Mortgage Interest Deductibility - using dividends to increase the deductible amount of interest -
QUESTION: A tad confused. I am a salaried employee with a closed mortgage (but with a lot of equity that I can borrow on). I was thinking of doing the following: Increasing my mortgage by say $50,000 and using these funds to purchase dividend paying stocks (not sure if the fact they pay dividends has any merit). Will not be put into an RRSP account. Would I then be able to deduct the mortgage interest on the $50,000 in my tax return? Also, is the interest fully deductible or only up to the dividends paid? Finally, aside from increasing mortgage deductibility, if I don't use the dividends to pay down the mortgage (I do have the ability to increase my mortgage payments) and then borrow and reinvest the same amount for new stock/mutual funds, does this mean the interest on the $50,000 is not deductible? Thanks, xxxxx-------------------------------------------------
david ingram replies:
You may be confused but you have the idea down just about pat.
Everyone else goofs here and checks off the box to re-invest the dividends. By having them paid to you, you can decrease the original mortgage. Then borrow (with your new found equity) an equivalent amount of money to buy the amount (maybe a little more or less so that it does not look totally artificial) of funds that would normally be bought with the re-invested dividends.
My advice is NOT to increase the existing mortgage. You need two lines of credit or an open mortgage for the original amount so that you can pay it down first and an open line of credit to increase when ever you borrow more money for investment.
If you go with two lines of credit, you have to monitor the situation because the clerks at the bank or credit union do not usually understand it. I had a major problem with one credit union this week. They were doing it exactly backwards even though the two lines of credit were clearly marked business and personal. They were increasing the personal line of credit for the third time even though the other was clearly labeled the business line of credit.
The problem was that although the over all line of credit was $500,000, for the financial institution's convenience, when issued, they had limited the business at $160,000 and the personal at $340,000 which was the original amount of the non-deductible mortgage. Even though the $340,000 was down to $250,000, the institution started taking money out of the personal line when the business line hit the magical $160,000 figure.
It is usually better to get specific cheques for the line of credit so that when you write one for a business or investment reason, it is clearly coming from the borrowed money and can be shown clearly to the CRA or IRS if questioned about it.
The following is the history of this and why it is worth it.
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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?
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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. Al Wood. 604-530-3430.
david ingram replies:
I had some 90 people at a free seminar on this subject today and am just about all "free"ed up on the subject.
You should be taking the rent you receive and use it to reduce the non-deductible mortgage on you r Langley house.
You can find out more by reading my November 2001 Newsletter in the top left hand box at www.centa.com.
Reading Fraser Smith's Book 'THE SMITH MANOUVRE' will also give you ideas on how to make the Langley Mortgage deductible.
Your excess flow should be used to reduce the $244,000 mortgage as soon as possible. Of course, the interest on the down payment loan is also deductible on Form T776.
The following is part of the handout at today's seminar -
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 an 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 us e 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 the Internet and can be found in the March 1997 and November 2001 newsletters.
I was pretty heavily involved in the Federal Conservative Party (ran for the North Shore Nomination in 19780 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 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 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 into his capital account; 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 there ‘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,
he 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:
- The Lipsons contracted to buy a home in Forest Hills in Toronto
- Mrs Lipson took out a demand loan to buy share in the family business from her husband.
- The shares were transferred to Mrs Lipson as a section 73(1) rollover
- Mr Lipson used the funds to buy the house
- They “both” took out a mortgage on the house to repay the demand loan
The following was an excel spreadsheet that was presented and you might be able to figure it out.
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 | |||||
5 | 5 | |||||||||
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 | |||||||
10 | TWO | 10 | ||||||||
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 | |||||
13 | 13 | |||||||||
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 | |||||||
18 | THREE | 18 | ||||||||
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 | |||||
21 | 21 | |||||||||
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 | |||||||
26 | 26 | |||||||||
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 | ||||||||
31 | DEDUCTIBLE | 31 | ||||||||
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 | ||||||
36 | Why only | 21600 | 36 | |||||||
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 | ||||||||
39 | 39 | |||||||||
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 | |||||||
44 | 44 | |||||||||
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 |
And this will also show the mathematics of paying down a mortgage with the earnings from a Mutual fund.
