This is a multi-part message in MIME format. ---------------------- multipart/related attachment --Boundary_(ID_/jjFviUTIWMCkVOQtJ8nKg) November 2001 CEN-TAPEDE - Taxation based on where you work, mortgage = tax deductitble, Canada vs US, Mortgage Interest not Deducktable, Open = vs Closed Mortgage, Mutual Fund Portfolio QUESTION: Could you please provide me with information on the SMITH MANEUVER?. A = listener to your radio show tried to explain it to me, but was having a = difficult time. =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D david ingram replies: My November 2001 newsletter was first published in the North Shore News = for the North Shore Credit Union in 1976. It then went into my = Investment Guide and was republished about every two years until this = last version in November 2001. =20 In 1981, Fred Snyder, presented the concept to a MacCauley Nicolls = Maitland Real Estate Office as a method for Realtors to make more sales = and get more listings. The manager Fraser Smith wrote Fred a letter = thanking him for the talk. The Smith Maneuver is a method of making your mortgage deductible. = Several different methods follow the spot about Canadians who need to = pay tax to the United States when performing services. =20 For instance, I gave a copy of this newsletter to my client yesterday = afternoon because I wanted to show him how to make his mortgage = deductible. He read the front page and it turned out that he had been = working in the United States for five years and has renewed his L1A visa = three times and because he is paid from a Canadian payroll, he has never = filed a US tax return. The company has no other office or employee in Canada but set the = payroll up to pay him alone. He still performs 40% of his services in = Canada so the L1A is justified. The immigration lawyer who got his L1A = for him never told him that he had to file a US return and the Canadian = CA who has prepared his returns for the last five years never mentioned = it either. However, my new client is liable for large penalties for = failing to file his US returns. Read on and remember that this question and others can be answered every = Sunday morning at 9 AM on 600AM in the Lower Mainland of BC. Those = outside of BC can listen to the program live on the internet at = www.600am.com. The Long Distance number is 1-866-778-0600 and the local = number is (604) 280-0600 We are also doing weekly free seminars on making your mortgage interest = or your summer cabin interest or your car interest or your motorhome = interest or your sailboat interest or your credit card interest = deductible every Thursday Evening at 7 PM at 1764 West Seventh in = Vancouver. You have to phone (604) 731-8900 to register. We are also presenting a "better" alternative to RRSP accounts. Jonathon Chevreau wrote a comprehensive and very good article on = mortgage interest as a deduction in the NATIONAL POST. It can be found = at: http://www.freedomparty.on.ca/freedomflyer/ff35_12.htm=20 Hope this helps. I hate sending the answers in this format because it = tends to get stripped out by a lot of virus checkers but it is = comprehensive enough that it is worth losing some to get good stuff out. =20 =20 =20 November 2001 =20 The CEN-TAPEDE david ingram's US/Canadian Newsletter 108-100 Park Royal South, West Vancouver, BC, V7T 1A2=20 (604) 913-9133 (9 AM - 5 PM) - Fax 913-9123=20 DID YOU KNOW? -- TAXATION IS BASED UPON WHERE YOU WORK - NOT = WHERE YOU LIVE.=20 =20 Canadians performing services in the United States, and in = 43 of the states in particular, are required to file the respective = state return(s) and a US federal 1040NR or 1040 income tax return, even = if their remuneration was paid from Canada. This applies, but is not = limited to:=20 * Executives attending meetings in the US and, in = particular, California,=20 * Service technicians servicing Canadian products under = warranty,=20 * Salespeople selling Canadian products in the US,=20 * Journalists (eg. covering Canucks Hockey games, INDY = races or O J Simpson trial),=20 * Horse trainers, race car mechanics The above are exempt from tax up to $10,000 of earned income = but the taxpayer must file returns to prove his or her exemption per = Article XV. If you earned over $10,000 in the US, US taxation depends = on where the employer gets its ultimate tax deduction for the wages paid = out. If you are in the US more than 183 days, you are usually taxable on = your world income.=20 =20 ** Entertainers, actors, musicians, = performers,=20 ** Professional athletes, race car drivers, = jockeys.=20 The above are exempt from tax up to $15,000 in gross earned = income (which includes travel expenses) but still have to file the = return to prove their exemption under Article XVI.=20 =20 *** Transport Employees, Truckers, Flight Attendants, = Pilots if over $15,000.=20 Transportation employees are exempt from tax in most cases = even if in the US for more than 183 days, if they are exercising their = regular employment. They must, however, file the tax return to exempt = the income.=20 =20 With Chartered Accountants, US Lawyers, and US CPA's as = associates, I feel that the CEN-TA Group has the experience and the = qualifications to look after most, if not all, US / Canadian tax = problems.=20 =20 Contact George Hatton, CA, Sonja Clark, CA, CPA, LLB, D'Arcy = von Schleinitz, David Ingram, or Gail Ritter at (604) 913-9133 - Fax = (604) 913-9123 for US and CANADIAN INCOME TAX PREPARATION, ACCOUNTING = and / or CONSULTATION.=20 Contact David Ingram for US Working Visas.=20 =20 MORTGAGE INTEREST AS A DEDUCTION=20 =20 People usually think that Americans have it all because they = can deduct their mortgage interest and property tax on their income tax = return. This is true. They can make these deductions, but to do so, = most families give up a $7,000 standard deduction. This is fine if your = mortgage interest is over $5,000 or so, but the practical fact is that = 90% of mortgages in the US are $50,000 or less and interest on $50,000 = isn't enough to justify giving up the standard deduction.=20 =20 In addition, Americans might have to PAY TAX ON THE PROFIT = when they sell their principal residence. If you have lived in the = house for two of the last five years, there is a $250,000 per person = exemption.=20 =20 The US deductions are not free. There is a future potential = tax liability. The principal residence house profit can be taxable even = if you did not claim the deductions.=20 =20 Canadians DO NOT PAY TAX on profits from the sale of the = family home. AND, Canadians can re-arrange their affairs to make their = mortgage deductible.=20 =20 HOW TO MAKE YOUR CANADIAN MORTGAGE INTEREST DEDUCTIBLE FROM = YOUR TAXABLE INCOME=20 =20 (and maybe make a million on the side at the same time)=20 =20 It is useless if not downright dangerous to plan personal = finances around "US", so let's get on with planning for "ME". We will = either be divorced or a widow(er) or dead. We all have to plan for = ourselves alone and assume the other person will be gone. Let's also = make our decisions based upon investments that we understand as opposed = to diamonds, or jewelry, or art or antiques, or strip bonds, or or = or....