# Rental property for tax damming



## andrewf (Mar 1, 2010)

I'm in the process of saving a down payment for a condo in the 200k - 250k range. I'm a bit loth to jump into the market at these prices. Things seem quite overpriced. But that's not the point of this post. The idea I wanted to explore was whether it makes sense to buy a rental property for the purposes of cash damming, in order to repay the non-deductible principle residence mortgage more quickly.

So cash damming requires an investment activity that produces cash flow, which is why a rental property would be appealing, given the cash flow yield (before expenses) on your initial investment. If a unit yields 6.5%, then with a 20 - 25% down payment, it yields 26 - 32.5% cash on equity. So, you use the rental income to make prepayments on your principle residence mortgage, and pay for the expenses related to the rental property, such as taxes, insurance, maintenance fees and mortgage payments, with a LOC, secured against your principle residence. If the rental unit brought in as much rent as your mortgage payment on the principle residence, allowing you to effectively double your payments, you could reduce the amortization time (5% rate, monthly payments) from 25 years, to about ~9-10. You could use 1 yr fixed rate mortgages to implement this, rolling the LOC into the 'investment loan' mortgage each year, and eventually retiring the non-deductible mortgage entirely. Once this mortgage is paid off, you can begin paying down the investment loans, or use the cash flow to grow your investment portfolio.

This doesn't, of course, reduce total debt load, it just allows you to more quickly transform the non-deductible debt into tax-deductible debt. The deductions on the interest paid on the mortgage, at 5% interest and 35% tax bracket, would yield about $1750 in tax savings per year per $100k of non-deductible mortgage. 

So, what are the tradeoffs/cost of that tax savings?

Here's what I came up with:
-increased exposure to real estate risk (offset by more potential for capital gains), particularly leveraged investing
-risk associated with tenants, renting, vacancy, etc.
-'bad reputation' risk. Some lenders will report LOC balance as consumer loans to credit ratings agencies. This debt/borrowing profile could make you look like more of a credit risk than you actually are. This risk can probably be managed by carefully selecting lenders.

I think the risks are generally acceptable for the return available, and it seems like a better way to eliminate your 'bad debt' than the Smith Manoeuvre with dividend paying stocks. After all, I'd say dividend paying stocks are more likely to decline by 30% than your typical home, and low volatility is very important with leveraged investing.

What do you people think?


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## GeniusBoy27 (Jun 11, 2010)

This is an interesting concept for sure. Is it legal? Are there attribution rules that are required by CRA? 

I'm going to run this by my accountant.


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## andrewf (Mar 1, 2010)

It's totally legal. Sorry, I goofed in the title. It's called cash (flow) damming. MDJ has a post on it here.


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## FrugalTrader (Oct 13, 2008)

I think you may be putting tax advantages in front of the advantage of the investment itself. IMO, I think you should look at the investment viability of the condo first (cash flow positive etc),then look at optimizing with tax strategies.


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## the-royal-mail (Dec 11, 2009)

This is a terrible idea. Between the taxes, condo fees, repairs, management fees (or your time/effort if you do it yourself) and mortgage costs you will be LOSING tons of money. You would need to bring in at least $2000/month in rent to make any profit here.

The only people who make money on condos are developers, lawyers, city hall and real estate agents.


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## andrewf (Mar 1, 2010)

MDJ,

Of course, the rental would have to make sense. I'd be looking for a place that is at least capable of being cash flow neutral after allowances for vacancy and repairs. I was doing some poking around on MLS and on some rental sites to see what kind of earning power some units had in my area, and it seems like it's definitely possible to get to cash flow neutral with some careful selection and negotiating.

Royal,

Respectfully, I think you're not being objective. I certainly don't believe that it's _impossible_ to make money renting a condo. It's all a matter of rental income potential vs. costs. They're not cursed!

I do agree that it can be challenging, especially with the every rising maintenance fee, etc.


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## FrugalTrader (Oct 13, 2008)

Andrew, if you are in the Toronto area you may want to consider contacting Berubeland. She seems to know the Toronto rental market well and she may help you find a cash flow postive property.


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## GeniusBoy27 (Jun 11, 2010)

I also agree, there are always possibilities of finding cash flow positive properties ... even in Toronto. You just have to be infinitely patient, and do the math.

I've seen condos be undervaled under durress situations. So anything is indeed possible.

In fact, my condos have been cash flow positive from the start, but you have to have the patience to pick and choose.


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## Four Pillars (Apr 5, 2009)

Andrew, your idea sounds pretty clever.

Question - I'm a bit confused. Do you already have a non-deductible mortgage and you want to add a deductible one and then do cash damming?

