Tax Deductibility of Margin Interest

[Park]

"Consider these ideas to keep your interest deductible: Skim the interest, dividends, or other income from property (but not capital gains) from your leveraged investments before these amounts are reinvested, and spend this income in any way you'd like. This won't jeopardize your interest deduction because you're not dipping into your principal, or invested capital. However, once this income is reinvested in additional units or shares, it forms part of your capital, and you may run into an interest deductibility problem when you make withdrawals later."

http://www.theglobeandmail.com/globe-in ... 0/?page=23

The above quote is from Tim Cestnick's 2010 "101 Tax Secrets for Canadians"

If one is using a margin loan to invest in stocks, you can take out the dividends, and still retain the tax deductibility of the interest. But based on the above, if you use the dividends to reinvest in the same margin account, then there may be an interest deductibility problem when you withdraw later on. Is this true? If so, then if you want to reinvest the dividends, you should withdraw the dividends and invest them in a separate account.

[adrian2]

I try to take all mutual fund distributions in cash and do not re-invest dividends (and take them out annually). I'm also keeping a list of the securities in my kind whose cost base is non-borrowed money; whenever I sell part of those, I take the money out of the margin account -- everything else is borrowed and proceeds of sale must stay in the account.

To say it once again loud and clear: I strongly dislike DRIP's and the like -- it's not only the issue mentioned above, but the order of magnitude added complexity at tax time. Few people are at the exact cusp of neither adding nor withdrawing from their investment accounts; for everybody else it's a non-issue what to do with the dividends: either add them to the additional money to be invested or spend them.

[Mouly]

I think the issue Cestnick is getting at here is the headache involved in tracking things and knowing how to keep in the good graces of how RevCan interprets your actions. For example: you bought 1,000 shares of a stock entirely with loaned money and then via a DRIP it grew to 1,200 shares. You then sell 250 shares. How are those 950 remaining shares classified? Is it:
- 950 tax deductible shares?
- 700 tax deductible shares and 250 not deductible?
- 791.66 tax deductible shares and 158.333 not deductible?

Yes, there's probably a correct answer but not only do you have to know it, you also have to convince RevCan of it, and also track it. A big pain in the ass. I think he's saying it's easier to just sidestep the whole problem.

I used to have to deal with this and eventually decided that I'd not re-invest directly so that I could avoid the hassle.

[adrian2]

For example: you bought 1,000 shares of a stock entirely with loaned money and then via a DRIP it grew to 1,200 shares. You then sell 250 shares. How are those 950 remaining shares classified? Is it:
- 950 tax deductible shares?
- 700 tax deductible shares and 250 not deductible?
- 791.66 tax deductible shares and 158.333 not deductible?

IMHO, last answer.
More precisely, from the initial loan of Y to buy the 1,000 shares, a portion of 250/1200 Y has become non deductible, so that the corresponding part of annual margin / loan interest is not deductible. Now take into consideration that you likely have more than one security bought with loaned money...

I used to have to deal with this and eventually decided that I'd not re-invest directly so that I could avoid the hassle.

I avoid DRIP's like a plague.