=20 =20 We all know that indulging in consumer credit at high = interest rates to purchase diminishing assets is a luxury we cannot = afford. Compound this fact with the non-deductibility of that high = interest and we come up with rule number 1: INTEREST PAYMENTS THAT ARE = NOT DEDUCTIBLE ARE A NO NO!=20 =20 However, before I talk about how to make interest payments = deductible, I want to point out that nothing can be deductible if you do = not have a record of it. This whole subject makes me angry. If I start = sounding like the movie "NETWORK", do not be surprised. People tell me, = "lawyers cost too much" and then pay through the nose, because they did = not consult a lawyer in time. They tell me that doctors cost too much = and then find out just how much they do cost when they do not pay their = medical premiums. People tell me that dentists cost too much and do not = brush their teeth. But what really makes me angry is when they say that = accountants cost too much and wander into my office or anyone else's = office with a shoe box or garbage bag or attach=E9 case full of receipts = with three different years on them. Why don't they do a basic sort... at = least into years? It is this same person who will complain when we = charge for sorting the receipts. All we have to sell is our time; if you = use an accountant's time, expect to pay for it.=20 =20 Would you like to know the simplest way to look after your = records if you are a commission sales person, farmer, fisherman, or just = plain one man or woman business? It isn=92t tying you to a computer = program. TRY THIS!=20 =20 KEEPING RECEIPTS THE EASY WAY=20 =20 Take over one drawer in a desk or vanity and get about 25 or = 30 # 10 envelopes. Label them with an expense item in your business or = work: Gas, Oil, Hotels and Motels, parking, telephone, and so on. When = you get home at night or to the office in the morning, merely empty your = pocket, purse, etc. into the relevant envelope. Around Jan 15th of the = next year, simply add up the contents of each envelope and write the = amount on the outside of the envelope. Those are your expense items for = your profit or loss statement or expense statement in either Canada or = the United States.=20 =20 YOU DO NOT NEED DOUBLE ENTRY BOOKKEEPING FOR YOUR "SIMPLE" = BUSINESS. The only reason for double entry bookkeeping is to try and = stop people from stealing from you. If you have no employees, no one is = stealing from you.=20 =20 If you are audited by the Internal Revenue Service (IRS) or = the Canada Customs and Revenue Agency (CCRA), you have all the relevant = receipts for their query neat and totaled. Best of all, when you go to = your accountant or tax man to have your return prepared, you will not be = paying $75 to $150 an hour to have someone else sort and add your = receipts. When it comes to an audit, the auditor will prefer to have the = receipts segregated in this manner.=20 =20 On the subject of why you should keep receipts, try this one = on for size. We will pretend you earn $55,000 per year and are on the = edge of a 45% marginal tax bracket. You take a business trip from = Vancouver to Victoria. It costs $100 for the ferry there and back. You = spend $15 for a meal on the ferry going and $30 for a meal there and $30 = for a meal coming back (you meet a client on the ferry and buy him = dinner); total expenses $175. If you do not keep these deductible = receipts, you might just as well have torn up a =93seventy-five=94 = dollar bill and thrown the pieces overboard.=20 =20 At least most of that trip was deductible. Even though you = spent $175, you got $75 back in the form of a tax refund or tax you did = not have to pay. It only cost you $100. However, one of the rubs in this = life is that if you just decided to take your family out to dinner and = spent $70, you would have to earn $120 and pay $50 tax to have $70 to = pay for the dinner.=20 =20 =20 This is the best example to arrange your affairs to make = them 'deductible'. WORK AT IT! If you do not, no one else will and you = will pay three to four times as much for the same thing.=20 =20 By the way, the VISA / MC / AMEX receipt is NOT sufficient. = The reason is that people going to lunch have been known to give the = actual receipt to one person while the other person uses his or her VISA = slip as a receipt. Both the CCRA and IRS insist on the actual receipt.=20 =20 =20 PAYING FOR A NEW CAR=20 =20 Try this. I will ignore any finance charges for the purpose = of this example and assume everyone has the ability to pay cash, (the = example is far worse with interest factored into the equation).=20 =20 A commission salesman buys a $24,000 Magic Wagon and it is = used 75% of the time for business. He is able to write off $18,000 of = the purchase price of the car and gets back at least $8,100 as a tax = refund. The car cost $16,000 or so in out of pocket cash. Or the = salesman would have to earn $30,000 and pay $14,000 tax to have $16,000 = net to pay for the car. His neighbor buys an identical car and has to = earn about $44,000 and pay $20,000 tax to have $24,000 left to pay for = the car. Add in the differences in gas, oil, insurance and interest and = the cost can easily be two or even three times more to pay for the = non-deductible car.=20 =20 NOT KEEPING RECEIPTS IS EXPENSIVE!=20 =20 If you can't afford a new car and your salesman neighbor = buys a new car every year, it is partly because the tax system is = helping to pay for it.=20 =20 Although there is no doubt that a self-employed person is = entitled to certain expenses, as is a real estate agent or even a sea = captain, YOU MUST HAVE RECEIPTS. In 79 DTC 899, Judge Delmar Taylor made = the ruling that although employees earning commissions were permitted = deductions for certain expenses not deductible by other types of = employees, it was incumbent upon them to maintain records and = documentation in support of such expenses. When no documentary evidence = was produced, the whole claim was dismissed. It should be noted that Mr = P Litvinchuk had earned $47,700 in 1974 and claimed unvouchered expenses = for "parking meters, drinks, pay phones, etc. of $2,400". He earned = $55,570 and claimed $2,000 for 1975, and during 76, he earned $67,834 = and claimed $600. The tax office offered $600 for 74, $600 for 75 and = $300 for 76 and Mr Litvinchuk appealed to get his original claim. Judge = Taylor gave him nothing.=20 =20 Many taxpayers seem to think that there is a reasonable or = an `allowable' amount of 5%, 10%, 15%, etc. that the tax office allows = without receipts. NOT SO! Although the policy of the tax office is to = allow `something', they in fact do not have to allow anything as the = previous case showed. (For more wonderful `real life' stories of tax = cases, see my "The Ultimate Year Round Tax Book" which is also = published by Hancock House). Certainly the amounts claimed by Mr = Litvinchuk were small in relation to the earnings, but as you have seen, = reasonableness does not enter into it.