Nothing wrong with the idea, although as pointed out, not very diversified. That is probably the main difference between doing this move with a rental property vs a portfolio of div stocks.

The other drawback is that you will have less flexibility in terms of picking exactly how much extra debt you want to have. 

With a rental property you need to borrow a minimum amount which is probably a good chunk of coin. 

When borrowing to invest in stocks, you can literally increase your debt level at your own pace. You can borrow $200k right off the bat or just start with $1k and slowly work your way up (or not).


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## andrewf (Mar 1, 2010)

Four Pillars:

I'm currently renting and saving my down payment to buy. I like to look at financial decisions from every angle before jumping in. But the idea would be to get the first place, obviously with a non-deductible mortgage, build up some equity (perhaps putting RRSP savings on hold for a few years), and use that equity to leverage into a second property for cash damming purposes. I think I'd use a LOC to cover expenses and once a year, roll the balance into a second mortgage on the principle residence. This second mortgage could be on a one year term to help facilitate this. I'm not sure how well that would work--could you get the same rates on a second mortgage as on a first mortgage (at least better than a HELOC)?

Point taken on the ability to fine tune your level of risk. It's worth noting that it isn't easy or cheap to unwind a rental investment if your circumstances change.


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## Sampson (Apr 3, 2009)

Four Pillars said:


> Question - I'm a bit confused. Do you already have a non-deductible mortgage and you want to add a deductible one and then do cash damming?


Continuing on FP's chain of thought. The question of cash damming is mute until you have that principle residence. Its a good technique. I do/use it myself and love the tax benefits.

Continuing on FT's advice. Make sure your numbers work without the benefit of the cash dam. If you have positive cash flow prior to the tax benefit, then the additional savings/return is gravy.

@ TRM. With all due respect, your comment is quite generalized. I'm been making a nice profit on my condo for quite some time now.


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## Berubeland (Sep 6, 2009)

The condo taxsaver was looking at would be cash flow positive with 20% down. 

I saw a 2 bedroom for sale for $99,000 in that same building. I rent a suite there and this May got $1200 for it. 

I'm not sure why it's so cheap, it can't possibly last and there's no reason for it. I know an owner (the one I rent for) and she's had the place for the last 7 years or so. There's nothing wrong with the building. The area is fine too.


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## Sampson (Apr 3, 2009)

Berubeland said:


> I saw a 2 bedroom for sale for $99,000 in that same building. I rent a suite there and this May got $1200 for it.


I'm baffled that units can be that cheap in Toronto or the inner GTA. Such range in the pricing.


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## Berubeland (Sep 6, 2009)

I also like a townhouse complex close to morningside and kingston road. They just built a brand new mall there. 

The area had been rough, but I see it coming round. You literally walk out the condo gate across the street to the brand new mall. 

Price for 3 bedroom town was $120,000. It's a stacked townhouse with loads of space. Building very neat and tidy. 

Port union is adjacent to this area, I see it going up in value. Rentals will still be a careful proposition for a while. You'd have to take your time and get it right!


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## andrewf (Mar 1, 2010)

Berubeland, it sounds like I'd be better off talking to you when I'm ready to buy, even my principle residence, than an estate agent. You seem to have a very good nose for deals.

I'm in the Mississauga area--any general tips? House/condo prices here seem a bit nuts compared to what I'm renting for. The few places that I saw and thought had potential as income properties were some 2+1's and 1+1's near Square One in the low $200k range.


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## Berubeland (Sep 6, 2009)

The problem is that finding deals is a lot of legwork. First I get every single active listing emailed to me. Then I look at all of them. Then I have to physically go look at them and evaluate them against all the properties I have ever seen and rate them, then look at the development I see in the area. 

I think about if there is likely to be gentrification, but I can't predict when that is going to happen. 

For instance I had a friend of mine buy a property in the lorne park area. This year that area went up 30%.The layout of the house was such that it was easy to make a third apartment. She was making about $2000 per month in cash flow but it drove her crazy that the utilities were high so she would drive by every day and see if the tenants had left lights on when they weren't home. After hearing about this for a year I told her to sell. 

She made a 70,000 profit. She paid 145,000 for the property about 8 years ago if she wasn't so nuts that house would be worth over 400K today. She also didn't like the location. I kept telling her, think about the money. Mississauga Rd around the corner is a great location but you'll never rent it for a profit. 

Right now the market is readjusting to the new realities of less buyers. Less buyers = less demand = lower prices. I'm thinking we'll see more realistic prices. The problem is that when you're buying into a descending market, it's hard to make a short term profit. If you're buying an income property it doesn't matter too much. I'd suggest 10 year mortgages in this environment. 

We haven't even reached the "sky is falling" stage of this adjustment. 

