# Advice on cash damn strategy



## gt_23 (Jan 18, 2014)

Hello All - I have some investment real estate and had always been planning to implement a cash damn when I was ready to buy my own place (have been renting up to now). I'm finally in the position to do this and was hoping to get some feedback on whether the cash damn would be beneficial from people who have thought about or tried it in the past.

Here are the details:
- I would purchase a condo for $350k with 20% down, so $280k mortgage @ 2.9% fixed (5 y) with 25 year am.
- I have a $100k unsecured LOC ready to go at 3.5% (P+0.5) revolving
- The three investment properties in my name are eligible for this maneuver. I would have roughly $3000 p.m. in eligible expenses (interest, prop tax, insurance, maintenance, etc.)
- My marginal tax rate is about 33%
- Monthly P+I on principal rez would be $1313

I would pay $3000 per month of business expenses from the LOC and take the same amount from rent receipts to make a principal repayment on the principal residence. Based on my math, the non-deductible mortgage on the principal residence would be eliminated in just under 6 years and I would owe about $211k on the LOC (assuming no capitalization of interest).

The obvious challenge is I will need to get an additional LOC around end of year 3 (which would likely be 4%). So assuming the average rate on the LOC debt is about 3.75%, I would have a deduction of about $7400 per year, or $2400 refund . If I didn't do the cash damn, I would pay about $6000 per year ($211k @ 2.9%) in non-deductible interest.

So with the cash damn, I pay $5000 interest (7400-2400) and without it I pay $6000. If this were true, then it only saves me about $1000 per year. Is my reasoning correct? Why would I borrow at a higher rate (3.75% vs. 2.9%) just to generate a tax refund? (I guess maybe if I was at 50% tax rate it would be better). What are the major downsides to cash dam? 

Thanks in advance.


----------



## andrewf (Mar 1, 2010)

It doesn't need to stay a LOC. If you take a mortgage to pay off the LOC which was an investment loan, the mortgage is also an investment loan. In other words, you can roll the LOC into a mortgage.


----------



## Mortgage u/w (Feb 6, 2014)

I've thought of doing this but its lots of trouble for not that much advantage. You can acheive the same result (or better) by refinancing the rental properties and taking out the equity. You can still deduct your interest if the equity will be used for investment purposes and the interest rate is surely less than the LOC.


----------



## gt_23 (Jan 18, 2014)

andrewf said:


> It doesn't need to stay a LOC. If you take a mortgage to pay off the LOC which was an investment loan, the mortgage is also an investment loan. In other words, you can roll the LOC into a mortgage.


Thanks - I didn't realize this could be done, though I assume I wouldn't do it until the mortgage is paid off at year 6, so as not to mix the two types of debt into one mtg.


----------



## gt_23 (Jan 18, 2014)

Mortgage u/w said:


> I've thought of doing this but its lots of trouble for not that much advantage. You can acheive the same result (or better) by refinancing the rental properties and taking out the equity. You can still deduct your interest if the equity will be used for investment purposes and the interest rate is surely less than the LOC.


Ok...I think this is what you're suggesting:

- Refinance rentals to 80% and pay off exisiting rental mtgs (deductible)
- Use net amount (equity) to buy principal residence for cash
- End result: all debt is deductible

Is the net amount of the refinance (i.e. the equity) tax deductible, since I'm not using for "investment"?


----------



## Mortgage u/w (Feb 6, 2014)

gt_23 said:


> Ok...I think this is what you're suggesting:
> 
> - Refinance rentals to 80% and pay off exisiting rental mtgs (deductible)
> - Use net amount (equity) to buy principal residence for cash
> ...


The net amount of refinance can be tax deductible so long as it does not surpass your original purchase price of the rentals....any amount over would need to be justified with either renos to the rentals or investment elsewhere such as another rental. You're essentially taking back your down-payment, making the interest tax deductible and using the funds again on your owner-occupied property.


----------



## andrewf (Mar 1, 2010)

^ I would be very cautious with that approach. A more conservative interpretation is that loan interest is deductible if the proceeds of the loan are used to invest in assets that can produce income. Borrowing against investment property to buy a principle residence is not an investment loan. If you have any doubts, consult an accountant.


----------



## FrugalTrader (Oct 13, 2008)

The borrowed amount is only tax deductible if used towards an investment that (potentially) produces income.


----------



## houska (Feb 6, 2010)

1) Interest is tax deductible if and only the debt proceeds are being used to acquire an asset which (potentially) generates investment income. Acquiring a principal residence does not qualify. OTOH, you might be able to get around this if you find a way how you (perhaps even very temporarily?) sell your investment property (therefore perhaps triggering a taxable capital gain), use the proceeds to acquire your principal residence, then borrow against the principal residence to (re-)acquire your investment property. Needs thinking through.
2) If it does qualify, as others have said, OK if your tax deductible loan is a mortgage vs an LOC. Many banks offer all-in-one accounts where you can have separately tracked subaccounts so you can have two mortgages (both primary ones, therefore at normal mortgage rates) to avoid commingling funds.
3) I can't help myself - I think the words "credit" and "damn" go often together, but rarely "cash" and "damn" (just teasing - you meant "cash dam"  )


----------



## showmethemoney45 (Feb 27, 2015)

What if you refinanced the rental and placed the money in a seperate account. Each month you pay your rental property expenses with this money and use the cash flow to pay for your personal property? Still tax deductable?


----------



## 0xCC (Jan 5, 2012)

showmethemoney45 said:


> What if you refinanced the rental and placed the money in a seperate account. Each month you pay your rental property expenses with this money and use the cash flow to pay for your personal property? Still tax deductable?


This seems like it would probably be ok, but what is the advantage? Surely the interest rate on the refinanced amount would be greater than what that amount earns in a separate account so why not just do it month by month by using a separate LOC like originally suggested? In other words, take the rental income pay off the mortgage on the personal property and take cash out of the LOC to pay the mortgage on the rental.


----------



## showmethemoney45 (Feb 27, 2015)

0xCC said:


> This seems like it would probably be ok, but what is the advantage? Surely the interest rate on the refinanced amount would be greater than what that amount earns in a separate account so why not just do it month by month by using a separate LOC like originally suggested? In other words, take the rental income pay off the mortgage on the personal property and take cash out of the LOC to pay the mortgage on the rental.


I'll be using the $ quickly as we are building a cabin so it wouldn't be much better to withdraw "when needed." Also, the interest rates on a variable mortgage are better than a HELOC. Prime -.75% vs Prime +1.0%
"


----------



## 0xCC (Jan 5, 2012)

showmethemoney45 said:


> I'll be using the $ quickly as we are building a cabin so it wouldn't be much better to withdraw "when needed." Also, the interest rates on a variable mortgage are better than a HELOC. Prime -.75% vs Prime +1.0%
> "


In that case I think what you are proposing is different and won't qualify. It sounds like you want to pull equity out of a rental property and use that to build a personal use property and then claim a tax deduction on the interest on the equity that was pulled out of the rental property. In that case the funds that you are now paying interest on were not used to invest and are therefore not deductible.

If you were to pull the equity out to invest in another rental property that would be ok. If you were to use the income from a rental property to pay the mortgage on the cabin and then use a separate line of credit to pay for anything related to keeping the rental property running and properly maintained that would probably be ok (but it is starting to get a little bit into a grey area I think).


----------



## showmethemoney45 (Feb 27, 2015)

0xCC said:


> In that case I think what you are proposing is different and won't qualify. It sounds like you want to pull equity out of a rental property and use that to build a personal use property and then claim a tax deduction on the interest on the equity that was pulled out of the rental property. In that case the funds that you are now paying interest on were not used to invest and are therefore not deductible.
> 
> If you were to pull the equity out to invest in another rental property that would be ok. If you were to use the income from a rental property to pay the mortgage on the cabin and then use a separate line of credit to pay for anything related to keeping the rental property running and properly maintained that would probably be ok (but it is starting to get a little bit into a grey area I think).


You're using the refinanced money to pay all rental expenses related to rental properties. (over a period of a few months) Then in turn use the rent to pay for the personal property. I don't see how this is different than "cash damming."


----------



## 0xCC (Jan 5, 2012)

showmethemoney45 said:


> You're using the refinanced money to pay all rental expenses related to rental properties. (over a period of a few months) Then in turn use the rent to pay for the personal property. I don't see how this is different than "cash damming."


From a tax perspective the CRA cares about what the borrowed money was used for. If you use the borrowed money to finance a personal use property you won't be able to deduct interest payments. If you use the borrowed money for investments activities that have the potential to generate income then you can deduct the interest. I mentioned that using a LOC to pay for expenses on the rental property while using the rental revenue to pay for personal property is a little bit of a grey area, it seems to be stretching things a little bit to me and might raise some eyebrows at the CRA.

