Is Mortgage Interest Tax Deductible?
Many Canadian homeowners have wondered if mortgage interest is tax deductible. Chances are, they’ve heard that their neighbours to the south can claim their mortgage interest (it’s true). Also, with the sharp increase in Canadians working from home, there’s an impression that work-from-home employees can write off their mortgage interest, which is NOT the case.
In this article, I’ll clear up the confusion and let you know when you can and can’t claim mortgage interest as a tax deduction.
Mortgage interest in Canada vs. the U.S.
As mentioned, you cannot claim a tax deduction on mortgage interest paid on a principal residence in Canada, only on an investment property (more on that later.) You can, however, in the U.S.
According to the Internal Revenue Service (IRS), U.S. homeowners can deduct home mortgage interest on the “first $750,000 ($375,000 if married filing separately) of indebtedness.” Higher limitations apply if you incurred indebtedness before December 16, 2017.
Americans can no longer deduct mortgage interest if they do not use their home loan proceeds to purchase, build, or renovate a home.
When can you deduct mortgage interest in Canada?
The short answer is that you cannot deduct mortgage interest payments on a principal residence in Canada. You can claim part of the mortgage interest paid if you use your principal residence to earn rental or self-employment income. Let’s look at the various scenarios where you can deduct mortgage interest.
Full-time rental properties
A dedicated rental property is the most straightforward scenario for deducting mortgage interest. If you own a property that is rented full-time, you can deduct 100% of your mortgage interest costs for that property on your income taxes.
Part-time rental properties
Nowadays, many Canadians own short-term rental properties that they rent out for part of the year, e.g., Airbnb. In that case, you can claim the mortgage interest as a tax-deductible expense on your tax return, but only for the proportion of time that you rented it. For example, if you rented it out for six months, you could claim 50% of the mortgage interest paid during the year.
Renting out part of a property
Another common scenario is homeowners renting out part of their principal residence, like an extra room or a basement suite. In this case, you can deduct a portion of the mortgage interest paid during the year based on the percentage of overall square footage that you rent out.
For example, if your 3000 square foot home includes a 1000 square foot suite you rent out full time, you can deduct 33% or one-third of your mortgage interest.
Property used for a business
The mortgage interest is fully tax-deductible if you have a property used exclusively for business purposes. Note that you cannot use the property as a principal residence.
Work from home – For an employer
During the COVID-19 pandemic, thousands of Canadians moved to a work-from-home arrangement, even if they worked for an employer. Many of those remote workers continue to work from home. But while the Canada Revenue Agency allows for some tax breaks for work-from-home employees, claiming mortgage interest is not one of them.
Work from home – Self-employed
If you are self-employed and work out of your home, you can claim a portion of the mortgage interest paid as a tax deduction. The percentage of interest you can claim will depend on the amount of space you use in your home for work purposes and the amount of time you spend. If you work full-time and use 50% of your home, you can deduct more interest than someone who works 15 hours a week and only uses 10% of the space in their home.
The Smith Maneuver
The Smith Maneuver is a tax strategy that converts your mortgage interest so that it’s entirely tax deductible. It’s a fairly complex setup that I won’t explain in detail in this article, but here is a basic rundown of how it works:
Fraser Smith, a B.C.-based financial planner, popularized the Smith Maneuver. It takes advantage of the fact that the interest on money borrowed in Canada for the purpose of investing is tax deductible.
For the Smith Maneuver to work, a homeowner must take out a re-advanceable mortgage containing a Home Equity Line of Credit. Each month, as their mortgage is paid, the homeowner reborrows the principal amount freed up and contributes the money to their investments.
Eventually, the entire balance is converted to an investment loan and is fully tax-deductible. Investors must keep track of their investment contributions to prove they are using the money to invest.
There are other stipulations that I won’t address here. Check out this podcast interview with tax accountant Ed Rempel for more information on The Smith Maneuver.
Mortgage interest tax deduction FAQs
How much mortgage interest can I deduct on my taxes in Canada?
The only way to deduct 100% of your mortgage interest in Canada is by owning a rental property or property used exclusively for a business. If you are self-employed or rent out part of your home, you can deduct a portion of your mortgage interest.
What are the risks of the Smith Maneuver?
The most considerable risk of the Smith Maneuver comes from rising interest rates. Remember that the money you are borrowing is being used to invest. Your investment returns must be greater than the interest you are paying on your mortgage, or you could lose money.
What house expenses are tax deductible in Canada?
If you are self-employed and working from home, the CRA allows you to claim certain business-use-of-home expenses. This includes but is not limited to, a portion of your property taxes, heating, electricity, home insurance, and telephone bill.
The bottom line on mortgage interest tax deductions
Most Canadians won’t be able to deduct their mortgage payment interest come tax time. Thankfully, many other deductions are available, including RRSP contributions, charitable donations, and college tuition and expenses.
If you want to convert your mortgage interest to a tax-deductible expense, the easiest way may be to convert your principal residence to a rental property. You can collect rental income and get a tax deduction.