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The Cash Flow Dam (Cash Damming) Explained



For the Smith Manoeuvre and tax minimization enthusiasts out there, you may have heard about The Cash Flow Dam (or cash damming).  Cash Damming is a fancy phrase for a fairly simple concept that can help optimize your taxes if you have a mortgage and a personal small business.

What is The Cash Flow Dam?

The Cash Flow Dam is tax arrangement that allows a personal small business owner (sole proprietor/partnership) to pay down their non-deductible mortgage faster.  In other words, it is a variation of the much discussed Smith Manoeuvre, without the investing, that helps convert bad debt into good debt.

How Does it Work?

Cash Damming uses a line of credit to pay for business expenses while taking the increased business cash flow to pay down a non-deductible mortgage/loan.  This results in a growing tax deductible business loan, and an accelerated pay down of a non-deductible mortgage.  This only works with a non-incorporated/personal/partnership small business.

For example, say you had a small business with $1,000/month in expenses and a readvanceable mortgage.  The $1,000/month expense would be paid by the home equity line of credit (HELOC), and the extra $1,000 sitting in your business account now would be used to pay down your non tax deductible mortgage.  The key to this strategy is that interest paid on borrowed amounts used for personal business expenses are tax deductible.  In the end, you’ll have a large tax deductible business loan and no mortgage.

Some of you may be thinking that this new loan just created a new monthly interest expense in addition to the existing mortgage payments.  The new interest expense can be avoided by capitalizing the interest.  That is, use the business line of credit to pay for itself which keeps the account tax deductible while using $0 of your own cash flow.  You can read more about capitalizing the interest here (with diagram).

How is Cash Damming different than the Smith Manoeuvre?

Cash damming uses business expenses to enable the loan to be tax deductible whereas the Smith Manoeuvre uses investments.  The Smith Manoeuvre is on the riskier side as it involves leveraged investing into public equities.

Applications

  • Rentals - If you are a rental investor, instead of using your own cash flow to pay for expenses, cash damming would involve using a line of credit instead.  This strategy will essentially allow your rentals to pay for your personal mortgage while keeping the tax man happy.
  • Self Employed/Side Business – If your personal company isn’t incorporated, and your monthly expenses are fairly high, then the cash flow damn can convert your non-deductible mortgage into business loan fairly quickly.  The net after tax result is a much lower overall interest cost.

I’m not a tax professional. Any information in this article should be taken for its entertainment value only.  A professional accountant should be consulted before implementing the strategy above.





106 Comments, Comment or Ping

  1. Good explanation – I didn’t know what that was called. I was debating on doing something similar for my blog next year since I have relatively high expenses (for a blog) – Mr. Cheap doesn’t come cheap and my wife also helps out and is on the payroll.

  2. Great idea FP. Have you looked into incorporating your online business?

  3. I’ll consider it but for now the revenues are too low to make it worthwhile. Hopefully that will change in the future. :)

  4. 4. nobleea

    So how does it work for rentals. Is the entire mortgage payment (P+I) considered a valid business expense? Or just the interest? Or is is the full amount and then you pay taxes on the capital gain when you sell (if you do)

    I suppose it’s much easier if you have a seperate LOC for tracking. I wonder how hard the paperwork would be if you used a LOC that you also used for other purposes.

  5. Nobleea, AFAIK, any interest paid to service a business loan is also tax deductible. So I can’t see why you wouldn’t be able to use a line of credit to pay the rental mortgage. However, with that said, I’m not sure that you could capitalize the interest on that LOC because that would be 3 layers.

    IMO, any LOC used for business/investing should be kept separate.

  6. You absolutely HAVE to keep any LOC used for business separate from any personal use. I got caught on this one last year because my former bank (TD) screwed things up. I had to sell some stock, wait 30 days and rebuy. I didn’t get audited or anything like that but it was still something I had to deal with.

    The problem with mingling funds is that if you make any payments to the principal, it is not clear whether you are paying down the deductible debt or the non-deductible debt. This is not something you can “designate” or assume it is in proportion to the amounts of deductible and non-deductible debt.