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 | |||||||||||
Deductible | Non | HELOC | ||||||||||
Assume you have a borrowed | 100,000 | to buy funds and they pay | 0.06 | original | less | Deductible | interest | |||||
A | B | C | D | E | F New | G | H | I | J | K | L | M |
You pay | 0.06 | pay your | 35% Tax | borrow for | Invest't | Mutual | earnings | worth | mortgage | earnings | original | not de- |
borrowed | interest | Refund | new funds | loan | Fund | 0.06 | ductible | |||||
2007 | 100000 | 6000 | 2100 | 6000 | 106000 | 100000 | 6000 | 106000 | 100000 | 6000 | 94000 | 6000 |
2008 | 106000 | 6360 | 2226 | 6360 | 112360 | 106000 | 6360 | 112360 | 94000 | 6360 | 87640 | 5640 |
2009 | 112360 | 6742 | 2360 | 6742 | 119102 | 112360 | 6742 | 119102 | 87640 | 6742 | 80898 | 5258 |
2010 | 119102 | 7146 | 2501 | 7146 | 126248 | 119102 | 7146 | 126248 | 80898 | 7146 | 73752 | 4854 |
2011 | 126248 | 7575 | 2651 | 7575 | 133823 | 126248 | 7575 | 133823 | 73752 | 7575 | 66177 | 4425 |
2012 | 133823 | 8029 | 2810 | 8029 | 141852 | 133823 | 8029 | 141852 | 66177 | 8029 | 58148 | 3971 |
2013 | 141852 | 8511 | 2979 | 8511 | 150363 | 141852 | 8511 | 150363 | 58148 | 8511 | 49637 | 3489 |
2014 | 150363 | 9022 | 3158 | 9022 | 159385 | 150363 | 9022 | 159385 | 49637 | 9022 | 40615 | 2978 |
2015 | 159385 | 9563 | 3347 | 9563 | 168948 | 159385 | 9563 | 168948 | 40615 | 9563 | 31052 | 2437 |
2016 | 168948 | 10137 | 3548 | 10137 | 179085 | 168948 | 10137 | 179085 | 31052 | 10137 | 20915 | 1863 |
2017 | 179085 | 10745 | 3761 | 10745 | 189830 | 179085 | 10745 | 189830 | 20915 | 10745 | 10170 | 1255 |
2018 | 189830 | 11390 | 3986 | 11390 | 201220 | 189830 | 11390 | 201220 | 10170 | 11390 | -1220 | |
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. |
I hope the formatting stays with the email.
Not sure if this will help or not. What you should do is get Fred Snyder to do a written financial plan for you. see the red a couple of lines up.
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david ingram's US / Canada Services
US / Canada / Mexico tax, Immigration and working Visa Specialists
US / Canada Real Estate Specialists
My Home office is at:
North Vancouver, BC, CANADA, V7N 3L7
Cell (604) 657-8451 -
(604) 980-0321 Fax (604) 980-0325
Calls welcomed from 10 AM to 9 PM 7 days a week Vancouver (LA) time - (please do not fax or phone outside of those hours as this is a home office) expert US Canada Canadian American Mexican Income Tax service help.
$1,700 would be for two people with income from two countries
Catch - up returns for the US where we use the Canadian return as a guide for seven years at a time will be from $150 to $600.00 per year depending upon numbers of bank accounts, RRSP's, existence of rental houses, self employment, etc. Note that these returns tend to be informational rather than taxable. In fact, if there are children involved, we usually get refunds of $1,000 per child per year for 3 years. We have done several catch-ups where the client has received as much as $6,000 back for an $1,800 bill and one recently with 6 children is resulting in over $12,000 refund.
Email and Faxed information is convenient for the sender but very time consuming and hard to keep track of when they come in multiple files. As of May 1, 2008, we will charge or be charging a surcharge for information that comes in more than two files. It can take us a valuable hour or more to try and put together the file when someone sends 10 emails or 15 attachments, etc. We had one return with over 50 faxes and emails for instance.
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