# Questions on withdrawing money from a leveraged investment account.



## Senk (Dec 29, 2010)

I am aware that dividends and interest can be withdrawn from a leveraged investment account without affecting the deductibility of interest paid on the investment loan. I have a couple of related questions:

1. Can the full amount of dividends and interest received be withdrawn or only the amount that exceeds the interest paid.

Example: $100 in dividends earned during the year. $75 in interest expense paid uring the year. Can $100 be withdrawn from the account? Or $25?​
2. In my leveraged account I also hold a couple of trusts. The trusts distributions include taxble income (Box 26), capital gains and return of capital. From what I understand, the return of capital portion can not be withdrawn. Can the taxable income amount be withdrawn? What about the capital gains.​
Thank you very much in advance.


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## andrewf (Mar 1, 2010)

1. $100

2. The common understanding is that only dividend and other income may be withdrawn, while capital gains and return of capital must be first used to repay the investment loan. I'm not totally sold on the rationale for not allowing withdrawals of capital gains (as it is taxed as income in the current year), but better to be safe than sorry. If you want to push it, I'd consult a qualified accountant and not an internet forum. YMMV.


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## Jungle (Feb 17, 2010)

You can also use your ROC and other income to purchase more shares kept inside the investment account.


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## OptsyEagle (Nov 29, 2009)

This is all open to interpretation. I believe the rule stems from the fact that *if you sell the investments that were purchased with borrowed money, then the interest on that money would cease to become deductible*. From this the many scenerios of withdrawals have come.

Even interest or dividends withdrawals, if within a margin account, could be argued to effect your deductibility. You see, if you have $100,000 in stocks and owe $50,000 in margin debt against them and the stocks pay you a $1000dividend which you remove, the deductibility of the entire account could be in jeapardy, if the wrong auditor were reviewing this. That is because, just before the withdraw, the dividend that was paid, first went to pay down the debt owing, leaving it a $49,000. The auditor could then say that in your next transaction you borrowed another $1,000 for personal use, rending the entire deductibility of the account's interest invalid, due to the cominguling of personal and investment use.


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## sleek (May 13, 2009)

@Senk

I once spent a month of research trying to get clarification on this question. This is important to me as I am a full time investor who makes my living purely from investing.

On one forum, I found at least twenty differing opinions on this matter. The question was further complicated by the deductibility of interest on interest.

I came across a letter written by Manulife Financial to CRA asking for clarification on this issue. Even big corporations have a problem with this.

I also found that the Finance Department and CRA have differing opinions on interest deductibility and that CRA will often allow things that go against what the Finance people have written.

I even found and downloaded the Canadian Tax Act, read the relevant sections, and still, this is a grey area for me.

Below is a link from Million Dollar Journey discussing the issue:

http://www.milliondollarjourney.com/key-tax-considerations-on-an-investment-loan.htm


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## cardhu (May 26, 2009)

Senk … the question of whether something is held inside or outside of any particular investment account is a red herring … it doesn’t matter … you can withdraw any amount you want, any time you want, from any source you want (see note 1) … whether your interest expense retains its deductibility has nothing to do with which account the money/investment resides in, but rests entirely on what you do with the money. 

_note 1 … depending on who you borrowed the money from, there may be margin restrictions that you need to work around, but those have nothing at all to do with interest deductibility._

Having said that, I know what you meant … yes, you can take 100% of the dividend income, interest income, or “other” income (ie from trusts), and use it for whatever purpose you want, without jeopardizing your interest deductibility … ROC distributions must either be reinvested or used to pay down the leverage debt, to maintain interest deductibility … capital gains arising from the sale of an investment must certainly be reinvested in order to maintain interest deductibility … capital gains distributions from a trust or mutual fund are a not as clear-cut, though I tend to think that the same rule applies, regardless of whether the gain is direct or indirect. 



andrewf said:


> I'm not totally sold on the rationale for not allowing withdrawals of capital gains (as it is taxed as income in the current year),


Well, capital gains arising from the sale of an investment are also taxed in the current year, but the law is crystal clear in that case that there must be continuity of investment, in order to enjoy continuity of interest deductibility … therefore, current year taxation is not a valid test. 



OptsyEagle said:


> the deductibility of the entire account could be in jeapardy


Optsy … you are unusually off your game on this one … the suggestion that the deductibility of the entire amount could be jeopardized in the circumstances described is absolutely unfounded … I agree that a margin account introduces an element of “grey” into the mix, but even so, in your example the most that an auditor could deny would be 2% of the interest incurred, going forward (the interest on $1000 being non-deductible while the interest on $49,000 remains deductible) … commingling of deductible and nondeductible debt is allowed … its just not recommended. 