Back to my problem... no one wants to pay me to go around and look at properties for them even though it would probably be a great deal for them. I also ran a construction company at the same time as I was taking on property management contracts. There's a difference between cosmetic repairs and a place that should be bulldozed. There's no substitute for legwork. 

The second part of the problem is even when I find it people don't believe me. The're not sure about the area, they don't like the bath or something like this.


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## kcowan (Jul 1, 2010)

If they don't like the bath or something else, they are not investors.


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## explorer416 (Jun 11, 2010)

*Thinking of trying this myself...*

Hello all,

So I read andrewf's idea and became intrigued.

I currently have a principle residence with a non-deductible mortgage as well as a rental property with a interest-deductible mortgage already set up. All income and expenses from the rental property are currently intermingled with our regular chequing account. The rental property is cash flow positive (but maybe not using Berubeland's definition - we don't account for a 10% management fee as I manage it myself, or a vacancy rate as I have been able to rent it out for all months that we have had the place).

I need a little more clarity around the cash damming concept before going ahead with it. As some of you are already doing this...



Sampson said:


> Its a good technique. I do/use it myself and love the tax benefits.


... I'm hoping you can offer some help! 

My questions:
1) Are LOC rates typically in line with available mortgage rates or are they significantly higher?
2) How and when do we pay off the LOC? Just with the bigger tax refunds? Don't pay it off until the primary mortgage is done? But with a higher interest rate (assumed) on this loan, won't you end up with a bigger loan than the two smaller loans put together?
3) I didn't completely get the "capitalizing the interest" idea explained in the MDJ article referenced above. Can someone help explain this?
4) What happens if we decide to sell our principle residence? Does everything have to be dismantled and restarted? Should we only do this once we're in our permanent home (a move that may happen in the next 6-24 months)?

Any help that can be provided will be greatly appreciated!


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## andrewf (Mar 1, 2010)

explorer:

1) HELOC rates seem to be set a prime + 1 as the posted rate, which is obviously higher than the rate you can get for variable rate closed mortgages (Prime - 0.75 or so right now?), but comparable to 5 year open variable mortgages. HELOCs are obviously more like open mortgages, as you can always elect to pay off the loan at any time, where a closed mortgage has some limits.

You can also probably negotiate the HELOC rate down.

2) You pay off the principle residence mortgage first, as well as any other non-deductible debt (car loans, etc.). As you noted, there are some tax savings that would help with debt repayment, and as you noted in your first question, HELOC rates are higher than closed variable mortgage rates so the result is indeterminate as to whether the debt is lower after doing this than if you had just stuck with the status quo. For the HELOC to grow faster than your principle residence declines, your principle residence mortgage rate would have to be at least a third lower than the HELOC rate (ie, 3% for the non-deductible mortgage and 4.5% for the HELOC).

I'd argue that if the spread between HELOC and mortgage rates is large, you can probably just roll the HELOC into 1 year fixed rate mortgage as a second mortgage on your principle residence or if your mortgage on the investment property comes up for renewal, you can re-advance some of the equity there to repay the HELOC. Either way, those loans would remain tax deductible for investment purposes (just keep records of the transactions!).

The name of the game is reducing your after-tax borrowing costs to the lowest possible level.

3) Capitalizing the interest goes like this: say the interest payment due on the HELOC is X dollars. To make this payment, you withdraw X dollars from the HELOC to your chequing account, then pay X dollars from your chequing account onto the HELOC. Your investment loan increases by X dollars, and any interest owed on that X dollar loan is tax deductible. So rather than making interest payments out of your cashflow from the investment property, you allow the interest to compound, at least until your principle residence mortgage is repaid.

4) Not sure how this works. It's possible to move the investment loan to be secured by a new property, but it's worth discussing with your lender. There's certainly some paper work to be done, so you'd have to weigh that against the benefit you would see by doing this sooner rather than later. Depending on your income, I expect you'd at least be able to get an unsecured line of credit for the transition period between houses to repay the investment loan. Once you have your new property, assuming you have enough equity (from your down payment on the new mortgage, essentially), you can get a new HELOC secured on that property.


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## james_57 (Jul 5, 2010)

Berubeland said:


> We haven't even reached the "sky is falling" stage of this adjustment.


Be patient.


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## Four Pillars (Apr 5, 2009)

Berubeland said:


> ...
> 
> Back to my problem... no one wants to pay me to go around and look at properties for them even though it would probably be a great deal for them. I also ran a construction company at the same time as I was taking on property management contracts. There's a difference between cosmetic repairs and a place that should be bulldozed. There's no substitute for legwork.
> 
> The second part of the problem is even when I find it people don't believe me. The're not sure about the area, they don't like the bath or something like this.


