Can mortgages be tax-deductible?
In the United States, mortgage interest is tax deductible if you meet certain requirements. In Canada, however, mortgage interest on a principal residence is not tax deductible. But what if there was a way to turn your mortgage interest into a tax advantage?
The misconception that securing the mortgage to an investment property is the precondition allowing the interest deduction has fooled many. In truth though, it is not the asset that is being used to secure the loan, but rather the use of the money borrowed which enables a taxpayer to take a deduction on the interest paid.
For example, say you were to use the extra money from re-financing your rental property to put a downpayment on a new personal property, the additional interest associated with the inflated mortgage would not be tax deductible because the money was used to purchase a personal asset. However, if the additional financing were to be used in maintenance of the actual rental property then the possibility for deduction would exist.
Personal home (to invest)
Many homeowners attempt the “Smith Manoeuvre”– a strategy that Fraser Smith developed as a financial planner. It worked so well that he wrote a book about it in 2002. One of the conditions for this strategy to successfully work is that the investments must show the potential to pay income as opposed to only exempt income or capital gains.
Stock trading on a major exchange can produce both a dividend and a potential capital gain, just like a rental property can produce both a stream of rental income and a capital gain on sale. An investment in pure gold, on the other hand, would not normally qualify you to deduct your interest.
Re-organize your finances
It is a good idea to re-assess your liabilities and assets to see if you are missing out on any tax planning opportunities. You’d be surprised how a simple shuffle in your finances can convert tax-inefficient debt into tax-efficient mortgages.
For example, you have a substantial investment portfolio outside of an RRSP and a mortgaged family cottage. In the current setup, the investment portfolio pays dividends and interest both attracting tax, whereas the interest payments on the personal-use cottage provides no tax benefits. A beneficial step to take would be to liquidate the existing portfolio, buy the cottage, then refinance it and invest in a new portfolio.
If you find yourself interested in implementing any of these strategies, it is recommended that you speak to a financial planner. It can be a complex process and you need to be comfortable with a large amount of leverage, since the prices of your stocks can fluctuate. Sound advice and critical analysis from a good financial planner can make a world of difference to your financial situation.