Mortgage Refinance - Investment property and PR

Hi folks,

I have a new T1 client who refinanced the mortgage on his rental property and applied the funds towards paying down his principal residence mortgage. The former tax preparer told him that he could write off the interest on the new mortgage against the rental income on the rental property. Has anyone heard of this?

I believe that the interest would be considered personal use since it was used for his principal residence and not for income producing purposes. It is therefore not deductible.

I suppose it could be done if the circumstances and paper trail supports this action. It would not be uncommon to mortgage the principal residence to buy a rental property.

This is the other way around. The rental property had little to no mortgage but the principal residence had a $890k mortgage. As such the person, refinanced the rental property and used the funds to paydown the $890k mortgage on PR

When were the properties bought? Why should he not be able to use the interest against the rental property. I believe I would.

If you use the funds to pay down your principal residence mortgage, the interest related to the refinanced money, is not tax deductible.

The regulations governing the deductibility of interest are outlined in paragraph 20(1)( c ) of the Income Tax Act. To qualify for deduction, four criteria must be fulfilled:

  1. An obligation to pay the interest.
  2. Payment or liability for interest during the tax year.
  3. Reasonable interest costs.
  4. Use of borrowed funds to generate business or property income.

While the first three conditions are usually straightforward, the fourth condition is pivotal, often causing confusion and prompting numerous court cases. I would recommend you refer to the Income Tax Folio S3-F6-C1, Interest Deductibility, outlining its stance on the tax deductibility of interest based on previous court cases across various scenarios.

Also why on earth would they choose to not pay off their rental property, they’d make more profit off of it. At times, I have clients where I instruct them to either use their refinanced funds on another property or they use the money on stock investments, specifically companies that offer dividends. That way, the interest could be used as a write off.

CRA wil always trace the acquisition and use of loan funds in any borrowing scenario to establish that the funds were used to either acquire income-producing property or replace an exisitng debt for same. Where that does not apply, they don’t bother digging deeper - they just disallow it. (Rightly so, as @GuyWhoPlaysGolf states in point 4.)

I always tell clients that the interest deductibility is based on what the borrowed funds are used for, not what the funds were borrowed against.

Doing something personal with the borrowed funds (like paying down your house mortgage) is usually a non-deductible use.