  7. 7. nobleea

    yeah, that makes sense.

    is it possible to split an existing LOC in to two accounts? it’s a HLOC so it’s registered against the property.

    also, does it matter if the LOC used is against the rental property? or is that just using your equity how you see fit?

  8. Good question about splitting the LOC – I think this is dependent on the product you use. I have Firstline Matrix which does not allow sub-accounts but I know there are other LOCs out there which do. I suppose one could pay the fees and get another secured LOC set up.

    I don’t think it matters how you use the money from the LOC – as long as it is used for investment in businesses of some sort. Stocks, rental properties, blogs, any other business – they are all eligible.

    On an unrelated topic – if you have capital losses from stocks – is there a limit to how many years you can carry it forward?

  9. 9. nobleea

    FP;

    Don’t quote me, but I think capital losses can be carried back 3 years and carried forward indefinitely?

  10. 10. mjw2005

    Is this not just robbing Peter to pay Paul…I am trying to wrap my head around this. Forgive my ignorance here. I am self employed but have very little overhead so this may not apply to my situation….

    What do you mean by capitalizing the loan…..I get your diagram in relation to someone using borrowed money for Stock Investments….but how as you say does one capitalize the loan for a small business so that the small business pays the loan itself with you paying nothing…..I don’t get it…confused…..

  11. mjw,

    This is basically what happens:

    1. Business has expenses
    2. LOC pays business expenses
    3. LOC has interest owed
    4. Pay LOC interest with chequing account
    5. Withdraw same amount from LOC back to chequing account

    Make sense?

  12. MJW – yes, you are robbing Peter to pay Paul, however if Peter can’t write off the interest and Paul can, then there can be some benefit.

  13. Quite interesting strategy. I actually have a few client that has it in place (mostly with rental properties) and it works perfectly.

    In fact, I wonder when do government get taxes from rental properties income? There are so many ways to avoid/defer taxes with rental properties :-)

    There are a few banks offering HELOC with split accounts.

  14. 15. Kevin

    Hi Everyone,

    I’ve been looking into this quite a bit the past couple of days. Here are 2 links with valuable info. One is just another explanation of how to do it, the other is a link to the CCRA’s website with their explanation and the rules on it.

    http://howtobesetforlife.com/Reports/CashFlowDam.pdf

    http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.pdf

    Hope this helps a bit

  15. 16. Kevin

    oh and MJW,

    you are Robbing Peter to pay Paul but you are paying down the principle on your own mortgage which eliminates your personal debt quicker. At first it’s not the easiest thing to understand but if you consider that the income doesn’t dissapear and your overall debtload is decreasing at the same pace as it previously was but you are transferring your bad debt to good debt.

  16. 17. cannon_fodder

    Just a note… I created a Smith Manoeuvre calculator some time ago and the link has been located on this website. http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls

    It supports the use of Cash Damming if you want to see how it may work in your particular situation.

    Cash Damming can be, obviously depending on how large your business expenses are, the fastest way to convert your non-deductible mortgage into deductible debt. This could easily save you thousands of dollars per year for many years.

  17. 18. Elbyron

    1. Can I use the HELOC to pay for the principal portion of the rental property’s mortgage, or am I limited to using the HELOC only for expenses that are already considered tax-deductible, such as the interest portion of the mortgage?

    2. Is the interest on funds borrowed to pay a down-payment on a rental property considered to be tax-deductible? (I would draw from a HELOC on my principal residence)

    3. Which spouse can claim the tax deduction for a jointly-borrowed HELOC? If this is based on who is on the title for the rental property, then what are our options if we’re both on the title?

  18. 19. lint

    hoping for an update the Elbyron’s comments as well. I’m a little confused on what can be deemed an expense for the purposes of cash damming with a rental property.

