You refinanced your rental and pulled out equity — is all that new interest still deductible? Not automatically, and this is one of the most expensive misunderstandings in rental property tax. The CRA doesn't care that the loan is secured by a rental; it cares what the borrowed money was used for.
Interest is deductible when borrowed money is used to earn income. That's the whole rule, and its logic runs opposite to how most owners think. The property securing the loan is irrelevant; the destination of the dollars is everything.
A mortgage on your personal home is deductible if the borrowed funds bought a rental property. A mortgage on your rental is not deductible if the refinance proceeds paid for a family vacation. Owners routinely assume it works the other way — rental property, therefore rental interest — and file returns that don't survive a second look.
Pull equity out of Rental A to make the down payment on Rental B, and the interest on that new borrowing is generally deductible — the funds went to earn income. The same holds for borrowing used for renovations on an income property or other eligible income-earning purposes. Grow a portfolio this way and the interest deductions grow with it, legitimately.
The catch is the word "generally." The deduction is only as good as your ability to demonstrate the use — which brings us to tracing.
Use refinance proceeds for personal spending — the renovation on your own home, the car, the debt consolidation — and the interest on that portion is simply not deductible, no matter which property secures it. And if one refinance funded both a rental purchase and personal spending, you now have a blended loan: partly deductible, partly not, in proportions you must be able to establish. Every payment, every rate change, every future refinance drags that split forward. Blended borrowing isn't fatal, but it's a permanent bookkeeping obligation most people never realize they signed up for.
The CRA's expectation is that you can trace borrowed funds from the advance to the income-earning use. In practice, clean tracing looks like this: refinance proceeds land in a dedicated account, move directly to the new property's purchase, and never mingle with personal cash along the way. Separate borrowings for separate purposes beat one big blended loan every time — even at the cost of a little convenience.
Commingling is the killer. Run refinance proceeds through the account that also pays for groceries, and you've turned a clean deduction into an argument. It made our list of rental property bookkeeping mistakes because we see the damage every spring.
Done deliberately and systematically, converting non-deductible borrowing into deductible investment borrowing is a recognized strategy — the Smith Manoeuvre is the best-known version, using a readvanceable mortgage to rebuild home equity as investment credit. The principle is identical to everything above: deductibility follows use, and the records prove the use. The difference is that the strategy makes tracing a monthly discipline instead of a year-end scramble.
The takeaway: before you sign refinance papers, know where every borrowed dollar is going and how you'll prove it — the deduction is decided at that moment, not at tax time. If your borrowing has already gotten tangled, book a free consultation and we'll assess what the paper trail can still support.
This post is general information, not tax advice for your specific situation.
