The Order of Events Matters In Tax Law

People prefer things in good order. Life is simpler when organizing is well done. Most of the time, you cannot assign a value to it, but there is an exception.

Making interest tax-deductible

In Canada, the tax law specifies that an expense may only be deducted if it was incurred in earning income. Expenses incurred for personal things are not deductible.

If you arrange a mortgage to buy your home, the interest is a personal expense. If you borrow money on a mortgage to invest, the interest is tax-deductible. If you own a home with a mortgage and an investment portfolio, you should be sure the purchase order is correct.

It’s easy if you have cash to use in the beginning, For example, you have $500,000 in cash and buy a house for $500,000. Later the same day, you take a mortgage for $350,000 and invest. The interest is tax-deductible.

If you buy investments worth $350,000 and put $150,000 down to buy the house, the mortgage interest is not deductible. Even though you end up in exactly the same place, you get a different answer.

It matters at least a little. Even 2% of $350,000 provides a $7,000 tax deduction, worth more than $2,500 per year.

If you have already the wrong order

It is more difficult but still possible. As the mortgage approaches its renewal date, you sell investments you would have sold anyway but don’t reinvest yet. When the mortgage comes due, you pay it down as far as you can and arrange a new mortgage for what it would have been anyway. Then repurchase investments.

Suppose the $350,000 mortgage had been reduced to $275,000 and by the time renewal comes around, you have accumulated $200,000 from the orderly sale of investments. You apply the $200,000 to the mortgage, thus reducing the house-related part to $75,000. You then borrow another $200,000 and buy investments.

The interest relating to the reinvestment loan will be deductible.

If you have a business.

Sometimes a business owes the owner money. Suppose the business borrowed to repay those amounts, and the owner used the money to pay off the mortgage. The owner could then give the lender collateral security against the house. Ends up in the same place exactly. There is a loan against the house, and in this case, the business has a tax deduction.

You should talk to an accountant to be sure there are no hidden pitfalls.

The takeaway

On the surface, personal debt looks much like business or investment debt. Organize your affairs so their after-tax characteristics are different.

I help people have more income and larger, more liquid estates.

Call or email or in Canada 705-927-4770





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