  19. Elbyron, lint, these questions should be confirmed by an accountant, however, this is my understanding:
    1. I’m not sure about this one, but it would make sense to use the HELOC to pay for interest deductible portion only. For example, when I capitalize the interest on my investment loan, I use a loan to pay the interest only.
    2. Yes, you can use a heloc to pay the down payment on an income property and still make the tax deduction. Same as if you buy a stock with a HELOC, the interest is deductible.
    3. I believe you can “choose” which spouse you want to claim the deduction. It depends on who is “servicing” the loan, whoever is paying for it should be the one claiming the deduction/income. If both are paying, then you can choose whichever spouse makes the most tax sense.

    Again, i’m not a tax pro, so it would be in your best interest to run these questions by an accountant.

  20. 21. Ed Rempel

    Hi Elbyron & lint,

    1. You can use the HELOC to pay all the deductible expenses of the rental property, plus the principal portion of the mortgage payment. Borrowing to pay the principal portion of your mortgage payment is essentially the same as transferring the loan from your mortgage to the HELOC, so if the mortgage is deductible, then transferring the debt or paying the mortgage from a HELOC would still be deductible.

    2. Yes. FT is right.

    3. For accounting and tax purposes, the expenses must be matched up to the income. Whichever spouse claims the investment on their tax return most also claim the interest on money borrowed to invest in it.

  21. Thanks for the clarification Ed, I was going to send you these questions via email. :)

  22. 23. lint

    for expenses I see mortgage (p+i), utilities, property tax, insurance, maintenance. which ones are deductible?

  23. 24. Ed Rempel

    Hi lint,

    Expenses for the Cash Dam are the same as expenses for income tax purposes. That would include generally any reasonable expense specifically related to the rental unit, including all the ones you mentioned.

    The only exception for deductibility is the principal portion of the mortgage payment, which is not deductible, but you can borrow to pay it as part of the Cash Dam.

    Ed

  24. 25. lint

    thanks Ed. Having some discussion with my accountant on what can be considered a deductible expense, and this supports my case.

  25. 26. Sebastien

    As part of trying to understand how cash damming works, I came across this article, see the section “The Donald (Trump, that is)” at http://www.mortgagebrokernews.ca/industry-talk/the-tax-tips-and-traps-you-should-know-now/43645, it says:

    “Legitimate expenses for use of proceeds on the business loan clearly extend to mortgage interest, property taxes, insurance and management fees. However, principal payments on the investment property mortgages are not a valid expense and the Donald needs to ensure that any principal mortgage payments are funded separately and specifically not funded through the rental cash dam.”

    I was wondering if this was corroborating or not what you Ed and lint were discussing, I was under the impression that we can apply the cash dam to the entire rental property mortgage i.e. when borrowing from the HELOC to pay the mortgage (principal + interests) of the rental property, that the interests were tax deductible (if borrowing for the down payment is tax deductible, why borrowing for principal portion of the mortgage wouldn’t?), but I’m a bit confused now after reading this article, any thoughts on this?

    Thanks,

    Seb

  26. 27. Ed Rempel

    Hi Sebastien,

    The article from the mortgage broker you quoted is not correct.

    Reborrowing to pay the entire rental mortgage is tax deductible, but for 2 different reasons.

    The Cash Dam allows reborrowing to pay for expenses, which would only include the mortgage interest.

    Reborrowing to pay the mortgage principal is essentially refinancing a tax deductible loan. If a loan is tax deductible and you take a new loan to pay it off, the new loan is generally deductible as well.

    For example, if you borrow on a credit line to reduce your rental property mortgage, the credit line interest on that borrowed amount would also be tax deductible. That is essentially what you are doing when you pay the mortgage principal in the Cash Dam.

    Ed

  27. 28. Sebastien

    Thank you very much Ed, that’s very helpful as there is all sorts of conflicting information out there as you saw in that article. A few other questions:

    1. Can the HELOC used to do the down payment on the rental property be the same as for the cash dam (as both are tax deductible) or if for accounting purpose the CRA would like to see 2 separates HELOC in this case (even if they are both related to the rental property)? You mentioned I think in another post that we need 2 separates HELOC when doing the Smith Manoeuvre and a cash dam, was wondering if this was the same reasoning for down payment vs. cash dam?

