My wife and I rent a basement suite and in the spring bought a condo and started renting that right away and will be following your instructions on the “smith maneuver” and want to be clear that we can put the rent from both the basement suite and the condo down on our mortgage and then use the line of credit to pay all the expenses on the condo (including the mortgage)?
Also, we would like to have your office prepare our tax return so how soon prior to the dead line next year would you take new clients?
david ingram replies:
as you have described your action, the interest on the line of credit set up to handles the expenses of the rental condo should be deductible under current legislation and the tax cases that are out there.
If you intend to use us, we would like the information as son as possible, by the end of March if possible. However, we do not appreciate piecemeal information where you send something when you know it is not all there.
Please hold off sending to us until you have everything.
As well as the Smith Maneuver, you should read the November 20012 newsletter in the top left hand box at www.centa.com.
Reading the following and the tax cases involved will help a bit.
My question is: Canadian-specific
QUESTION: We have a rental property generating regular rental income and got enough equity to cover our outstanding principle residence's mortgage. Is there a way we can move this equity to pay off the principle residence's mortgage and still be able to legitimately claim interest payable as tax deductible?
david ingram replies:
Had 91 people at a free seminar at the Holiday INN on Sunday August 12th.
The following is the handout at that seminar.
Hope it helps.
We recently bought a 4plex in Kitimat as a rental investment. We used a Scotia home equity loan for the down payment and a TD mortgage for the other 75%. We have a mortgage on our principal residence in Langley of $244,000. Our monthly payments on the 4plex will total about $1,300 , and the rents will be about $2,000. What would be the smartest method for paying this mortgage? What do we do with the excess cash flow? Is it possible to deduct the interest on our primary residence mortgage? Thanks.
David Ingram's US/Canada Services
Mortgage Interest as a Deduction in 2007 – dealing with GAAR
I first conceived of this method in 1975/76 when a client of mine had a rental duplex and had a tenant who was injured in a car accident. It was at the time of the changeover from private insurance to ICBC and the injured single mother tenant was waiting for a car accident insurance settlement.
My client allowed his tenant to stay in the half duplex for more than a year and to stay afloat him self, he borrowed money to pay the duplex bills. When doing his 1975 tax return, we deducted the interest paid on the loan because the purpose of the loan was clearly to fund the rental duplex.
When he finally got his cheque for more than $5,000 from the tenant, it would have been all over if he had just paid the loan off and we had not thought about it. But my client, bless his soul, phoned and asked if he had to pay off the loan (which was deductible) or could he use the money for another non-deductible purpose.
My answer, after thinking about it for a day or so, was that he could use the $5,000+ for any purpose he could think of. At the same time, I said this, I was also writing something for the North Shore Credit Union and put my ‘new’ method of making the mortgage interest deductible in this report which they then published as part of an advertisement in the North shore News in (I think) November, 1976.
I expanded it and it was
next published by Hancock House Publishers in my Investment Guide
in 1979, 1980 and 1985 and 1991 and BC Business magazine in 1979.
Sometime in there, the Ontario Dental Association also ran it in their magazine.
It then became part of a lot of Internet sites and can be found in
the March 1997 and November 2001
newsletters at www.centa.com in the top left hand
I was pretty heavily involved in the Federal Conservative Party (ran for the North Shore Nomination in 1978) and am proud to say that we got mortgage interest as a tax deduction on the 1979 federal Income tax return.
Unfortunately, Joe Clark, the Prime Minister at the time, did not count the number of yes votes in the House (there were enough if he had waited for the Social credit members to arrive) and lost a non-confidence motion on Dec 12, 1979, and on Feb 18, 1980, Pierre Trudeau was re-elected as Prime Minister and even though there was a 4-page form and a line on the T-1 General that year, the deduction was killed retroactively by the liberal government and we no longer had this benefit for all without manipulating the paperwork.
In 1981, Fred Snyder was running a series of seminars and teaching my method to a lot of different groups. In one seminar, he taught it to Realtors, McCauley, Nicolls, Maitland and Company and the manager Fraser Smith wrote Fred a letter thanking him for explaining the methods. In 1985, Fraser Smith than published the SMITH MANOUVRE which explains the method in great detail and at the time, VANCITY Savings Credit Union was featured in the book and was very good at setting up the method.
Then on Oct 27, 1988 John Singleton had approximately $300,000 in his lawyer’s capital account. He got permission from his law partners to take the $300,000 out (it was his but was being used as security in his law practice). He used it to buy a house and then used the house as security to borrow $300,000 which he then put back into the law firm's capital account to fund the law practice. This was all done in one day. Of course, since the money in the account was now borrowed for business purposes, he deducted the interest on his 1988 and 1989 returns and the Tax Department turned him down. He appealed and lost in the Tax Court of Canada but won in the Federal court of Appeals. The CRA appealed to the Supreme Court and in October 2001, the Supreme Court of Canada found in favour of John Singleton in a 5 to 2 decision.
This case has now been quoted and cited in many other cases. In OVERS 2006 TCC 26, Mr Overs paid back a shareholder-loan, which would have been included in his income. By doing what he did, co-incidentally, the interest expense was made deductible.
Mrs Overs borrowed funds to purchase shares of his holding company at their fair market value. However, Mr Overs did NOT use a 73(1) rollover as Lipson did. Therefore, no capital gain was realized but the attribution rules in section 74(1) worked to transfer the interest expense on the wife’s borrowed funds -- back to him.
Judge Little turned down the CRA’s claim that tax benefits arose from this series of transactions. The taxpayer followed the Income Tax Act in repaying his loan and transferring the shares to his wife. Justice Little ruled that the transactions were NOT avoidance transactions and therefore GAAR did not apply. Judge Little ruled that none of the transactions could be considered “abusive tax avoidance”.