=20 =20 Tax Law is like Parking Meters=20 =20 Either you are over-parked or you are not. The fact that you = were going for change for a $1,000 bill is irrelevant. You should have = had a Magic Wagon with a built in change dispenser. The difference = between over parking or speeding and income tax is that when they catch = you for speeding, they do not go back three years and give you a ticket = for every day you sped in the last three years. Income tax goes back = three, four, up to eight years on a regular basis.=20 =20 And, when you get caught for speeding, you KNOW you were = breaking the law. You would never tell the nice traffic officer, = =93what do you mean, I can=92t speed here, I have been speeding here = EVERY DAY FOR TEN YEARS, but, when the CCRA auditor suggests that you = can=92t claim something, the first thing you will say is: =93I=92ve = been claiming that for ten years and EVERYONE ELSE at the office has = been claiming it as well.=94=20 =20 On the other hand, also in 1979, a Sea Captain, Paul Allen = from Lunenburg, Nova Scotia, who was an employee, was allowed 100% of = his truck expenses because it was used to transport goods to and from = the boat and was used exclusively for boat related activities. He also = used his car for business trips and was allowed 20% of his car. He had = an office in his home which he used to interview prospective crew = members and was allowed 10% of the expenses of his house and last but = not least, he had spent $447 for a party at his house (he did not have = receipts) and Judge J B Goetz allowed the total amount because the party = was for crew members, suppliers and maintenance personnel.=20 =20 Obviously, the quality of the evidence, the mood of the = judge, and the circumstances change in each and every case.=20 =20 I will now return to the subject of making interest = deductible. Twenty-two years ago I was very heavily into rearranging = peoples' finances to make mortgage interest deductible. The 1979 = election of Joe Clark and the actual production of a mortgage interest = deduction form with the tax return stopped the momentum. Lately, it has = been rare for people to come in and pay their money to make their = interest deductible. And this is strange, because of course the interest = is usually three times what it was in 1977 and 1978. In fact, in 1978, I = would get thirty people a month and now I get 20 a year. I guess that = people just like paying taxes or maybe those that would have come in and = paid a $300 fee have now figured it out themselves by reading my book or = a prior edition of this newsletter. Or, maybe they just want to pay more = tax.=20 =20 Our "deductible mortgage" program typically took four to = five years to implement. Joe Clark's government was bringing the = deduction in for mortgages up to $50,000 over a four-year period. The = deduction was actually included on the 1979 Income Tax Form. But Joe = Clark was defeated and so was the deduction.=20 =20 The biggest part of our mortgage interest deductibility = involved purchasing some rental real estate (you need an outside source = of income). I am proud to say that as well as making the house mortgage = deductible, in most cases the rental real estate has gone up = significantly. Some of our purchasers in Brampton realized $120,000 = profits from $10,000 down and made their mortgage deductible at the same = time.=20 =20 CANADA VERSUS THE UNITED STATES=20 =20 The mortgage interest situation in Canada is different from = the US. In Canada, mortgage interest is not deductible where the = mortgage was put on the house to buy it as a principal residence or as a = seasonal cabin/chalet. On the other hand, we in Canada do not have to = pay tax on the capital gains profit when we sell our house. In the = United States, there is a standard deduction or a person may `itemize' = deductions. Itemized deductions include mortgage interest, property = taxes, medical and dental, and even income tax preparation fees. When a = mortgage is getting small (because of age or buy down), it is possible = that a family of six could have a larger standard deduction than the = mortgage interest and property taxes works out to and they have to pay = tax on the profit (capital gain) as well.=20 =20 And in the States, mortgage interest is no longer deductible = on that part of a mortgage, which exceeds the original purchase price. = So after years of saying that there has been less need of my type of = service in the US, it has become obvious that the US's changing to a = `more Canadian' type of system makes the following proposal appropriate = for both countries.=20 =20 It used to be that all other interest in the US was also = deductible. Your Sears interest was deductible, your Visa interest was = deductible, and your mother's car loan was deductible. But all that has = changed. With the rules `Canadianized' over a four-year period starting = in 1986, US taxpayers can no longer claim all that interest. As a = consequence, US taxpayers have to start rearranging their affairs in the = same manner.=20 =20 HOWEVER, ANYONE WHO WANTS TO REARRANGE HIS OR HER AFFAIRS, = CAN MAKE HIS MORTGAGE INTEREST AND CAR LOAN INTEREST, AND BOAT LOAN = INTEREST DEDUCTIBLE. It helps if you are self-employed. But if you are = not self-employed, the same results can be had with the ownership of = rental property or a good mutual fund portfolio. It is also possible to = make a million on the side while you are rearranging your affairs.=20 =20 KILL YOUR CORPORATION=20 =20 Oh, I almost forgot. If you are the proud owner of a = one-person corporation, this will not work. In fact if you are the proud = owner of a corporation, with the exception of a couple of very esoteric = credits like Scientific Research Tax Credits (SRTC) or Flow Through = Shares, you will pay MORE income tax with a corporation than without. In = addition, you will pay an easy $600 to $1,000 more for tax and legal = work per year.=20 =20 If you have a corporation, you should likely kill it, or at = least put it on a back burner for a while until you get all your = interest deductible. If you have a corporation for `insurance purposes', = i.e. so that you can't be sued, forget it. The courts find it very easy = to go after the major shareholder of a corporation where that = shareholder is the only or chief employee and where the problem arose = because of the actions of that employee/shareholder.=20 =20 SITUATION=20 =20 A dentist making $100,000 a year wants to buy a $100,000 = sailboat but he has no cash. He could afford the $1,000 a month payment = if he did 100% financing but he would have to make $2,000 a month and = pay $1,000 tax to have $1,000 left over for the boat payment if the = interest was not deductible. If the interest were deductible, he would = pay the $1,000 a month interest and get a $500 per month cash deduction = off his income tax.=20 =20 We will assume he has a $200,000 house with a $50,000 = mortgage (Lives in Lunenburg or Prince Rupert, etc.). We will assume = that his practice grosses $20,000 a month and that after all expenses, = he has exactly $100,000 left as his earnings.