An auditor could, of course, say whatever he likes … but if he were to say that the entire amount was no longer deductible, he’d be wrong, and its not very likely his bosses would support his argument … he certainly would lose his case if it made it into a courtroom … the problem, of course, with renegade auditors, is that few cases end up before a judge because most people don’t have the resources or the energy to take it to that level, even when they have an open and shut case. 



OptsyEagle said:


> the fact that *if you sell the investments that were purchased with borrowed money, then the interest on that money would cease to become deductible.*


That’s not a fact at all … the interest would only cease to be deductible if the money were then used for an ineligible purpose … selling a leveraged investment is not a problem … using the proceeds for an ineligible purpose is the problem.


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## andrewf (Mar 1, 2010)

"Well, capital gains arising from the sale of an investment are also taxed in the current year, but the law is crystal clear in that case that there must be continuity of investment, in order to enjoy continuity of interest deductibility … therefore, current year taxation is not a valid test. "

If you only remove the gain, there is, in principle, a continuity of investment.


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## cardhu (May 26, 2009)

andrewf said:


> If you only remove the gain, there is, in principle, a continuity of investment.


No, there isn't ... if you borrow money to buy 200 shares of RY, and then you sell 100 of those shares, you now only own half of the original investment.


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## OptsyEagle (Nov 29, 2009)

Cardhu, 

My point about the ineligibility of all the interest is the issue that surrounds cominguling of loans between personal and investment use. I believe the onus would be on the borrower to prove how much is personal and how much is investment and in the transaction I stated, especially if done mulitiple times, this would become very difficult over time. An auditor may possibly void the entire deduction, although I agree, they also may not. Whether he/she should deny the deduction would need to be determined in court, which I always try to avoid, and hence my point about this issue.

As for the deductibility of interest on money borrowed for investments that are subsequently sold. I believe I am correct on my interpretation here, that they would deny the future deductibility of this interest. The following quote is from the CRA website pertaining to carrying charge deductions.

_"•most interest you pay on money you borrow for investment purposes, but generally only as long as you use it to try to earn investment income, including interest and dividends. "_

http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns206-236/221/menu-eng.html

I would suspect that an auditor would so decide that an investment that is sold can no longer earn investment income, but perhaps that also may need to be decided in court.

Its really is too bad that our tax system is not black and white.


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## andrewf (Mar 1, 2010)

Well, you have 100 shares and cash corresponding to your purchase price for the 100 shares. That cash can be reinvested, and there will be continuity of investment, no? Otherwise holding cash at any point would represent a discontinuity, rendering investment loans useless unless they go directly from borrowing to purchase with no intermediate steps.


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## peterk (May 16, 2010)

andrewf said:


> Well, you have 100 shares and cash corresponding to your purchase price for the 100 shares. That cash can be reinvested, and there will be continuity of investment, no? Otherwise holding cash at any point would represent a discontinuity, rendering investment loans useless unless they go directly from borrowing to purchase with no intermediate steps.


I _think_ the word "sold" in this context refers to removing money from your leveraged investment account. Not actually "selling" anything within your account, or holding cash.

What still seems up in the air is that if removing dividend profit will affect the deductibility. It seems that most people say it won't affect it (how else would you pay off that big interest bill?) but it's still very unclear to me.


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## cardhu (May 26, 2009)

OptsyEagle ... my point is also about the commingling of loans between deductible and non-deductible uses ... commingling is allowed ... the courts have already dealt with cases involving commingling, and have never ruled that an otherwise valid deduction is rendered invalid as a result of commingling ... I agree that the onus is on the taxpayer to provide supporting documentation, and I agree that an auditor might ask to see said documentation before signing off on his review ... the same is true of a margin account in which the investor does NOT take any cash withdrawals ... and in both cases, failure to provide adequate supporting documents might jeopardize the deduction, but the mere fact of commingling certainly shouldn’t. 

As for the deductibility of interest on money borrowed for investments that are subsequently sold … selling of leveraged assets is allowed ... the courts have already dealt with cases involving the selling of assets and have never ruled that future deductibility of interest is voided by the simple act of selling ... you can buy and sell as often as you want, and as long as each of the uses of the money is an eligible use, then the deductibility of interest remains intact … selling a leveraged investment is not a problem … using the proceeds for an ineligible purpose is the problem. 



andrewf said:


> Well, you have 100 shares and cash corresponding to your purchase price for the 100 shares. That cash can be reinvested, and there will be continuity of investment, no?


No … you do not have continuity of investment unless you reinvest the entire proceeds of sale … reinvesting just a portion of those proceeds (ie. only the amount corresponding to your original purchase price) is not continuity … at least not for the purpose of determining deductibility of interest expense. 

