# Mortgage Musical Chairs



## Letran (Apr 7, 2014)

Something just dawned on me the other day

Just finished doing my taxes, wherein in my rental properties I got to write off the interest cost of my mortgages. In my principal home I could not. 

This is not news for me of course. I've always known this but yet I have tended to rapid pay my rental properties (probably because I see them as risk)and I've pretty much ignored my principal home mortgage. (low interest I wasn't in a hurry) Instead of paying it down I'd use the money instead to buy other rental properties.

After doing my taxes it clicked in my head that I could transfer all my remaining mortgage balance on my principal home and spread them out between 3 of my oldest rental properties.

E.g.

Principal home mortgage balance $300k

Rental Property 1, FMV $380k
Mort Balance: $140k 

Rental Property 2, FMV $375k 
Mort Balance: $150k 

Rental Property 3, FMV $415k 
Mort Balance: $165k 

I'm thinking I'll remortgage all 3 properties on their maturity dates of course and add$100k each of the 3 and I'll be mortgage free, well at least in my principal home. My wife will be so happy.

and the beauty of it of course is that if I then become negative cash flow on these properties I can write off the losses too? They are all way positive cash flows right now having low mortgages

Is there a flaw in my logic? I seem to be missing something. 

I'm even thinking maximize it on the 2 properties instead like $150k each. The renewal on the third property is 4 years away.

Regards,


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## Just a Guy (Mar 27, 2012)

The flaw in your logic is, any borrowed money must be used for investment purposes to be tax deductible. If you remortgage your rental and use the money to pay down your personal property, that portion is not tax deductible as it was not used for investment purposes.

If you get a heloc on your house and use it to put a downpayment on your rental, it would be tax deductible. If you then remortgaged the rental and paid off the heloc, the mortgage would be tax deductible (as long as it was no more than the downpayment portion borrowed in the first place since you're just transferring the debt). However, if you do a cash downpayment, non borrowed, you can't technically borrow money to pay yourself back and make that tax deductible.

This is why I personally buy properties 100% on borrowed money right from the start.

Btw, the reason you can't deduct the mortgage on your house is because you get free capital gains on it, unlike a rental where you pay capital gains. However, you pay for a house with after tax dollars, whereas the income from a rental you get to deduct expenses on pretax dollars.

By writing off the money on your personal property the way you suggested, you're technically avoiding paying taxes on the money, which is why you can't do it.

With real estate, the government allows you to defer taxes, but it still wants its share in the end.

You could refinance your rentals and buy more rentals, or stocks, or other investments if you wanted to and still write off the interest.


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## andrewf (Mar 1, 2010)

As JAG said, OP cannot do what he described and maintain the ability to deduct from income the interest expense.

What I would suggest to OP, which might be nearly as effective, is to use a technique called 'cash flow damming'. Essentially, use all gross income (rent payments) to pay down principle residence mortgage, then borrow (either against the investment properties or the principle residence) to pay expenses related to the investment properties (includes mortgage payments, taxes, insurance, etc.). This will, over time, convert your non-deductible principle residence mortgage into a deductible one. Of course, don't take financial advice from people on the internet; consult your accountant to ensure you are doing it correctly.


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## Market Lost (Jul 27, 2016)

Just to put a name on what has been already been pointed out nice in the thread - this is called a "sham transaction", and it's not appreciated in the least by the government. As your thread name suggests it's a game of musical chairs, and when the music stops, CRA comes calling. 

This is a US link, but the concept is exactly the same in Canada
http://definitions.uslegal.com/s/sham-transaction/


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## Letran (Apr 7, 2014)

...Darn

Thanks Guys

I knew that was too easy


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## Letran (Apr 7, 2014)

Hold On, Hold On, Hold On

JAG Said "You could refinance your rentals and buy more rentals, or stocks, or other investments if you wanted to and still write off the interest."

So I got 300k of Non-Reg invested funds. Follow me here. I liquidate this and pay off my Personal Mortgage. Everything is dandy Right. THEN

as JAG said I could refinance my rentals and buy investments funds and still write off the interest. Yes?


Please put a smile in my face


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## Just a Guy (Mar 27, 2012)

You need to pay taxes on the non-registered funds. You can't buy the same stocks you just sold for a period of time, I think 30 days, but essentially yes, you could probably do that.

Depending on your gains, the first part could prove to be quite a hit to you financially, especially if you already have an income for the year you cash out. Essentially cashing out gives a lot of your gains to the government in the form of taxes. If you don't sell, you're deferring the taxes owed. If you cash out slowly, with no other income in that year you may be able to keep all your gains tax free.

So, you pay off your house with after tax dollars. Your current investment are tax deferred. If your investments did well, it may not be profitable to pay off your house, especially if the value decreases in the future because of a real estate correction, and borrow to buy investments.

I don't see the reason why you're worried about trying to write off less than 3% in interest. You could refinance your rentals and buy more investments, double your holdings as it were and probably earn well over 3% you'd be writing off.


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## Market Lost (Jul 27, 2016)

Letran said:


> Hold On, Hold On, Hold On
> 
> JAG Said "You could refinance your rentals and buy more rentals, or stocks, or other investments if you wanted to and still write off the interest."
> 
> ...


Sorry, no can do.

The government looks at your starting positions and sees $X in loans, and $Y in investments, but the interest in the loans in not deductible because it's against non-income producing property. So now, you do a bunch of transactions and you end up with $X in loans and $Y in investments, but a miracle occurs and the interest is now deductible because it's against income producing property. This is actually the very definition of a sham transaction. In addition, you could be paying capital gains on your sales to add insult to injury. Brian Costello used to make me scream at my radio when he said this, then he got busted and I felt much better. 

You should also read the other thread I comment on where I explain how interest on rental property is only deductible for loans made to either acquire property or make renovations to it. You can't just increase the mortgage to incur a larger interest expense. If you want to do this, then you can use your stock to perform the Smith Maneuver. I don't usually suggest this, but if you really are intent on writing off your mortgage, it's the only way that I know of that can do it without having CRA come down on your head.


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## Just a Guy (Mar 27, 2012)

I think you are still able to do this given enough time between the transaction. The government can't say, you once had an investment, but never sell it and get out on investing because, if you ever ty to use leverage in the future it'll be disallowed because you once had money. 

Of course, I don't know this to be true, and why I hire an accountant. I also have never told him to try anything grey, I like my taxes to be b&w.


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## Letran (Apr 7, 2014)

Market Lost said:


> Just to put a name on what has been already been pointed out nice in the thread - this is called a "sham transaction", and it's not appreciated in the least by the government. As your thread name suggests it's a game of musical chairs, and when the music stops, CRA comes calling.
> 
> This is a US link, but the concept is exactly the same in Canada
> http://definitions.uslegal.com/s/sham-transaction/


I can't seem to open the link. But I thought in the US, YOU CAN write off your write off your principal home mortgage interest already?


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## Market Lost (Jul 27, 2016)

Letran said:


> I can't seem to open the link. But I thought in the US, YOU CAN write off your write off your principal home mortgage interest already?


The link was only to define what a sham transaction is, it isn't to do with if you can write mortgage interest off. You can also use this one - http://www.legalmatch.com/law-library/article/sham-transaction-definition.html

A little off topic as this isn't an American site, but the mortgage interest deduction in the US is not what you would think, and most mortgage holders don't even use the deduction.


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