    2. What happens when we sell the rental property? If we just keep the HELOC (or not reimburse it completely), at that point is the HELOC still tax deductible until it is completely reimbursed?

    3. Are the actual rental property expenses still tax deductible in addition to the interests on the HELOC or if that would be considered double-dipping?

    Thanks,

    Sebastien.

  28. 29. Ed Rempel

    Hi Sebastien,

    1. The HELOC used for the down payment can also be used for Cash Dam. This is because in both cases, the amount borrowed is used for the rental property and claimed on the rental property statement on the tax return.

    2. Under the “Disappearing Source Rules”, if you sell the property and pay 100% of the proceeds onto the credit line, the interest on any remaining balance would continue to be deductible as long as you maintain that balance separately.

    This is a further advantage of the Cash Dam, since the part of the amount borrowed with the Cash Dam may remain deductible even after selling the property.

    3. Yes, of course the actual rental property expenses are also deductible.

    Think of it this way. Let’s say you are unable to find a tenant for a year, but continue to pay all the expenses of the building. If you borrow on your credit line to pay those expenses, then that credit line interest would be tax deductible.

    That’s all the Cash Dam is really – borrowing to pay the expenses. Most people use the rent to pay the expenses, but CRA says specifically that you can use the rent for other purposes and borrow all the money to pay the expenses.

    Ed

  29. 30. Sebastien

    Thanks Ed,

    So technically it shouldn’t matter what we do with the money after the sell of the rental property, like reimbursing the rental mortgage and/or investing in something else, as long as we don’t borrow again from that HELOC used for the cash dam, I would assume that everything is fine?

    I’m now trying to evaluate the pros and cons of starting a cash dam with my rental property, for my principal house I’m currently on a STEP with Scotiabank for another 2 years, my current mortgage is at prime – 0.5, the HELOC is at prime + 1, so currently with prime at 2.5% with a marginal tax rate of 40% it pretty much break even now in terms of after tax loan cost, but as the interest rate will go up the tax deductible loan will probably slowly become efficient… especially if in 2 years I can transfer my STEP to another bank with better rates ;-)

    Sebastien.

  30. 31. Ed Rempel

    Hi Sebastien,

    After you sell the rental, you should immediately pay the cost onto your credit line. If you reinvest it in something else, you should separate this into a new credit line.

    This is because you existing credit line is deductible against rental income. If you sell and pay the cost down, any remaining amount would still be claimable against rental income. However, if you reinvest in something else, such as stocks or mutual funds, then that interest would be deductible on a different line on your tax return, so you should split that credit line.

    How long are you planning to keep your rental property, Sebastien? That would be the main consideration for evaluating the Cash Dam. With today weird rates, the immediate tax savings may be minor, but here is the key point – the amount you reborrow this year is tax deductible every year, as long as you own the rental property.

    So, once rates normalize, this should be a benefit for you for years. The amount deductible grows every year.

    Just to be clear, the projected benefit of the Cash Dam far smaller than the Smith Manoeuvre, since it is purely a tax strategy. The SM is a leveraged investment strategy, plus a tax strategy. However, since the Cash Dam is purely a tax strategy, there is no downside other than doing the transactions and tracking them.

    It’s like claiming a tax deduction. There is no downside to claiming it.

    Your mortgage discount from prime is .5%, which should be a bigger discount soon. Also, your credit line is at prime +1%. Some banks are already at prime +.5%, and secured credit lines at prime are likely to return as interest rates normalize.

    Ed

  31. 32. Sebastien

    Hi Ed,

    The plan would definitely be to have one HELOC just for the down payment/cash dam and never use it for any other purpose, a separate HELOC would be used for investments. I’m actually not sure how long I will keep the rental property, the PITA factor might play a big role here, the rental property mortgage now is 1 year fixed to keep my all my options open, I’m going to reevaluate every year. So maybe I should wait a little then to see what kind of discount rate I can get in a year or 2 (when I have the chance to renegotiate my principal mortgage, I heard it’s not easy though to transfer a STEP to another financial institution) before starting a cash dam? Would there still be an advantage of doing it now with my current mortgage at prime – .5, HELOC at prime + 1 even if there is a small chance I might sell earlier (1-5 years)?