=20 =20 As we have already discussed, if he puts a mortgage on the = house to buy the boat, the interest is not deductible because the money = was used to buy a boat and yacht interest is specifically forbidden as a = deduction in Canada unless the boat is a full time working boat (could = be a rental). In the US, if the original cost of the house was $100,000 = and a new mortgage was put on up to $150,000 from the $50,000 that was = outstanding, only interest on $50,000 would be deductible. If the = original cost was $150,000 or over, than the interest on the whole = $100,000 WOULD be deductible.=20 =20 But let's take the worst case scenario and assume the = original cost of the house was $50,000 and the $50,000 loan on it now = was used to put the kids through university and fix the roof and = plumbing. Therefore, any increased loans against the house bears = non-deductible interest.=20 =20 The dentist has $140,000 worth of expenses per year. The = expenses are for rent, light, heat, telephone, labs, supplies, repairs = to equipment, assistant's wages and dental technicians. If he were short = money some week because a cheque from a dental plan was late, and he = borrowed money to pay for the rent and his assistant's salary, the = interest would be deductible.=20 =20 So what SHOULD the dentist do?=20 =20 First our dentist goes to his or her `creative' mortgage = person or bank manager (Joan Marsh maybe at (604) 535-9981) and says, "I = want to arrange a floating business loan for my practice as a dentist. = The total amount of the loan may be as much as $100,000." The bank = manager will usually say yes, because our dentist is going to give the = bank a mortgage on the $150,000 equity in his house.=20 =20 Each month for the next year, our dentist deposits all the = gross receipts of the practice into a term deposit. He takes out his own = personal expenses only. EVERY SINGLE TIME HE NEEDS TO PAY A BILL FOR THE = PRACTICE, HE BORROWS THE MONEY FROM THE BANK THROUGH HIS PRE-ARRANGED = FLOATING BUSINESS LOAN. When the Term Deposit is up to $100,000 (or = $114,000 including GST and PST), he takes the $114,000 out and pays cash = for the boat. The net result is that there is deductible $114,000 loan = against the business and every single cent can be shown to have been = borrowed to pay business expenses. If our dentist or doctor or lawyer or = accountant has any other non-deductible interest (such as the first = $50,000 on the house), he can now use the boat as security to borrow = more money for the business while he pays down the other non-deductible = loan.=20 =20 HOW ABOUT A SHOE STORE?=20 =20 The owner of the store wants to buy a nice little one = bedroom Condo in Winnipeg for $60,000. He has no money saved and the = shoe store is just making it plus a little extra but he is already = paying out non-deductible apartment rent of $650 a month. If he could = pay $800 a month deductible interest instead of $650 a month = non-deductible rent, he would be about $200 to $300 ahead each month = because of the tax refund/deduction.=20 =20 What does he do? What DOES he do??=20 =20 Simple.... He stops paying his bills for a couple of = months. Every cent coming in goes into a term deposit.... Every cent = except for what he needs for personal expenses. When his creditors have = yelled a couple of times he goes to the bank and borrows money to pay = them. What does he use as security? He uses his term deposit of course. = Depending upon the monthly gross of the business it will take six months = to a year to get the $60,000 into the term deposit. Now he has cash to = pay for the apartment. Of course the bank won't release it because it is = security for their business loan.=20 =20 What does he/she do? He slyly suggests to the bank manager = (Joan Marsh) that he will have a paid for condo and the bank could take = the condo as secondary security as well as a charge against all the = business assets. The net result, a $60,000 loan with the main security = being a condo, BUT the money was not borrowed to buy the condo. Every = cent was borrowed to pay rent on the business, pay staff, buy stock, = advertise, etc. It is an absolute paper trail of source and application = of funds. (For an example of about thirty tax cases on deducting = interest, see my "THE ULTIMATE TAX BOOK, published by Hancock House = Publishers Ltd.")=20 =20 So I repeat, anyone who is self-employed or owns a small = business (proprietorship, not corporation), or WHO OWNS RENTAL PROPERTY = or an income bearing portfolio, can make his or her mortgage deductible. = It might not work in two years, it might take three, four, five, or even = six years, but IT WILL and DOES WORK.=20 =20 This is how you do it. Let's assume you have rental property = (If you do not, we could and will arrange for you to buy it and manage = it for you and set up the following program). That rental property might = be the first MURB you bought or even a ski chalet. When you have a = business, are self-employed or have rent coming in, no one tells you in = what order you have to spend your income.=20 =20 For instance, if not in this program and you had to borrow = $1,000 to fix the roof on your rental property, WE KNOW `automatically' = that the interest on the $1,000 loan is deductible. Where we have a = problem in our mind is when we have the money available to fix the roof = and I say "BORROW IT ANYWAY".=20 =20 The problem is that we have been conditioned by some = antiquated accountant to keep our business and personal accounts = separate or set up a separate account for our rental house. Then we are = told to pay those bills out of that account. THAT IS THE WORST ADVICE = YOU EVER RECEIVED ABOUT FINANCE (well maybe second to the advice to buy = a whole life insurance policy). When you have a separate account and you = have used all the money from the rent to pay the bills for the rental = house, and you still need money to fix the roof on your own house and = you borrow the money to fix your own roof, the interest is not = deductible. But if you took the rent money received and paid cash for = the roof, then borrowed the money to make the mortgage payment for the = rental property, the interest would be deductible. The money from the = rent, from the dental fees, from the accounting fees, from the shoe = sales, is YOURS FIRST to do with as you please. YOU, and =93ONLY=94 YOU! = decide what you are going to pay first. Unfortunately, we have been = conditioned to pay "DEDUCTIBLE" bills first when we should be paying = "NON DEDUCTIBLE" bills first.=20 =20 Look at the "flow through" for the first year of a typical = MURB of which there were some 350,000 sold to investors so that they = could CLAIM A RENTAL LOSS on their income tax return. Remember, a MURB = is just a multiple unit residential building. MURB's still exist. They = just do not have as much artificial tax deduction associated with them.=20 =20 A typical situation might be that you take in $11,000 rent = and spend $17,000 and you are encouraged to do this by the Governments = of both Canada and United States because it is cheaper for the = governments to give you, the investor, a tax deduction then it is to = provide subsidized housing. In this example, where are you going to get = the $6,000 shortfall? You have to earn it or borrow it. If you borrow = it, the interest is a deduction. Why not take the $11,000 rent and pay = down your own mortgage by $11,000 and borrow the whole $17,000 to fund = the rental property.