And Judge Bowman ruled in favour of Evans (2005 TCC 684). Judge Bowman found there were no avoidance transactions in what could only be described as a super complicated and very sophisticated series of business restructurings that ended up with a former shareholder receiving cash by using specific rules in the Act, including sections 85 (rollovers), 110.6 (capital gains exemption), 112 (tax free inter-corporate dividends), 74.5 (attribution) and ss. 84(3) (deemed dividends).
Judge Bowman assumed that these ‘were’ avoidance transactions. He then dealt with them on an individual basis to decide whether the avoidance transactions were ‘abusive’. His final decision was that provisions of the Income Tax Act operated as intended and there could not be any abuse.
However, Judge Bowman was not of the same opinion with the LIPSON Family who lost in Lipson v. The Queen, 2006 TCC 148
Mr Lipson owned a profitable business and:
Judge Bowman used the Section 245 GAAR provisions to rule that the Lipson family was guilty of Gross Abuse of the Tax system. Perhaps, if they had a business reason for the loan or had not used the Section 73(1) tax free rollover, he would have found in their favour as he did with the EVANS 2005 DTC 1762 case. In the LIPSON case the wife’s borrowing did not put income in her hands and it was unclear what the business reason for the transactions were.
|1||WHY BOTHER MAKING YOUR MORTGAGE INTEREST DEDUCTIBLE??||1|
|2||by david Ingram - www.centa.com -||(604) 980-0321||2|
|3||WELL - LET'S PRETEND THAT YOU HAVE AN OUTSTANDING||$ 100,000.00||3|
|4||Let's pretend that you are paying 6%||0.06||times||6000.00||4|
|6||How much do you have to earn to pay||6000||6000.00||6|
|7||At a||0.3||marginal tax rate||you would need||8571.43||7|
|8||you would pay tax of||2571.43||8|
|9||To Have enough to pay the interest of||6000.00||9|
|11||WELL - LET'S PRETEND THAT YOU HAVE AN OUTSTANDING||$ 300,000.00||11|
|12||Let's pretend that you are paying 6%||0.06||times||18000.00||12|
|14||How much do you have to earn to pay||18000||18000.00||14|
|15||At a||0.35||marginal tax rate||you would need||27692.31||15|
|16||you would pay tax of||9692.31||16|
|17||To Have enough to pay the interest of||18000.00||17|
|19||WELL - LET'S PRETEND THAT YOU HAVE AN OUTSTANDING||$ 600,000.00||19|
|20||Let's pretend that you are paying 6%||0.06||times||36000.00||20|
|22||How much do you have to earn to pay||36000||36000.00||22|
|23||At a||0.4||marginal tax rate||you would need||60000.00||23|
|24||you would pay tax of||24000.00||24|
|25||To Have enough to pay the interest of||36000.00||25|
|27||You can easily see that the larger the mortgage payment||27|
|28||the more money you have to make and the larger your||28|
|29||marginal tax rate would be - BC runs from 23% up to $35,000||29|
|30||and is 44% over $118,000 or so||30|
|32||But if the last mortgage of||600000||could be deductible||36000.00||32|
|33||the interest paid of||36000||would get a tax deduction of||14400.00||33|
|34||and you would only need to earn the difference||21600.00||34|
|35||instead of the||60000||on line 23 above||35|
|37||Well, you could earn||21600||, borrow||14400||(line 33)||37|
|38||for a few days from Fred, and then pay Fred back with the refund||38|
|40||The difference in earnings is||60000||line 23||40|
|41||minus new necessity of||21600||Line 34||41|
|42||for an earnings savings of||38400||42|
|43||or a monthly difference of||3200||43|
|45||And, if you are self employed as I am, I would have to do||45|
|46||$200,000 of business and pay $140,000 of expenses to have a profit of||46|
|47||$60,000 left over to pay the tax on the $60,000 on line 23||(Aug 11, 2007)||47|
|Using New Securities Account to make mortgage deductible||This is to show the method only|
|Most, if not all people buy a Mutual fund and have the dividends reinvested|
|in the fund. Do NOT DO THAT if you want a deductible mortgage||Non|
|Assume you have a borrowed||100,000||to buy funds and they pay||0.06||original||less||Deductible||interest|
|You pay||0.06||pay your||35% Tax||borrow for||Invest't||Mutual||earnings||worth||mortgage||earnings||original||not de-|
|Because the earnings from the mutual fund are mostly dividends and capital gains which are very tax efficient|
|there will be little tax on the earnings - certainly less than half of the tax savings in column D|
|In this example, I have assumed an interest only HELOC and assumed that you would have paid your regular non-deductible interest|
|which would decrease each year because of the principal being paid down in column K.||column M represents HELOC interest|
|Every one's situation is different. YOUR cash flow will be different. And to escape GARR, you must be making a business decision|
|If you wish to make your mortgage deductible. A perceived increase in earnings from a mutual fund loan would likely be sufficient|
|but there are NO, NONE, NOT ANY Guarantees.|
|If this situation interests you, you are advised to get a written financial plan from Fred Snyder FIRST - His Number is (604) 731-8900|
|david ingram, home office phone (604) 980-0321 - Please do NOT phone before 10 AM or after 9 PM but you can phone 7 days a week|
|there are NO message machines - If you do leave a message with a person, If I do not get back in 4 hours, I WILL NOT BE RETURNING|
|the call - I leave it to YOU to follow up. I get over 700 emails a day and my record for phone calls on April 30 2006 was over 140.|
CEN-TA Cross Border Services - Tax, Visas, Immigration