WHY NOT MAKE THAT MORTGAGE TAX-DEDUCTIBLE?
Garth Turner Column
July 9, 2001
Imagine if you were able, like the Yanks, to write off all the interest on your mortgage payments from your taxable income. Since most of your payment is interest, that would be a windfall to surely increase your wealth by slashing your tax bill.
Well, stop dreaming. You can do it.
The key lies in this fundamental principle: If you borrow money to create more money, then the interest is tax-deductible. That is the logic behind General Motors borrowing millions to build a new factory - the interest is a legitimate business expense and can be used to reduce profitability, and taxes. Ditto for you. Borrow money to invest in the economy and receive growth on it, and the interest is a legitimate expense in your hands.
Now there's a lot of controversy and confusion over this point, and in my books it appears the blame for it lies squarely on the head of the Canada Customs and Revenue Agency, formerly known as Revenue Canada. The CCRA has failed to amend wording in its annual tax guide that is totally misleading. Here it is, under the heading of Carrying Charges and Interest Expense - line 221:
"You can claim the following carrying charges and interest you paid to earn income from investments: most interest you pay on money you borrow, but generally only as long as you use it to earn investment income, including interest and dividends. However, if the only earnings your investment can produce are capital gains, you cannot claim the interest you paid."
Sadly, that little exercise in jargon has scared a lot of people away from borrowing for investment purposes, believing if they buy stocks or mutual funds that do not pay interest or dividends, the interest is not deductible. But it is. Any financial advisor, tax lawyer or accountant will set you straight.
Equally wrong is the warning contained in some of the tax preparation software packages on the market, which say: "If you borrowed money to invest in stocks or mutual funds that do not earn interest or dividend income, you cannot deduct the interest you paid on your loan."
That is an incorrect interpretation of CCRA's badly-worded statement. Ignore it. Better still, throw out the software and let a professional do your taxes. Write this on a piece of paper and tape it to the fridge - "Interest on money borrowed to invest is tax-deductible." End of story. Now, on to your mortgage.
There are two strategies I like for creating a tax-deductible mortgage:
(1) If you have an existing mortgage on your house, you can make all or part of it tax-deductible through an asset swap. Now most people who have mortgages also have various forms of investments, like mutual funds. The idea is to take these assets and swap them for mortgage debt. Do it this way: First, sell your investment assets. Cash them in, being mindful there will be a small tax bill to pay on any capital gains you realize. Second, use this cash to pay off your residential mortgage (or a portion of it). Third, arrange a new mortgage. Fourth, use the new mortgage money to buy back the investment assets you originally sold.
Now you still own an equal amount of investment assets, and you still have a mortgage on your home. But because you borrowed against your home (in the form of a mortgage) in order to buy assets that create wealth, the interest on your mortgage is now tax-deductible. You have just given yourself a giant tax break.
(2) Now, if you live in a house with no mortgage, it's even easier to build wealth and still get a fat tax reduction, using a home equity loan.
This thing is getting more common all the time, as the major lenders create products that allow you to tap into all those mortgage payments you made over the last few decades. You can generally borrow up to 75% of the appraised value of your home with an equity loan. The good news is that because the loan is well-secured by the real estate, you can get it at a rock-bottom rate of interest, generally the prime rate. Even better news is that, so long as the money is used for investment purposes, to create wealth you'll be taxed on later, the interest can be written off.
To make this simple and effective, most lenders will allow you to have interest-only payments, which means you never actually pay back the principal amount borrowed. But why would you want to, when the entire cost to you is deductible from your personal taxable income?
So, instead of just having a house with no mortgage, you end up with an investment portfolio that could be worth tens, or hundreds of thousands of dollars, plus the ability to substantially reduce your taxable income.
But, but, but, the critics cry, by setting up a home equity loan you then have to make monthly payments on the debt which - even though they are tax-deductible - still require a cash flow. Where's that money going to come from?
Patience. All will be revealed in the next column ... GO
Watch Garth Turner's Investment Television, Sundays at 1 pm on Global. www.garth.ca.