Saving money is difficult here in Canada, especially in Ontario.
When the government is charging over 50% personal income tax rate, for every dollar you make above the top bracket, you are only left with less than 50 cents to spend.
My parenting philosophy is to demonstrate by example. My daughter Robin is at the age when she learns everything by watching us. If we are on our phone all the time, all she wants is a piece of the phone so she can be on the phone all the time too.
Talking about demonstrating by example – the Ontario government will likely balance their budget in the future but it also plans to add another $30 billion in debt over the next few years, estimated to reach $326 billion in 2019.
If that’s how our government is showing us, the hardworking Ontarians, how to spend our money, no wonder it is difficult for us to save anything.
Just as we get excited about having free post secondary education for our kids, keep in mind 9% of our tax dollar paid is used to pay off interest now. Not debt yet!
If our debt is going up by about 10% over the next year, who knows how much our tax dollar will go into paying interest by 2019? And how much of it will be when our kids finally get to enjoy their so called “free” education?
There’s really no free lunch.
Now onto this week’s topic.
Over the weekend, we visited an old friend who lives in Unionville, Markham.
Unionville is a nice area, with many little boutique shops.
It is also the area where one of the best high schools in Ontario is located.
As most real estate investors know, great schools always increase the housing price nearby.
Of course, we learned from my previous blog post that the interest incurred on money borrowed to earn investment is deductible and interest incurred on money borrowed to finance your own home is not deductible.
Savvy real estate investors like you and I may ask – is there a way to make the interest deductible?
I actually stumbled across this strategy last week.
The individuals would first sell their home to a corporation.
The corporation then issues a promissory note to the individuals.
Then the corporation would apply for a regular mortgage to finance this house. And use the proceeds to repay the individuals.
Therefore the entire mortgage interest on the presumably 80% loan to value of this house is deductible. Smart, eh?
The individuals can then use the money to purchase their new dream home.
One of the biggest disadvantages is that the couple would have to pay the land transfer tax.
When the individuals sell their home to the corporation, land transfer tax is triggered, calculated based on the fair market value of the house at the time the transaction occurred.
For our friends, their house is currently worth $1.4million. Land transfer tax will cost roughly $24,475.
That’s a lot of $$$ to begin with.
Of course, for taxpayers who live in Toronto, the land transfer tax can be doubled.
Definitely you need to look at whether the tax deduction on the interest is worthwhile making you pay the land transfer tax.
This couple paid $800,000 for the house a few years back. Their current mortgage balance is $500,000.
By refinancing the house to 80% loan to value, the couple can take out $620,000 to purchase their next home.
Let’s work out the numbers.
If they can borrow up to 80% loan to value ($1,120,000) in their old residence, the interest cost (with 2.5% interest rate) for the first five years is $131,268. Roughly $470K interest cost for the entire term.
We learn from the previous blog post that only the portion related to the rental would be deductible. In this case, only interest related to the $500,000 of $1,120,000 is deductible.
For the first five years, $58,602 is deductible and $72,666 is not deductible.
For the entire mortgage term (25 years), $210K is deductible and $260K is not deductible as a result.
Depending on how much money you make personally – if you are a high income earner, the tax cost is roughly 50% of the non-deductible portion.
If you don’t plan on selling the first home in five years, the tax cost for not deducting the interest is $31,333. If you don’t plan on selling the first home forever, the tax cost is $130K.
Now compared to the land transfer tax you will have to pay to sell it to a corporation of $24K, it doesn’t sound too bad all of a sudden.
If you already have a corporation or small business to begin with, this strategy can be a better one.
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant