Tax saving tactics

BY JAY BRIJPAUL

Normally, the interest paid on a principal residence’s mortgage is not tax deductible. However, according to the CRA, interest paid on money borrowed to invest is tax deductible. The ultimate goal is to reline mortgages to make them tax deductible.

Albert Einstein asserted that the hardest thing in the world to understand is income tax. When you pay a mortgage, a portion of your payment goes towards reducing the principal, and a portion towards interest. Lowering the principal portion would increase the equity in the home and this equity can then be borrowed for an investment. Let’s assume that the principal residence has a remaining mortgage of $200,000. It is best to convert this sum into a secure line of credit. Now, with every mortgage payment comes new equity to invest. Gradually, the entire $200,000 will change from a mortgage on the principal residence to money put towards a new investment. The $200,000 debt remains the same but it has been changed from a “bad debt” where the interest portion is not tax deductible, to a “good debt” where the interest portion is tax deductible.

In order to save on taxes, Gautam converted his mortgage so that anytime he paid down the principal, he can borrow against it. Every month he withdrew from the principle, he paid down and invested in shares from a chartered bank. The tax-deductible portion of the interest he paid triggered a refund which he then used towards paying down the line of credit and reinvesting into the principal. Gautam took advantage of his tax-free saving account and also bought an RRSP. This in turn triggered a bigger tax refund. He also received dividends from the stocks he bought. With all the tax savings and dividends, he was able to pay down the remaining line of credit faster.

Junior used a slightly different strategy to save on taxes. His property was mortgage free. He took a line of credit against his principal residence for $300,000. He then used this as a down payment on an investment property he bought for $600,000. Next, he took a mortgage for $300,000 on the investment property. Note that this was a “no money down” deal as the entire $600,000 was borrowed. The interest payment on the line of credit and on the mortgage of the rental became tax deductible against his gross income.

A basement apartment or a home office in a principal residence can also provide a tax saving strategy. The cost involved in retrofitting and registering the basement apartment is tax deductible. A portion of the mortgage interest, property tax, utilities and insurance can be written off against the rental income. For example, if the basement apartment is one-third the size of the property, then one-third of the mortgage interest, property tax, utilities and insurance can be written off. The good news is that the CRA will consider the entire property as the principal residence if three criteria are met.

The first is that the portion of the home used to generate income is from the principal residence. For example, the basement of the home the owner lives in.

The second is that there is no structural change done to the property for income generation. Structural changes can include an addition done to the existing property.

The last criteria that must be met is that the owner does not claim capital cost allowance on the property. A property is considered a depreciating asset in the eyes of the CRA because of wear and tear. While a yearly deduction is allowed on the income producing portion, if a homeowner takes this allowance, then upon sale, the owner must pay capital gains on the portion claimed as a rental apartment. This is noteworthy because there is no capital gains tax paid on a principal residence.

Income splitting is another great way to save on taxes. The party with the lower income must be actively involved in the day-to-day activities of the rental property. Some of the duties of that certify you as “actively involved” include bookkeeping, communicating with tenants, collecting and depositing rent; doing so will allow for the opportunity to split the income. An unemployed family member that is eighteen years of age or older and living at home can be compensated for taking on duties related to the rental unit. The expectation is that if you are renting your basement, you should be making some profit. It should be noted that claiming losses from year to year is a red flag and the homeowner can be audited.

My advice is to have a professional accountant to guide you. Their fees are tax deductible. Always keep receipts and if you are renting the basement apartment, set up a separate account for rental income as well as expenses. After all, you are now running a business.