If you borrow money for the purpose of earning investment or business income, the interest you pay on that debt is generally tax deductible. But what if your investment turns out to be a dud and goes to zero — or you’re forced to shutter your business — while you still owe money on your loan? Should interest continue to be deductible for tax purposes long after the original source of that income has disappeared?
The answer, fortunately, comes in the form of a little-known rule in our Income Tax Act sometimes known as the “loss of source” rule. The rule, which has been in force since 1994, applies when the borrowed money no longer has the potential to generate income because the source of that potential income has disappeared. The rule, therefore, essentially permits you to continue to write off previously deductible interest expenses, even after the source of the investment or business income has disappeared.
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