    Thanks,

    Sebastien

  32. 33. Ed Rempel

    Hi Sebastien,

    If you are thinking of selling the rental, then starting the Cash Dam is probably not worth it. The benefit starts small and builds, but only becomes a big number over time.

    If it is just a “small chance” that you would sell, then the sooner you start the better. There is no real problem moving it or moving from a STEP to another bank. Just have the Cash Dam credit line start with the same balance you transfer out.

    Ed

  33. 34. Sebastien

    Hi Ed,

    The problem I see now with the STEP is that although we can open up to 3 lines of credit (e.g. 1 for down payment and cash dam on rental property, 1 for investment, 1 for personal expenses), only 1 can be automatically readvanceable (at least that is what the bank told me), so in this case it might be hard to combine a cash dam with e.g. a smith manoeuvre, how would that work assuming I wanted to do both?

    Regarding the actual implementation of a cash dam, assuming a new bank account was opened just for the rental property operations, can that same account used to deposit the rent be also used to deposit the borrowed money from the line of credit to pay rental expenses or if they have to be 2 separates bank accounts?

    And how those 2 strategies (cash dam and smith manoeuvre) does affect the credit score since HELOC from a STEP is reported to credit agencies?

    Thanks,

    Sebastien

  34. 35. Ed Rempel

    Hi Sebastien,

    While Cash Dam is a cool tax strategy and a simple concept, implementation can be tricky.

    You need to either increase your mortgage payment by the amount of the rent, or accumulate it in an account somewhere and make an annual mortgage prepayment.

    If you are doing both the SM and Cash Dam, you will probably need a slush fund or extra credit line for the amount you want to readvance each year.

    You should decide which one is more critical (or which one converts more to tax deductible) and automatically readvance that one. For the other one, you can either ask your bank to transfer the available credit each month, or you can borrow it on an unsecured credit line for a year and then have the available credit transfered.

    For example, if you decide that the Smith Manoeuvre is priority (since it is both an investment and tax strategy), then you can automatically readvance the SM. Then you can borrow the Cash Dam rental expenses on an unsecured credit line for a year. You should then have a lot of available credit in the SM credit line (because it is automatically readvancing both amounts each month), so you can then ask your bank to transfer the available credit from the SM credit line to the Cash Dam credit line.

    You cannot mix the rent with the rent expenses. The Cash Dam allows you to keep them separate and use them for separate purposes, but once you mix them, you cannot do Cash Dam.

    These strategies should have only a minor effect on your credit score, unless you have quite a few separate credit lines. Having 1 or 2 additional credit lines should not have a major effect. They also result in your mortgage being paid down faster, which could help your credit rating.

    Ed

  35. 36. lint

    Ed, can you clarify this point? “You cannot mix the rent with the rent expenses. The Cash Dam allows you to keep them separate and use them for separate purposes, but once you mix them, you cannot do Cash Dam.” I’m not clear what this means from an accounting perspective.

    Thanks

  36. 37. Ed Rempel

    Hi lint,

    The entire concept of the Cash Dam is you can use your rent or business income for a purpose other than paying the rental or business expenses. For example, you can use the income to pay down your mortgage and borrow money to pay the expenses.

    Most people use their rental/business income to pay their rental/business expenses. However, CRA specifically allows you to borrow money to pay all the expenses. For example, if you had no income for a few months and borrowed money to pay the expenses, the interest would be deductible.

    Then you can use your rental/business income to pay down your mortgage. If you have a readvanceable mortgage, then paying down the mortgage will automatically create credit available that you can use to borrow to pay your expenses.

