# Making principle residence mortgage tax deductible via debt swap to rentals.



## GregR (Apr 10, 2009)

Hello all.

So we currently own a principle residence as well as own and self manage 6 rental buildings with 13 units combined.
We have a mortgage on our personal residence and own 2 rentals outright and 4 rentals have mortgages.

We are thinking of refinancing our rental properties and using the proceeds to swap out our principle residence mortgage. By swapping our personal mortgage to the rental properties we hope to make the interest portion tax deductible.

Can any one see any issues with this plan? 

Would the interest portion of the new mortgage amounts on the rental properties be tax deductible even though the proceeds were used to pay off personal residence?

$ 139k principle residence mortgage and a HELOC of $50,000 available.
$ 78 k mortgage on Building #1 $190,000 value
$ 36 k mortgage on Building #2 $125,000 value
$ 68 k Mortgage on Building #3 $110,000 value
$ 57 k Mortgage on Building #4 $ 90,000 value

Total expenses are approx $7,000 to $7,500
Total Gross rental income $10,000 +

Just started investigating cash damming/ smith manoeuver. Would this be an option in this situation???

Our main goal is to transfer our primary residence to our rental properties to enable tax deductions on interest portion.


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## OhGreatGuru (May 24, 2009)

Try searching for other threads on this subject. I'm pretty sure it's illegal if CRA catches you at it, but I can't quote the tax provisions covering it.


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## Rusty O'Toole (Feb 1, 2012)

What is illegal about it?


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## Just a Guy (Mar 27, 2012)

Cash damming is perfectly legitimate as long as you don't transfer too much, too quickly. I think million dollar journey (link below) has a good article on how to do it.


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## Woz (Sep 5, 2013)

It's the current use of the borrowed funds that determines if the interest is tax deductible. If you borrow from your rental properties to pay off you principle residence mortgage then the interest wouldn't be tax deductible.

To do it properly, you would create two accounts, account A and B. In account A you would borrow from your rental property and use the funds to pay all rental property expenses. In account B you would deposit all income from your rental properties and use it to pay down your principle residence. That way the borrowed funds are only being used to generate income and therefore would be tax deductible.


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## GregR (Apr 10, 2009)

It looks like my best option is to slowly use cash damming to transfer non deductible interest to deductible interest. 

Am I correct in thinking that even though there is equity in the rentals using it to repay the primary home mortgage would render it non deductible, unless the equity is used to purchase more income producing assets?


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## CPA Candidate (Dec 15, 2013)

GregR said:


> Am I correct in thinking that even though there is equity in the rentals using it to repay the primary home mortgage would render it non deductible, unless the equity is used to purchase more income producing assets?


As I understand it, yes.


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## showmethemoney45 (Feb 27, 2015)

*Vacation home interest tax deduction*

Here's my situation:

I would like to take out a mortgage for a vacation home but I want to transfer the equity from my rental properties so the mortgage interest will be tax deductable in a legal way.

I would like to remortgage an existing rental mortgage to get $100,000 out at 2.5%.

My properties produce $170,000 in annual rental income.
My annual expenses are roughly $85,000 in operating costs and another $60,000 in mortgage costs (principle and interest)

If i keep proper track of my banking could I use $100,000 of rental income to pay down my principle mortgage and use the $100,000 borrowed from the rental to pay ALL my expenses? This would take roughly 10 months until all is transfered over and my rental property mortage is all tax deductable.

Let me know anyone's thoughts as I'm too good looking to go to jail


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## gt_23 (Jan 18, 2014)

GregR said:


> Hello all.
> 
> So we currently own a principle residence as well as own and self manage 6 rental buildings with 13 units combined.
> We have a mortgage on our personal residence and own 2 rentals outright and 4 rentals have mortgages.
> ...


If you refi your rentals and use the proceeds to pay off the non-deductible debt, its neither a cash dam nor a smith maneuvre. Conservative people will claim that you can't write off the interest on the refi amounts since it's not used for investment purposes. However, I know many RE investors who have used this method successfully. The catch is this: just like a business owner can withdraw his original investment from a business tax-free, so can a RE investor. The tricky part is figuring out how much of the equity in the rentals was from your original equity investment vs. price appreciation. The argument you would make if the CRA ever started sniffing around is that you are taking back your equity investment by adding debt to the properties, it really doesn't matter if you use that equity to pay off your principal res mortgage. The argument is subject to interpretation by the CRA like pretty much everything else in the tax code, but I know at least one investor who made it successfully, the others have never been questioned.

If you don't want to take the risk of that strategy then the cash dam would work fine for you, although you won't get the full tax benefit you would in the above scenario and you'll still have a charge on the principal res. Step 1: Get a readvanceable LOC on principal res if you don't already, Step 2: Debit your readvancable LOC for the total of your current expenses on the rental property every month (interest, tax, insurance, maint, etc.), Step 3: Use the rental income to pay down the mortgage portion of your readvancable LOC every month. The mechanics are more detailed than this, but National Bank has a great flow chart on the internet you can use.

There are two downsides of cash dam: 1) It will take you a couple years to convert the debt to get the full tax benefit of interest write off on principal res and 2) The interest rate on the readvancable LOC is likely to be higher than the mortgage rate on your principal res, so you get to expense the interest, but that interest amount is more than it needs to be in the first place. For example, your LOC rate might be 3.35% vs. 2.1% for the mortgage, virtually equivalent at a 35% tax bracket, so the accounting hassle of the cash dam is probably not worth it.

You need to play with your specific tax rates to find out if it makes sense.


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