London, ON: The government has recently clarified that interest expense from borrowing to purchase equity mutual funds is generally tax deductible. This clarification finally puts to rest a controversial issue for the strategy of leveraging, or borrowing to invest, which became very popular in the 1990s.

"This is an important event for all investors and financial advisors looking for tax-deductible investment strategies beyond RRSPs, especially middle-income investors, who often use mutual funds when borrowing," says Talbot Stevens, financial educator and author of the new bestselling booklet Dispelling the Myths of Borrowing to Invest. "The concept of leveraging is poorly understood and controversial enough without this grey area about whether the interest is deductible. This clarification levels the playing field, allowing mutual fund investors to know their borrowing costs are just as deductible as others who borrow to buy stocks with a margin account."

While the interest expense is tax deductible when borrowing to purchase investments that produce income, there was concern when leveraging equity investments that produced mostly capital gains, which do not count as income. In the last few years, the Canada Customs and Revenue Agency (formerly Revenue Canada) has made matters more confusing by emphasizing in the T1 General form that interest is not deductible when borrowing for investments that produce only capital gains. Their practice, however, was to allow the deduction for mutual funds, leading to conflicting interpretations by both accountants and government agents alike. 

"In the past when the tax experts could not agree on the deductibility of leveraging equity funds, it was obviously difficult for average investors to feel confident about their deduction," says Stevens. "Now, investors, advisors, and accountants can move on to other issues like understanding when tax-deductible borrowing to invest in equity funds makes sense and when it does not."

Talbot Stevens, who wrote the brief 44-page booklet Dispelling the Myths of Borrowing to Invest to help Canadians better understand this advanced investment strategy, cites a common myth held by many investors and financial professionals. "Most people, including many accountants, believe the myth that investment returns must be higher than your interest expense for borrowing to make sense," claims Stevens. "This is not true when some of the returns are deferred capital gains."

Stevens' booklet shows how someone in the 40% tax bracket can benefit from borrowing to buy equity funds when returns are only about two-thirds of their interest expense. Talbot also emphasizes that while leverage can help investors, it can also hurt them. "I've always counseled that investors only consider long-term conservative leverage with a trusted advisor, so they fully understand the potential downside and implement responsibly," cautions Stevens.

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Talbot Stevens is a financial educator, industry consultant, and author of "Financial Freedom Without Sacrifice" and "Dispelling the Myths of Borrowing to Invest". For other story ideas, visit the Free Resources menu of www.TalbotStevens.com. For more information, contact Judy Culford, Communications Director for Talbot Stevens, by calling (519) 663-2252, or emailing judy@TalbotStevens.com.