Edit: According to Desjardins this has been accepted since 2002: http://www.desjardins.com/ca/personal/goals-life-events/saving-money-taxes/cash-damming-technique/
And here is a MillionDollarJourney article: http://www.milliondollarjourney.com/the-cash-flow-dam-explained-cash-damming.htm

Cash damming seems to be like the Smith Maneuver but for a business. So this sort of removes my grey area concern but also re-enforces my statement that just pulling the equity out of a rental property to build personal property is a way to deduct the rental property interest.


----------



## nobleea (Oct 11, 2013)

showmethemoney45 said:


> What if you refinanced the rental and placed the money in a seperate account. Each month you pay your rental property expenses with this money and use the cash flow to pay for your personal property? Still tax deductable?


I thought I replied to this but it seems my comment disappeared.

I think the refi mortgage amount would gradually become tax deductible, but not right off the bat. Interest on money borrowed to pay business expenses is deductible, but just borrowing the money is only one half of the transaction. It only becomes deductible once you spend it on business expenses. So only the portion of the mortgage that has been spent on business expenses would be eligible. This amount would grow every month, in the meantime you'd be paying a lot of interest on money just sitting in an account.


----------



## showmethemoney45 (Feb 27, 2015)

nobleea said:


> I thought I replied to this but it seems my comment disappeared.
> 
> I think the refi mortgage amount would gradually become tax deductible, but not right off the bat. Interest on money borrowed to pay business expenses is deductible, but just borrowing the money is only one half of the transaction. It only becomes deductible once you spend it on business expenses. So only the portion of the mortgage that has been spent on business expenses would be eligible. This amount would grow every month, in the meantime you'd be paying a lot of interest on money just sitting in an account.


Yes!! I see your point about it being tax deductible over time. It wouldn't take too long as our operating expenses are roughly 10k/month. Looking to refi 100k.
Thanks for your comment


----------



## nobleea (Oct 11, 2013)

showmethemoney45 said:


> Yes!! I see your point about it being tax deductible over time. It wouldn't take too long as our operating expenses are roughly 10k/month. Looking to refi 100k.
> Thanks for your comment


If it all happens within a tax year, then the paperwork isn't as messy.
Can you cash flow properly with a mortgage? The nice thing with a HELOC is it's interest only, which maximizes cash flow. And it can be paid off at any time without penalty. A refi mortgage would double the monthly payment and there are early payment penalties.


----------



## showmethemoney45 (Feb 27, 2015)

nobleea said:


> If it all happens within a tax year, then the paperwork isn't as messy.
> Can you cash flow properly with a mortgage? The nice thing with a HELOC is it's interest only, which maximizes cash flow. And it can be paid off at any time without penalty. A refi mortgage would double the monthly payment and there are early payment penalties.


Cash flow would be fine. I think its just too much work to keep track of. There is already a HELOC in place that isn't being used-interest only payments. Then you don't have to pay legal fees to refi.

Thanks,


----------



## 0xCC (Jan 5, 2012)

showmethemoney45 said:


> You're using the refinanced money to pay all rental expenses related to rental properties. (over a period of a few months) Then in turn use the rent to pay for the personal property. I don't see how this is different than "cash damming."





showmethemoney45 said:


> I'll be using the $ quickly as we are building a cabin so it wouldn't be much better to withdraw "when needed." Also, the interest rates on a variable mortgage are better than a HELOC. Prime -.75% vs Prime +1.0%
> "


These two statements seem to be contradicting each other but it could be I am just misunderstanding.

In order for the CRA to be ok with how you are using the cash you need to take the revenue from the rental properties and use that for personal expenses. You need to pay for expenses related to the rental from either a mortgage or a HELOC (which makes more sense since you can increase the balance month by month). Then the interest on the HELOC or mortgage used to fund rental expenses is deductible.

If you refi the rental properties and take those funds and directly apply them to the cabin then the interest on the refi amount will not be tax deductible.

Again, you can take the revenue from the rental and use that however you want (like for paying the mortgage on your cabin for example) and then use a mortgage or HELOC to fund rental expenses and the interest on the rental expenses will be deductible. You can not refi the rental and use the funds from that refi to pay for anything personal and still be able to deduct the interest on that refi amount.


----------