=20 =20 Let's take another tack at it. (A little nautical term = there).=20 =20 Let's say you want to open up a camera store or a shoe store = or a store to sell western hats. You finally heard about urban cowboys = and realized Stetsons are big business. Of course, they stopped selling = three weeks ago, but you just found out about them so you are going to = open up a store and sell western hats. You borrow $30,000 and purchase = $30,000 worth of hats from the Stetson Company. In the next year, you = pay out $6,000 interest, $12,000 rent, $15,000 for wages, $5,000 for = other miscellaneous things and $2,000 for heat and light. You've spent a = total of $70,000 with the expectation of selling some hats. At the end = of the year you haven't sold one. Where did you get the $70,000 in the = first place? You put a mortgage on your house. The money was borrowed = for business purposes, voila, the interest is deductible, even though = the loan is a mortgage registered against the house.=20 =20 George Hatton, CA, a Cartier Partner who works out of the = CEN-TA location at Park Royal in West Vancouver read the above and = wanted a caution put in here. He is right. George wrote, =93The = concept works as well for a portfolio of Mutual Funds as it does for = Real Estate. The difference is that the fund value changes daily and = you (and the lender) know what that value is. Real Estate Values also = change daily but you don=92t really know an exact value and it is a time = consuming and expensive process to redeem real estate. On the other = hand, if you have made an inappropriate stock loan, it is common for the = Stockbroker or lender to call the loan when =93the lender=94 gets = nervous, selling you out of your position, and leaving you in the = position that you can=92t =93catch up=94. This is exemplified in the = next case.=20 =20 STOCK SOLD (shares, not stock in trade)=20 =20 In 1985, Russell I Emerson lost his claim. He had purchased = $100,000 of stock in 1980, with borrowed money. When the investment = turned out to be bad, he sold the shares in 1981 and incurred a $35,000 = loss. He claimed this loss in 1981 and deducted $17,500 as an allowable = business investment loss. He also refinanced a $63,750 loan to pay off = part of his previous loan. (Please note that the amount of the loan = exceeds the loss and confuses the issue.) The tax office disallowed the = interest expense on the grounds that the investment no longer existed = (shares had been sold). Judge Cullen of the Federal Court -- Trial = Division agreed with DNR. (In 1993, Canada's tax law changed to allow = interest on business expenses when the business has been closed).=20 =20 Jumping back a couple of paragraphs, you will see that it is = easier to think about it in terms of a store than in terms of a rental = building. Remember, a rental house or a rental apartment, or a rental = cabin, or a rental sailboat, or a rental motorhome or a rental airplane = is a BUSINESS. So, (my English teacher will be rolling over in her = grave) if you borrowed the whole $70,000, the interest would be a tax = deduction.=20 =20 Let's look at the hat store in another light. You sold = $20,000 worth of hats. If you used this against your $30,000 inventory, = you would still have to borrow $10,000 and the interest would be a = deduction.=20 =20 Besides covering business expenses you have had to live. You = have needed more money for your personal living expenses. You have to = eat and you have purchased a lot of booze to drown your sorrows since = you are not selling many hats. The question: Where did you get the = $10,000 for personal living?=20 =20 Well, if you borrow $10,000 for food, light and heat for = your house, the interest is not deductible. NO - not one cent. So what = should you do? What SHOULD you do? If selling hats has generated any = income, you should be using that income to pay for your personal = expenses, then borrow the money to cover the business expenses ( sound = familiar, do you see the difference?). If you borrow money for personal = needs such as food (both countries now), you have to use after tax = dollars to pay the interest because the interest is not deductible. But = if you borrow money for business purposes the interest is a deduction. = Therefore, always charge your business expenses and use the money (cash = flow) from your business to pay your personal bills. Anyone who is = self-employed or who owns rental property should be following this plan. = =20 Watch: At $40,000 a year if you pay out a $1,000 interest = bill, which is not deductible, you have to earn $1,600 and pay $600 tax = to have $1,000 to pay the interest.=20 =20 But!: If the same $1,000 interest is deductible, you will = get a $400 refund for a net cost of $600.=20 =20 Non-deductible interest costs twice as much in earnings = requirements as deductible interest at the lowest rates. At higher = marginal tax rates, it can cost up to four times as much.=20 =20 =20 MEANWHILE, BACK AT THE RENTAL APARTMENT=20 =20 You just assumed that the first $11,000 should be used to = pay the interest, the taxes and the repairs and maintenance on the = rental unit. Does it have to? It's your money isn't it? You can do = whatever you want to do with that money. You could take it and drive to = Mexico City, you could buy a used Cadillac, Or you could use it to put = your kids through school.=20 =20 You can do whatever you please with that money. What usually = happens is that, because of your desire to keep detailed records, you = set up a separate bank account for the rental property. The money goes = into this account and you are probably putting in money from your salary = to subsidize the payments. At the same time you borrow money to buy a TV = set or a car or to take a vacation. You borrow the wrong money don't = you?=20 =20 What you should be doing, of course, is using all of the = money from your salary plus the $11,000 rental income to pay down your = mortgage on your own principal residence. Remember, the money you earn = from any and all sources is yours first. You make the decisions about = what to do with it.=20 =20 Now you want to make your mortgage payments deductible. If = you have a creative bank manager, and he or she can do a little = mathematics (find one who can) and if you have an outside source of = income, THIS is what you do. Assume that you have a $49,000 mortgage for = this example.=20 =20 Assume your regular payments on the mortgage are $8,000 per = year. If your outside source of income provides you with $11,000 which = you apply to the non-deductible mortgage this year, you would reduce = your non-deductible interest costs and you would reduce the principal of = the mortgage. So, in the first year of this example use $11,000 you have = grossed from this outside source (business or rental property) to make = an additional payment on your personal mortgage.