If your business model isn't working (ie nobody is buying your product/service) then you need to change it or offer something else.


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## Dana (Nov 17, 2009)

We have been contemplating implementing this strategy for quite a while and due to analysis paralysis haven't taken action. Reading this thread has spurred us into action! Thank you for that. We have all the pieces in place: 

* a readvanceable mortgage
* a non-deductible mortgage on our principal residence
* a profitable investment property with a separate bank account for associated revenue and expenses. 

I just want to make sure that I understand the mechanics of the strategy;

*at the end of the month, write a cheque from our business account payable to our principal mortgage account equal to the amount of the allowable taxable business expenses for the month

* write a cheque from our re-advanceable mortgage for the same amount payable to our business account to cover the allowable expenses. 

Am I missing a step?

The investment property we will be using for this strategy is profitale and we would be able to transfer more than just the allowable business expenses each month. Are we allowed to do this or can we only transfer the amount of our monthly expenses? Should we transfer the excess as a separate transaction?

Any guidance is appreciated.


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## andrewf (Mar 1, 2010)

Take your rent cheques from the tenant(s) and deposit in your personal bank account and use as you like, including repaying your non-deductible mortgage. You can't deposit this in your business account and then withdraw to your personal account without potentially compromising the tax deductibility of the loan.

Pay business expenses out of your dedicated business chequing account, and draw funds from the HELOC as needed, directly into this chequing account. Only use the HELOC from the re-advanceable mortgage for business expenses--don't co-mingle.

I don't understand your last question. Any withdrawals on the HELOC must be used for investment purposes. You can't transfer it to your personal account.

It might be worthwhile showing your set-up to your accountant to make sure you're doing it correctly.


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## Dana (Nov 17, 2009)

andrewf said:


> I don't understand your last question. Any withdrawals on the HELOC must be used for investment purposes. You can't transfer it to your personal account.
> 
> It might be worthwhile showing your set-up to your accountant to make sure you're doing it correctly.


I wasn't very clear...can I apply the entire gross rent amount to our personal mortgage even if the gross rent is more than the expenses?


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## andrewf (Mar 1, 2010)

Yes. You can use the gross rent payment for anything you like. It's income, and there is no obligation to match it to the expenses associated with the investment.


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## Cal (Jun 17, 2009)

andrewf said:


> Take your rent cheques from the tenant(s) and deposit in your personal bank account and use as you like, including repaying your non-deductible mortgage. You can't deposit this in your business account and then withdraw to your personal account without potentially compromising the tax deductibility of the loan.
> 
> Pay business expenses out of your dedicated business chequing account, and draw funds from the HELOC as needed, directly into this chequing account. Only use the HELOC from the re-advanceable mortgage for business expenses--don't co-mingle.


And so that I understand this too...this is more tax efficient b/c it is simply the principal portion of the principal residence mortgage that is paid off on a re-advanceable mortgage that is transferred to the rental property via HELOC?

Vs. Using the rental payment to pay rental mortgage, in which case you are taxed on the income the same as above, but the investment interest is the only portion of the mortgage payment is tax deductable.

So, if you have a principal mortgage of $1000 and a rental property mortgage of $900, for example. And for arguments sake, the rental property has a mortgage of $900 a month and it never has repairs. I know, I know.

Then you would take rental property rent of $900, deposit into personal bank account, and apply it towards paying down the principal residence, on top of what you would normally pay.

And use your HELOC to pay $900 rental property mortgage.

The key being 'on top of what you would normally pay'

Therefore knocking down the principal residence mortgage, and maximizing potential tax deduct-ability.

Do I have that right?


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## Dana (Nov 17, 2009)

[/QUOTE]

Do I have that right?[/QUOTE]

This is how I understand it.


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## explorer416 (Jun 11, 2010)

Hello andrewf or someone else familiar with this concept.

I plan to be setting this up once I move into my new house later this year. I have a separate 1 bedroom investment property for which I will use this system.

My question is: Is it a requirement that the funds from the HELOC directly pay the expenses for my investment property? Currently, I am paying the expenses for my investement property (mortgage, property taxes, condo fees, home insurance) from my chequeing account. To run a valid cash dam, do I have to move these recurring payments such that they come out of the HELOC directly, or can I reimburse my chequing account from the HELOC for the exact amount taken each month for the various investment property costs?

Looking forward to your replies.

Thanks.


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## andrewf (Mar 1, 2010)

You should be able to reimburse out of your chequing account (or move the amount for the payment from the HELOC to chequing in advance of the expense being debited). The important thing is to have a clear paper trail so that you can clearly demonstrate the borrowing was for eligible investment related expenses. I suppose many people find it easier to use a dedicated chequing account, as this becomes unambiguous.


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