the “tracing rule,” meaning the borrowed funds must be directly traceable to the income-earning investment. The investment must have a reasonable expectation of generating income; borrowing to earn only capital gains does not qualify for this deduction. It is important to maintain meticulous records to demonstrate the direct use of borrowed funds for income-producing investments.

Requirements for Claiming the Deduction

Claiming deductible mortgage interest requires careful record-keeping and accurate calculation to ensure compliance with Canada Revenue Agency (CRA) guidelines. Proper documentation substantiates your claim, and appropriate calculation methods ensure the correct amount is reported.

Documentation

Maintaining comprehensive records is essential for supporting any claimed deductions. For rental properties, you should keep mortgage statements showing interest paid, loan agreements, and detailed records of all rental income and expenses. For business use of a home, documentation should include mortgage statements and evidence of the portion of the home used for business, such as floor plans or measurements. When borrowing to invest, retain loan agreements, investment statements, and clear records tracing the borrowed funds directly to the income-producing investments. The CRA requires taxpayers to keep all supporting documents for a minimum of six years from the end of the last tax year they relate to.

Calculation Methods

The method for calculating the deductible interest varies depending on the scenario. For rental properties, the actual interest paid on the mortgage used for the rental portion is deductible. If only a part of the property is rented, or it is rented for only part of the year, the interest must be prorated based on the percentage of the property used for rental purposes or the duration it was rented. For business use of a home, the deductible interest is a proportion of the total mortgage interest, determined by the percentage of the home’s square footage used exclusively for business. For investment loans, the “tracing rule” dictates that interest is deductible on the portion of the loan directly used to acquire income-producing investments, provided the loan’s primary purpose is clearly linked to the income-earning activity.

Reporting Deductible Interest to the CRA

Reporting deductible mortgage interest to the Canada Revenue Agency (CRA) involves using specific tax forms and adhering to record-keeping requirements. Understanding the procedural steps ensures accurate submission and helps avoid potential issues.

Tax Forms

Deductible interest is reported on various CRA forms, depending on the income-generating activity. For rental properties, you report income and expenses, including mortgage interest, on Form T776, Statement of Real Estate Rentals. If you operate a business from home, the deductible portion of mortgage interest is reported on Form T2125, Statement of Business or Professional Activities. Interest on loans used to purchase income-generating investments is reported on Schedule 4, Statement of Investment Income, as part of your T1 General Income Tax and Benefit Return. These forms allow taxpayers to detail their income and associated expenses, leading to the calculation of net income or loss.

How to Report

When filing your tax return, whether through tax software or paper forms, you enter the calculated deductible interest amount on the appropriate lines of the relevant forms. For instance, on Form T776, mortgage interest is listed as an expense against gross rental income. Similarly, on Form T2125, the proportional mortgage interest for business use of a home is included in the calculation of business expenses. It is important to ensure that the amounts entered precisely match your supporting documentation to facilitate any future CRA review.

Record Keeping

After filing, it is crucial to retain all supporting documentation for your tax claims. The CRA requires taxpayers to keep records for a minimum of six years from the end of the last tax year to which they relate. These records include mortgage statements, loan agreements, income and expense ledgers, and any other evidence that supports the deductions claimed. Maintaining organized records is important in case the CRA requests them for a review or audit.

Change in Use

If a property’s use changes, for example, from a principal residence to a rental property, it has tax implications that affect ongoing interest deductibility. The CRA treats a change in use as a “deemed disposition,” meaning the property is considered to have been sold at its fair market value and immediately reacquired. This can trigger a capital gain or loss, and proper reporting may require filing specific forms like T2091(IND). The interest deductibility will then shift to align with the new income-generating purpose of the property.