=20 =20 You must still pay the operating expenses for your small = business or pay the mortgage and operating expenses for your rental = properties. Where do these funds come from? You borrow them of course = (perhaps using the new equity on your personal house as security), and = now the interest is clearly deductible on that loan.=20 =20 Now, what has changed at the end of the first year? How much = money do you owe at the end of the year? You owe $38,000 on your = personal mortgage because the additional payment of $11,000 has reduced = the principal portion of your mortgage. Because you borrowed the money = to keep your small business operating or borrowed to keep the mortgage = payments, taxes, insurance and repairs current on your rental property, = you have another loan of approximately $11,000. You still owe $49,000. = But the difference is that the INTEREST ON THE $11,000 is DEDUCTIBLE.=20 =20 (You may have noticed that I have taken no principal off the = loan when we are paying $8,000 against a $49,000 balance. The reason is = that this was originally written at the height of the interest rates = when 15, 17, 19, and even 22% mortgages were floating around. 16% = interest on a $49,000 mortgage leaves no significant principal = reduction. Many people have still have 14 or 16% non-deductible second = mortgages. The principle is very valid. It works even better if you have = an older mortgage and are making significant principal reductions with = your basic monthly payments.)=20 =20 =20 Today, many people have 14, 18 and 26% Visa Card or Second = Mortgage interest rates. I know that today, Nov 8, 2001, I can get a = mortgage in the 4 or 5% range and that most Vancouver mortgages are = going to be $225,000 on a $350,000 or $600,000 house but this is a = concept that can be used in Australia, New Zealand, Germany, = Cornerbrook, Newfoundland, Coos Bay, Oregon, Chilliwack, Hope, Squamish = and Port Alberni. My readers are in 120+ countries and lots of small = towns and this is written for =93everybody=94.=20 =20 11% interest on $11,000 is $1,210. If you are in a 40% = marginal tax bracket, you have changed your tax bill by 40% of $1,210 or = $484 for this year and next year and next year and next year and next = year and next year if that is all you do.=20 =20 However, if you do it again the next year, you can reduce = your tax by another $500 and another $500 until the $49,000 = non-deductible is a $49,000 deductible mortgage. 11% of 49,000 is = $5,390. 40% of $5,390 is $2,156 less tax to pay.=20 =20 If we were starting with a $150,000 mortgage at 11%, the = interest is $16,500 and 40% tax is $6,600. But it isn't just that = simple. If you are trying to pay $16,500 non-deductible interest at 40% = tax bracket, you have to earn $27,500 and pay 40% tax of 11,000 (.40 x = 27,500) to have $16,500 left to pay the mortgage. In terms of `earning' = dollars, your mortgage is costing you 18.3333333%. Whereas, if it is = deductible, it is only costing you 6.6% in `earnings'.=20 =20 If you are renting out property, take all the rent payments = and apply them to your personal mortgage. At $1,000 per month rent, it = would take about three years to pay off that $49,000 mortgage (assuming = you are also making your regular payments).=20 =20 Every month you are turning non-deductible payments into = deductible payments. This is one of the best reasons I know of for = buying rental property. American readers might wonder what all the fuss = is about. They should realize that the majority of `itemized deductions' = is composed of mortgage interest and that when you claim itemized = deductions, you lose the `standard' deduction. Wouldn't it be nice if = you could get the `standard' deduction PLUS the mortgage interest as a = deduction. Using the above technique, you can. And if you do, you will = get out of the syndrome of deducting state tax one year and paying tax = on the refund the next year because it was included in the itemized = deductions.)=20 =20 If you have a rental house on which you are losing money, = the cash loss (and in the US, depreciation, and in Canada, Capital Cost = Allowance on a MURB) can be used as a deduction against other income. = Therefore, if you are in a 40% tax rate (federal tax plus provincial = and/or state tax plus city/county tax), and are `losing' $400 a month, = you would get a $160 / month tax refund or a reduction in the tax you = have to pay at the end of the year. Please note that we have added = property taxes, repairs and maintenance, advertising, management and = depreciation to the equation now.=20 =20 What do you do the second year? You take income from the = rental properties and the normal mortgage payments and you apply both to = your personal mortgage. At the end of the year you have paid (your usual = $8,000 plus another $11,000) $19,000 against your personal mortgage. At = the end of this second year, how much do you owe? $27,000 on the = original mortgage plus $22,000 of secondary financing. Keep in mind that = your regular payments are not reducing the principal materially. We are = going for the tax refund. If you turn around and use the tax refund to = reduce your borrowings, then the balance outstanding will reduce faster. = =20 Follow the same procedure for the third and fourth years and = apply the tax refunds and your borrowings have been reduced by $5,000 = and your interest is all deductible.=20 =20 By now, you should be able to see how to buy your Florida = Condominium, your place in the Gatineau Hills, your place in the Gulf = Islands and use the rent to pay the mortgage on your place of residence = and the interest you are paying becomes deductible. (There must be an = expectation of profit, i.e., you must be able to show a structured cash = flow projection where it is reasonable to expect that the type of = property you are renting will make a profit in the foreseeable future - = for more explanations on this point see my `THE ULTIMATE TAX BOOK', also = by HANCOCK HOUSE and available `ahem' in `better' book stores - not now = - try the Library.)=20 =20 Most people should be able to get rid of the non-deductible = interest in 4 to 7 years. Perhaps you should purchase two places, or the = house next door and use the rental income to reduce your mortgage. = Whether or not the property increases in value, simply by making your = present mortgage deductible, you would have enough cash flow to ensure = that you wouldn't be losing any real money on rental property.=20 =20 If you are already paying out $5,000 a year non-deductible = interest on your house, think about turning it into a deduction on your = tax return. If you could reduce your taxable income from $60,000 to = $55,000, what would happen? You would save $2,000 in income tax..... = That $2,000 will fund $182 a month loss on a rental condominium.=20 =20 If your choice is between having a clear title house, living = there safely and securely, plus buying either Government Savings bonds = and/or and RRSP in Canada or an IRA / KEOGH PLAN in the States OR having = a clear title house, putting a mortgage on it and buying a condominium = in Florida -- you should buy the condo in Florida. Do you remember why = you bought the IRA/RRSP? It was so that you would have enough money at = age 60, 65 or 70 to take out and have a Florida, or a Hawaii, or a = Nevada vacation. Well, the only way to guarantee you will have enough = money for shelter, is to buy it today at today's price.