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The following question is a follow up to an old one and includes the original answer. I have put the question in Blue and the new answer is in Maroon
ingram
Dave,
Q: I am a member of Ozzie Jurock's REAG group. Having read your suggestions in Ozzie's newsletter and on your own website with respect to using mortgage
interest on one's home as a tax deduction, (and your very interesting discussions on a number of other subjects), it is my intention to register a collateral mortgage on my residence which would initially have a zero balance owing.
I would then "borrow" against these funds to finance the
deposits on rental properties. I would assume that I could then write off the interest on this borrowed money. My banker has suggested that he can open up either a line of credit or a mortgage which I could operate in much
the same way as the line of credit (open and with the ability to make flexible payments into the mortgage), or even a combination of the two.
Both would be secured by the collateral mortgage. He says that if he technically sets up a mortgage rather than a line of credit, he can offer me a one-half percent less on the interest rate. I did have one question and chatted to Dieter Jurock the other day. He suggested that I e-mail you as you could probably tell me if there is any reason why the money should (from a tax advantage point of view) be borrowed through either a line of credit or alternatively a mortgage, or whether this makes no difference at all.
A: No difference - If you borrowed it on your visa or MasterCard to use as a downpayment, the interest is deductible.
You seem to have it figured out.
Just remember, use your rents to pay off personal bills, borrow money to pay expenses for the rentals if you are short of money.
Suppose my principal residence has a $300k mortgage and my rental property has a $100k mortgage with sufficient rent to cover the mortgage payments with a little left over.
Following your advice, I'd use the rent to pay down my $300k mortgage and borrow against it to pay my $100k mortgage.
As the deductible mortgage grows, the rental income will no longer cover the deductible interest payments, and I declare a rental loss to CCRA.
Another REAG member suggested that care must be taken here because CCRA may regard the rental property as not "for-profit", and disallow the
deduction.
What precautions are necessary to avoid CCRA disallowing this conversion of non-deductible to deductible mortgage?
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david ingram replies:
The rule is that you should have a reasonable expectation of profit. Recent cases have been against the CCRA when it comes to expectation of profit .
As long as you have a expectation of profit sometime inteh future and have bought the property as a business decision and are not in a dual use situation (such as a Whistler condominium) there should not be any problem with the CCRA.
Just make sure that you have a proper paper trail of the source and application of funds.
Your fellow REAG member was right about expectation of profit being a problem in the past. You can find four of the old cases where the judge ruled against the taxpayer at: http://www.centa.com/taxguide/rental_income.htm.
In a real case involving 5 condominiums that I sold to a client in 1980and 1981 we went through a severe audit in 1993 when the units were still losing money. He had actually bought the unts for the sole purpose of making his mortgage deductible which they succeeded in doing in total in five years.
When doing his return today, I declared an $11,000 profit and he paid some $3,500 in tax this year.
It does work. In this case, not only did he get his mortgage deductible and paid off ten years earlier than he would have done using a conventional mortgage, he is now making $11,000 a year and all the units will be paid off next year.
Oh yes, they are worth over $200,000 more than he paid for them. His total value is about $500,000 and I tried to figure out just how much he had paid into them. I figure that his out of pocket expenses for this almost paid for investment property at the moment is about $30,000 and will be zero in three more years.
Just a little warning. Although I believ it is a good time to buy, I also expect that we will have a slowdown. If you recognize the purchase dates of my clients units, you will recognize that there was a massive decline in the BC market at the end of 1981.
At one time his units were worth 25% less than he had paid for them.
Time does tend to heal real estate wounds if you can hold on.
If and when you buy, make sure that you have a cash flow or borrowing power to get through a 5 year slowdown or decline.
If missing two months rent would cause you financial hardship, you are in the wrong business
David Ingram of the CEN-TA Group
US / Canada / Mexico tax and working Visa Specialists
108-100 Park Royal South
West Vancouver, BC, CANADA, V7T 1A2
(604) 913-9133 - Fax 913-9123 [email protected]
www.centa.com www.david-ingram.com
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