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To clarify my understanding of margin loans in Canada: the interest expense incurred while trading on margin is deductible, as long as the stock pays dividends, right? Also, if it is deductible, would the amount be deductible against all income, or is it limited to being deductible only against the capital gains and dividends that the stock generates?

For example, let's say I borrow 100k at a 10% annual interest rate from my brokerage firm to purchase a certain stock. Over the course of 1 year, the stock generates 1k in dividends. And when I eventually sell the stock, I receive 105k. Unfortunately, both the dividend and capital gain (1k + 5k) amount to less than the 10k I will need to pay in interest to my brokerage firm.

In this example, would I be able to deduct the full 10k of interest expense against all of my income (including employment), or is the maximum amount I can deduct just 6k (from the dividend and capital gain of the stock)?

P.S. In reality, the interest wouldn't just remain at 10k; it would compound and likely be something closer to 10.1k. I heard that compounding interest is also deductible, is this true?

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  • Usually interest is deductible from the income the proceeds of the loan were used to generate. You'll need to check with CRA of course, but I'd expect investment interest deduction in Canada to be limited to investment income, similarly to the US.
    – littleadv
    Commented Jul 28, 2023 at 21:04
  • @littleadv I have read that Canada is a bit particular when it comes to interest deductibility, so I wanted to ask here to see if anyone had any specific insight towards it. I am assuming in the US, the deductible amount can therefore only be applied to the capital gains portion of a person's income (i.e. schedule D)?
    – AlanSTACK
    Commented Jul 28, 2023 at 21:08
  • In the US yes, capital gains is investment income. There are some limitations on tax exempt investments though - you cannot deduct interest expense used for income that is not taxable. I'm not sure if in the US there are matching rules (i.e.: whether you can deduct from any investment income, or from income specifically generated by the proceeds)
    – littleadv
    Commented Jul 28, 2023 at 22:11
  • @littleadv That makes sense. What about compound interest. Does the IRS let you deduct interest on your interest that you took out for investment purposes?
    – AlanSTACK
    Commented Jul 28, 2023 at 22:22
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    yes, I believe so
    – littleadv
    Commented Jul 28, 2023 at 22:58

1 Answer 1

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When is interest from margin trading deductible?

If you borrow money to purchase common shares, the interest expense will generally be deductible if there is a reasonable expectation, at the time the shares were acquired, that you will receive dividends. [source]

  • If the company has a history of paying dividends, then the answer is YES

  • If the company has a history of paying dividends but is currently going through a rough patch and promises to restore dividends later, then the answer is YES

  • If the company has no history of paying dividends or outright declares no dividends in the foreseeable future, then the answer is NO

When is compound interest deductible?

Compound interest is deductible, but only in the year in which it is paid (cash-basis accounting), as opposed to regular interest, which is deductible in the year it is charged (accrual-basis accounting). [source]

Can interest deductibility be applied to entire income?

Yes. You can usually deduct interest expense from your entire income in Canada. [source]

Interest will neither be denied in full nor restricted to the amount of income from the investment where the income does not exceed the interest expense.

If anyone is curious, you can read more about interest expense for investment purposes here.


Example Interest Calculation

$50,000 Gross capital gains
$25,000 Taxable capital gains (assuming 50% inclusion rate)
$10,000 Interest expense      (assuming interest is deductible)
---
$15,000 Taxable income

Now, let's say that your tax bracket is 30%. Then you would have to pay the government:

$15,000 x 30% = $4500 Taxes owed

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