Mingling Funds

by Mr. Cheap

Say I get paid a dividend (perhaps from my ROC that’s due mid-month) and its paid into my E*Trade account. That account has a negative balance (since I’ve been trading on margin). That interest paid on that negative balance is tax-deductible.

How is that affected if I withdraw the dividend payment and use it for something else? Say I withdrew it and applied it to a principle residence mortgage (non-deductible debt). From Revenue Canada’s perspective, would I have paid back part of my margin loan, then re-borrowed the money for non-deductible purchases (and thereby “contaminated” the margin loan), or would their view be that as long as I withdrew EXACTLY what was deposited, then I didn’t really repay any of the loan (it just traveled briefly through my account)?

If the mingling is bad, can/should I get E*Trade to make dividend payments directly to me?

Thanks if anyone knows! A pointer to a sites dealing with this issue would be greatly appreciated!

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{ 7 comments… read them below or add one }

1

Maybe it doesn’t matter. It’s not important that the margin loan is paid back; for the tax year when you borrowed on margin you are still entitled to deduct the interest payments. Or maybe I’m wrong?

Of course, the difference in this case is that – if your balance is now 0 or positive, for the next year you shouldn’t deduct any other interest payments. Yes, from this point of view, what you were asking is interesting: is it still considered a margin loan for the next years (after moving the dividends out of account) or the loan is considered paied off and the new “loan” is what you’ve just taken out as dividend?:)

2

Yes, exactly. I’m assuming I couldn’t pay down the margin loan, then reborrow the money (and pretend I’d never paid it down), but could I let the dividends go in, then withdraw them again within a month say?

3

Unfortunately, I don’t know the answer to your question so I’ll ask a similar one of my own.

If I have a line of credit which I’m using for leveraged investing – can I use this LOC for other uses as well and just calculate which portion of the interest is deductible? ie if I borrow $50k to buy BMO and another $50k to buy BMW (as in a BMW that is) from the same LOC can I still deduct the interest on the investment portion of the loan without fear of problems from the CRA?

Mike

4

Mike: I’m pretty sure that’s totally fine. Both are for investment purposes, so no problem. The ONLY potential problem is if you SOLD one of the investments. Once the investment is liquidated, you’re supposed to repay the loan (or stop deducting the interest). If you sold the BMW (and used the proceeds for non-investment purposes), but kept the BMO, divvying up the LOC at that point would be problematic I think. If you’d kept records of the LOC since buying the BMO and BMW, I’m pretty sure you’d be able divvy it up, but this would be awkward.

It’d be easy if you sold both and used all the proceeds for non-investment purposes (then you’d just stop deducting the interest).

If you sold the BMW and bought another investment, then again no problem (you entire LOC is used for investment purposes, still is and always has been). As long as you could trace back the money from your current investments back to the LOC, I think you’re totally fine (so use the LOC for long-term investments, not short-term investments you’ll need the cash back from). You’d even be ok (as far as I understand it) if you sold the stocks, and used the proceeds to buy an investment property. You could then deduct the LOC interest charges AND the mortgage interest charges.

If any of us go to see an accountant in the near future we should ask them these questions and report back.

5

It’d be nice to have an account that would let you “tag” portions of a debt like I posted about before (http://cheapcanuck.wordpress.com/2007/05/28/another-new-financial-product-id-like-to-see/)

It’d be even nicer if you could revise it, using past interest rates and whatnot to determine the most efficient book keeping strategy (e.g. if you sold and used the BMO stock, to analyse the credit line and pretend EVERY payment had gone to the BMO principle and interest and that the BMW had compounded – this would make the BMO a smaller portion of the current debt).

This would be so easy to do from a programming perspective… I hope more banks implement it (ideally for free).

6

I think I was a bit too clever in my example. The BMW is a car, not a stock. I’m not really planning to buy one but I was using the example where part of the LOC is used for non-investment purposes.

Your idea of tagging is a good one. I think there are some products that do this ie Manulife1 but of course u pay for it.

Mike

7

I need to read more carefully 🙂

I *SUSPECT* if you have a deductible amount and a non-deductible amount from the start with proper book keeping you could keep them separate (and figure out how to pay down just the non-deductible portion, so that as time went by more-and-more of it would be deductible).

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