How to Unwind a Spousal Loan Without Tax Penalties

A spousal loan is a legitimate tax planning tool that lets a higher-income spouse lend money to a lower-income spouse so investment income—interest, dividends and capital gains—is taxed in the lower-income spouse’s hands. When properly structured, the arrangement avoids the income attribution rules that would otherwise transfer investment income back to the lender for tax purposes.

Prescribed rate

The Canada Revenue Agency (CRA) sets a quarterly prescribed interest rate that must be charged on loans between spouses to prevent income attribution. The applicable rate is the CRA’s published prescribed rate for the quarter in which the loan is made. As noted above, the prescribed rate in Q1 2026 is 3%. That rate has varied over time—falling to 1% for periods following the pandemic onset and at other times in the past decade—which means legacy loans established during low-rate periods may still carry those lower rates if they have not been amended.

Repaying a spousal loan

While there is no legal requirement that the loan principal be repaid on a specific schedule, the loan must be documented and the required interest must be paid annually. To keep the income attribution rules from applying, the borrower must pay the annual interest to the lender by January 30th of the year following the year the interest accrued. Failure to meet this deadline can cause the income attribution rules to apply, effectively undoing the tax benefits of the arrangement.

The borrower may repay the principal at any time and using any source of funds. Common repayment sources include the income earned by the borrower, proceeds from selling investments purchased with the borrowed funds, or other personal assets. It’s important to bear in mind that selling investments to repay principal may trigger capital gains or losses depending on the investment’s adjusted cost base and sale price.

Forgiving a spousal loan during your life

Forgiving a spousal loan during the lender’s lifetime can create tax consequences for the borrower under Canada’s debt-forgiveness rules. If the lender cancels all or part of the debt while alive, the borrower may be required to reduce certain tax attributes: for example, non-capital or capital loss carryforwards may have to be reduced by up to the amount forgiven. This reduction can limit the borrower’s ability to offset future income.

In addition, the borrower may need to adjust the adjusted cost base (ACB) of depreciable or capital property they hold. A reduction in ACB increases the potential capital gain on a later sale of those assets. Any portion of the forgiven debt that is not absorbed by reductions to loss carryforwards or ACB adjustments may then be included in the borrower’s income, typically treated as a capital gain in the year of forgiveness.

Forgiving a spousal loan on death

A spousal loan can remain outstanding for many years without being repaid, and the original prescribed rate that was set when the loan was made generally continues to govern that arrangement. If the lender dies and the loan is forgiven in the administration of the estate, different tax consequences apply: the debt-forgiveness rules that can affect a borrower during the lender’s lifetime do not generally apply on the lender’s death. Likewise, the spousal attribution rules typically do not reapply to income earned from assets that the borrower purchased with the loaned funds when the debt is forgiven at death.

Practical considerations and documentation

To ensure the spousal loan achieves its intended tax outcome, proper documentation and consistent administration are essential. Key steps include drafting a clear loan agreement that specifies the principal, the prescribed interest rate, and the repayment terms; charging and receiving interest annually by the required deadline; and keeping records of interest payments and investment transactions. Both spouses should report the relevant interest, investment income and capital gains appropriately on their tax returns.

Because tax rules around loans between spouses can be complex and consequences for non-compliance can be significant, many couples consult a tax professional or financial planner before implementing a spousal loan. Professional advice can help ensure the loan is set up correctly, integrate the strategy with overall tax and estate planning, and avoid unintended tax liabilities.

Summary

When properly documented and administered, a spousal loan can be an effective way to split income between spouses and reduce a family’s overall tax burden. The critical elements for success are using the prescribed CRA rate in effect when the loan is made, paying the required interest by January 30 each year, keeping thorough records and understanding the tax implications if a loan is forgiven during life or at death. Given the nuances—especially around debt forgiveness and capital gains—seek professional tax advice if you are considering this strategy.

Read more from Ask a Planner:

• Can I still use my FHSA after my spouse bought a condo?
• Preparing taxes for someone who died
• How does rent from a family member or common-law partner get taxed?