=20 =20 But be careful. The following three cases point out the = problems with deducting interest and show that it is important to have a = proper paper trail.=20 =20 MORTGAGE INTEREST NOT DEDUCTIBLE=20 =20 In 1979, there were two cases, which I thought should have = been allowed as well. In the Holman case (I was involved as agent), Mr = Holman had borrowed money to build a new house. He used his old = paid-for house as security. When the new house was finished and he had = moved in, he rented out the old house. He then deducted the interest = from the rental income. We argued that the net result of the loan was = that Mr Holman got to keep the rental house, and would incur future = capital gains tax and rental income tax. It was obvious that if Mr = Holman had sold the old house, bought the new house for cash, and then = bought back the old house with borrowed money, it would have been = deductible. However, R. St-Onge, QC, of the Tax Review Board, ruled = that the borrowed money was used to buy a personal residence, and the = interest was therefore a personal expense and not deductible.=20 =20 Also, in 1979 Eva M Huber lost a similar case, which went = one step further. In this case, Huber sold the old house, but carried a = mortgage on it. She argued that her own mortgage interest was = deductible as it was there to enable her to carry the income-producing = mortgage (which I think sounds logical). J B Goetz of the Tax Review = Board found her position untenable and disallowed the deduction.=20 =20 The reason that the previous two cases did not win is that = they were judged on the 1979 Federal court loss by the Bronfman estate.=20 =20 In 1987, the Phyllis Barbara Bronfman Trust lost its = interest claim after a 14 or 15-year fight involving 1969 and 1970 tax = returns. Proving that might and money and the best lawyers and = accountants do not always win, the Supreme Court of Canada ruled against = the Trust. The Trust had many investments and when it came time to = pay money out to the beneficiaries, the trust decided to borrow the = money instead of cashing in investments, which it was holding. The = trust then tried to deduct the interest (similar to the Cochrane Estate = case). The Tax office turned down the claim. The Tax Review Board = turned it down in 1978; the Federal Court turned it down in 1979. But = the Federal Court of Appeal allowed the claim in 1983. The Supreme = Court had the last word in 1987 when it ruled against the Bronfman = Estate.=20 =20 DO NOT USE A HOLDING COMPANY=20 =20 I strongly advise you not to set up a holding company for = your real estate investments. If you do, you can't use any of the = deductions personally. It is usually impossible to buy a piece of = property with little or nothing as a down payment and rent it out for = the first couple of years and make a profit. In fact, in real terms, it = usually takes about five to seven years for inflation to work its magic = and a profit to come into the rental stream. And if you do make a profit = with nothing down the first year, you either `stole' the property, or = you have put a lot of time, energy or know how into making the property = worth more for rental purposes.... Otherwise the tenant should have = bought it for `nothing down'.=20 =20 If you pay cash, you will have a profit. But if you borrow = the money for a down payment, you will lose money. If you borrow money = to buy real estate and then put your assets into a holding company, = there is no profit to use the loss up against because the holding = company does not have a profit. You have to make the money from your = salary and loan it to the holding company to keep the company going and = you can't use the loss as a deduction on your tax return because it is = just a loan to the holding company. You very specifically do not want a = holding company.=20 =20 THE BANKER DID IT=20 =20 For several years I sent many clients to one particular = banker to get their `creative' financing in place. The banker was also = one of the company's bankers and we would kibitz occasionally, and I = would ask him when he was coming in to get some advice. He would just = laugh and I would leave it alone. Well when he retired five years later, = he had amassed (in 1984) a net worth of $480,000 in real estate by = following the methods used by the clients I had sent to him.=20 =20 I have had dentists, doctors, dress manufacturers, = mechanics, short people, tall people, fat people, skinny people, special = people, average people, and people I do not even like, follow these = concepts successfully.=20 =20 The aforementioned banker was a total skeptic at first. "If = it's so good, why isn't everyone doing it?" "Prove it to me", etc... All = we did was keep on sending legitimate, quality clients to him and when = he understood the concept, he went out and did it on his own. He started = buying some of the `funny' deals himself. So if you go into a bank and = explain what you want to the banker, you are doing that banker a favour. = =20 I want you to make sure that when you borrow the funds from = the bank to make payments on the rental condominium, or the rental house = next door, that you can show that you borrowed the money and that it = went to the trust company for the mortgage, or the municipality for the = taxes or the insurance company for the insurance. When your tenant gives = you a cheque for rent, I want you to show that you paid that money on = your personal mortgage principal.=20 =20 OPEN VERSUS CLOSED MORTGAGE=20 =20 Sometimes people say that they cannot do this because they = have a closed mortgage. It works best with open or annual or six month = term mortgages.=20 =20 However, if you have a closed mortgage, you can usually pay = off 10% extra on every anniversary date. If you pay regular payments, = plus 10% extra each anniversary date, it will likely be paid off in six = and a half years anyway. So, =93Never say Never!=94=20 =20 Sometimes people listen to me and assume that I am painting = a perfect picture. When they go to their bank, trust co., credit union = to pay off their mortgage, they are told there is a three-month penalty. = They then stop and assume I am wrong or something because of the three = month penalty.=20 =20 It is always worth a three-month penalty to convert an = existing closed mortgage to an open mortgage. "EVEN IF YOU HAVE TO PAY = 1/4 PERCENT MORE INTEREST OR EVEN 1 and a 1/2 PERCENT MORE".=20 =20 IT IS BETTER TO PAY 16% DEDUCTIBLE THAN 11% NOT DEDUCTIBLE = FOR MOST PEOPLE.=20 =20 IF YOUR MORTGAGE IS coming up for renewal in Dec, Jan, Feb = or March (I will bet that 33% of outstanding mortgages will come due in = the next nine months) then it is worthwhile for you to have another = appraisal done and a new mortgage written at another institution where = they will give you an open mortgage or at least one with better terms. I = repeat, an open mortgage makes the system work better.