Holding cash for brief periods between investments is not an issue. 



peterk said:


> I think the word "sold" in this context refers to removing money from your leveraged investment account. Not actually "selling" anything within your account, or holding cash.


No ... the word “sold” means sold ... as in selling the shares ... as I mentioned above, the question of moving money into or out of your leveraged investment account is irrelevant ... CRA doesn’t care where your leveraged assets reside, whether in a single account, multiple accounts, or in a shoebox under your bed at home ... and they don’t care (although you should) if those assets are commingled with other non-leveraged assets ... what they care about is what you did with the borrowed money. If you use borrowed money for anything other than an eligible use, then you can’t deduct the interest on that amount. 

In general, you can do whatever you like with dividend income without jeopardizing interest deductibility for debt incurred to buy the underlying shares ... the only caveat mentioned in this thread, (optsyeagle and I agree on this point) is that in a margin account, CRA might quibble with the sequence of events ... they might argue that the dividend payment was first used to pay down the debt, and that the subsequent cash withdrawal was a “new borrowing” and therefore subject to all the normal scrutiny facing any other borrowing, in determining interest deductibility ... I've never heard of this actually happening, but its a grey area.

In a margin account, there is no separation between your debt, your investments, and your dividend (or interest) income stream ... they all occupy the same space ... if you keep your leverage debt separate from your investments (ie. a HELOC for borrowing, and a broker account for investing), then this issue of sequence doesn’t exist. You can spend your dividend income as it arrives, with never a worry.


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## Eclectic12 (Oct 20, 2010)

cardhu said:


> ...
> 
> As for the deductibility of interest on money borrowed for investments that are subsequently sold … selling of leveraged assets is allowed ... the courts have already dealt with cases involving the selling of assets and have never ruled that future deductibility of interest is voided by the simple act of selling ... you can buy and sell as often as you want, and as long as each of the uses of the money is an eligible use, then the deductibility of interest remains intact … selling a leveraged investment is not a problem … using the proceeds for an ineligible purpose is the problem.
> 
> ...


Happy New Year, Cardu.

I agree with most of what you've written but I'm confused by the need to re-invest the total proceeds instead of the borrowed amount.

When I look at Canada Revenue's web site at the "Interest Deductibility and Related Issues" bulletin IT-522, ->
http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.html#P138_15186

In the "Restructured borrowings" section, example 5 says 


> Example 5
> 
> K Corporation acquired property L with $1,000 of borrowed money, the entire amount of which remains outstanding. K Corporation subsequently disposed of property L for $1,500 and used the proceeds of disposition to acquire property M for $1,200 and property N for $300.
> 
> Under the flexible approach to linking, K Corporation may choose that the current use of the borrowed money is entirely for property M, since the value of property M exceeds the outstanding amount of borrowed money ($1,000). Alternatively, K Corporation may choose to allocate 30% ($300/$1,000) of the current use of the borrowed money to property N (and consequently the remaining 70% to property M).


Since the sale is for more than the original amount, the concern seems to be linking the outstanding borrowed amount to the appropriate eligible investment. Where the entire proceeds is mentioned is when the proceeds were less than the borrowed amount.

The way I read it, if it is at the tax payers choice to link the borrowed value to a single investment, the excess - whether re-invested or removed, should be irrelevant.

Cheers


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## andrewf (Mar 1, 2010)

This is what drives me crazy. Better safe than sorry, but it'd be nice to have this explicitly clarified by CRA.


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## Eclectic12 (Oct 20, 2010)

andrewf said:


> This is what drives me crazy. Better safe than sorry, but it'd be nice to have this explicitly clarified by CRA.


Yup ... it's amazing what seems simple and a multi-year tax law suit later, isn't so simple!! 
*grin*


My personal favourite was my uncle. It was only 1 tax return and 15 adjustments before the advice from his local tax office was accepted.
I can understand some stuff can be confusing but when the starting point is the tax office, it would seem to need fewer ajustments.


Cheers


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## cardhu (May 26, 2009)

eclectic12 said:


> The way I read it, if it is at the tax payers choice to link the borrowed value to a single investment, the excess - whether re-invested or removed, should be irrelevant.


I think you’re right ... I was thinking of something else, a different scenario altogether ... but in hindsight, it wasn’t what andrew meant. 

Sorry for the mixup, andrew.


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## Eclectic12 (Oct 20, 2010)

cardhu said:


> I think you’re right ... I was thinking of something else, a different scenario altogether ... but in hindsight, it wasn’t what andrew meant.
> 
> Sorry for the mixup, andrew.


*whew* - the tax world is less confusing again ... for a few minutes anyway. 

*grin*


In any case, it still probably a good idea to keep notes so that if the question comes up with an auditor, the "borrowed amount" paper trail is clear.

Cheers


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