=20 =20 Just to remind you. I am talking about making the interest = deductible on the house that you already have. Instead of buying an IRA = or an RRSP, buy a summer cabin, a ski cabin, a waterfront cabin or a = sailboat, then use the cash flow the asset generates to make the = interest deductible on your house.=20 =20 LET'S REARRANGE THE OLD FINANCES=20 =20 First, YOU must realize that all money coming into your = pocket is YOURS to use first. YOU decide how you are going to dispose of = this money. YOU decide whether the mortgage gets paid first (out of = those funds) or whether the kids' teeth are fixed. When you are a = self-employed proprietor, you realize this only too well.=20 =20 The ingredients for making your mortgage deductible are:=20 =20 1. An open mortgage=20 =20 2. A Creative and/or Understanding Banker=20 =20 3. An outside source of income where there are deductible = expenses such as a rental house, rental condominium (even Hawaii), your = own proprietorship business, or a stock trading or mutual fund account = which is not registered.=20 =20 The method is simple. All the money that comes in from this = outside source PLUS your regular mortgage payment gets paid off on the = personal mortgage. At the same time, you have expenses, which have to be = paid. The expenses, which includes mortgage interest, taxes, repairs and = maintenance, agent's commissions, and other expenses of the rental = units, all normal expenses of operating your own business, and the = repurchase of stock if you are trading in stock. You see, we all realize = that if we had sold off $100,000 of stock, paid off the mortgage and = borrowed the money back to buy the stock, the interest would be = deductible; but that is a big step. What we miss is that we can do this = =93little steps=94 at a time.=20 =20 MUTUAL FUND PORTFOLIO=20 =20 For instance, if all you have is a mutual fund account with = reinvested dividends, TAKE THE DIVIDENDS INTO YOUR OWN HANDS AND PAY = DOWN THE MORTGAGE AND BORROW THE MONEY TO BUY =93ABOUT THE SAME=94 = AMOUNT OF MUTUAL FUNDS THAT THE DIVIDENDS WOULD HAVE BOUGHT. This works, = even if you borrowed the money to buy the mutual funds in the first = place.=20 =20 PAYING OFF OUR PERSONAL MORTGAGE IS THE FIRST STEP TO = FINANCIAL FREEDOM. If our `non-creative accountant' told us we should = incorporate, before we had the mortgage and any other personal debt paid = off, we have to put the corporation aside for a few months, until enough = cash flow has been generated to pay off the mortgage.=20 =20 Here Is How This Works For The Third Time.=20 =20 You have an open mortgage (or credit card debts) at 15% for = $50,000. In order to pay the $7,500 interest, you or someone in your = family must earn $14,000, pay about $6,500 to have the $7,500 left over = for the non-deductible interest payment. If you have a business grossing = $5,000 per month, you take the $5,000 per month and apply it to the = non-deductible mortgage. Then when you need money at the end of each and = every month to pay creditors, you borrow it (using the new equity in = your house as security for a secondary charge of some sort). i.e. You = use borrowed money to pay the rent, pay the utilities, pay the wages, = etc., by way of a floating chattel, or second charge.=20 =20 You will likely have to pay 1% or 2% more interest to do = this. But now the 16% interest on the $50,000 debt is DEDUCTIBLE. This = means that you or your business pays from $2,000 to $4,000 less tax this = year and next year and next year and next year.=20 =20 I have seen situations where a business could reduce its = GROSS by 54% and the owner would have more spending money because the = interest is deductible.=20 =20 If you are trading stocks, every time you trade, take ALL = the profit plus principal and apply it to your mortgage. When buying new = stock, borrow money for the purchase so that the interest is deductible. = Use dividends received to pay down the mortgage and use the increased = equity in the house to finance more stock or mutuals.=20 =20 And do not tell me it is not worth it. Obviously, the = self-employed person or heavy stock trader can manage this very quickly. = =20 The following example shows how the owner of rental property = can rearrange the deductibility of his interest payments quite quickly. = I have assumed starting in January for simplicity's sake.=20 =20 EXAMPLE - Salaried employee earning $60,000 and in an = effective 50% tax bracket (for easier calculation, depending on province = or state, and city, it could be from 40% to 50%) buys two condominiums = to rent out and applies the rent in a new and creative manner against = the $50,000 mortgage at 15% on his house. (In year one - he starts off = with $50,000, pays $8,000 in regular payments and applies $12,000 in = gross rents from rentals to the mortgage.)=20 =20 Year ONE looks like this: $50,000 + 7,000 Interest - 8,000 = Regular payment - 12,000 Extra payment =3D $37,000 O/S at 15% plus = borrows $12,000 to make payments on Apartments, and has to pay 16% or = $1,920 which is deductible =3D gets $960 tax refund. (For ease, I have = assumed January to December calendar year.) Total borrowed about = $49,000.=20 =20 Year TWO looks like this: $37,000 @ 15% + 5,000 interest - = 8,000 regular payment 12,000 extra payment =3D $22,000 O/S @ 15% plus = borrows $12,000 more (total $24,000) @ 16% to MAKE APARTMENT payments, = and has to pay a total of $3,840 which is deductible and gets back = $1,920 as a tax deduction. Total borrowed approximately $46,000.=20 =20 By the end of 42 months, we owe about $42,000 at 16% and the = interest is deductible (i.e., 16% of $42,000 =3D $6,720 with a $3,000 = tax refund).=20 =20 WORTH DOING? -- OF COURSE!=20 =20 =20 david ingram=20 The CEN-TA Group provides US / Canada Income Tax Advice, = Preparation and Assistance in obtaining US working visas under the Free = Trade Agreement (NAFTA)=20 =20 =20 More information can be found at www.centa.com.=20 =20 Call us at (604) 913-9133=20 =20 Fax us at (604) 913-9123=20 =20 Or email me at [email protected] for more information =20 =20 =20 =20 =20 Copyright =A9 1996-2004 david Ingram Updated February 23, 2004, All rights Reserved Cross-border Income Tax Preparation Experts NAFTA Consultation on Visas, Taxation, Immigration, Cross = Border, Canada, USA, Mexico =20 =20 --Boundary_(ID_/jjFviUTIWMCkVOQtJ8nKg) An HTML attachment was scrubbed... URL: http://www.centa.com/CEN-TAPEDE/centapede/attachments/aeae5514/attachment.htm --Boundary_(ID_/jjFviUTIWMCkVOQtJ8nKg)-- ---------------------- multipart/related attachment A non-text attachment was scrubbed... Name: taxes3.gif Type: image/gif Size: 1119 bytes Desc: not available Url : http://www.centa.com/CEN-TAPEDE/centapede/attachments/7af4f91d/taxes3.gif ---------------------- multipart/related attachment A non-text attachment was scrubbed... Name: ricebk.jpg Type: image/jpeg Size: 9488 bytes Desc: not available Url : http://www.centa.com/CEN-TAPEDE/centapede/attachments/8aa3ead6/ricebk.jpg ---------------------- multipart/related attachment--