    If you use your rental/business income to pay the expenses, then you have already not done the Cash Dam, since it is a method of keeping them separate.

    Does that answer your question, lint? I’m not sure exactly what you mean by “from an accounting perspective”. Do you mean the transactions or the tax issues?

    Ed

  37. 38. lint

    Hi Ed,

    I was looking for a clarification on your post that I quoted, specifically this part “but once you mix them, you cannot do Cash Dam.”

    Does this mean that if you use part of the rental income to pay some of the rental expenses, you cannot do Cash Dam? If so, why not? I can see that this would complicate the accounting, but your comment sounds like Cash Damming is all or none.

  38. 39. Tommy

    Hi Ed,

    I am a bit confused by “but once you mix them, you cannot do cash dam” comment from you.

    I currently have 3 revenue properties since last year. I wasn’t aware of the Cash Dam strategy as I have 3 separate accounts for rents to go in and expense to come out. With Cash Dam strategy, I can use the rent income to pay my personal mortgage and personal LOC (non-deductible). If I had known last year, I would have saved myself quite a bit of taxes as I reported a net income of $10K (due to extremely low interest rate).

    After hearing the benefit of Cash Dam, I want to start implementing the strategy.

    My plans are:
    1) Refinance my current mortgage to access more HELOC, and also set up an readvanceable LOC for Smith Manuver (for investments)

    2) Use my personal line of credit to pay the rental expenses
    *the personal LOC has had many transactions, but if I can use rental income to repay all of debt.. can I still use this LOC for Cash Damming? (of course moving forward, there will only transactions going OUT to pay rental related expenses)
    *also, can you clarify that if I use personal LOC to pay mortgage payments, will I be able to write off 100% interest? (since mortgage payments contain a portion of principal)

    3) pay down my all personal LOC and accelerate mortgage paydown on personal residence

    Thank you!!

    Tommy

  39. 40. Ed Rempel

    Hi Tommy,

    I don’t completely understand your situation. Do you have only one personal credit line? If so, then there is a problem with your method.

    To make your line of credit tax deductible with the Cash Dam, you should transfer the entire balance somewhere else, so that you start with zero. Then use it only to pay expenses for your rental properties.

    The rent cannot go into this same credit line, since then you have used it to pay the rental expenses. Deposit the rent somewhere else and then use it to pay off some non-deductible debt.

    The key point is that the rent income needs to always stay separate from the account where you borrow to pay the rent expenses.

    Yes, your credit line will be deductible if you pay your entire mortgage payment with it. Paying the interest is deductible with the Cash Dam. Paying the principal portion is really just transferring the deductible debt from your mortgage to your credit line.

    Ed

  40. 41. Tommy

    Hi Ed,

    I now have two personal line of credits. I have a bit of balance on both. My plan is to use one of them for Cash Damming purpose. My question is do I really need to set up another LOC (and cancel my original one) to make this work? I am selling some stocks to repay one of my personal LOC and make that my cash damming LOC. If I pay down the LOC to “zero balance”, can I just start using this account for cash daming? Of course, moving forward there will only be one transaction a month where I transfer some funds to cover my operating expenses. There will be previous transactions.. but they are not related to my cash damming. It’s just like TD may want to pull credit and go through loan process again… it’s annoying.

    After reading your suggestion, my plan is:

    1) open up a new chequing account for operating expenses (set up automatic withdrawals of mortgage payments, property taxes, condo fee etc)

    2) on monthly basis, I will transfer funds from cash damming LOC to this new operating account (there will be 3 mortgage payments, property taxes etc)

    3) the principal repayment on my personal mortgage will also increase my HELOC limit (I am in the process of getting a readvanceable HELOC), and I will use this funds for investments (Smith Manuovre)

    One more question:
    Say, I transfer $4000 to the new operating account (I have 3 revenue properties) each month from my cash damming LOC, does it matter how I repay the cash damming LOC, and where the funds come from? (since I will be using the rents to pay down the mortgage on my principle residence)

    Can I offset the LOC by transferring the minimum payment required (3% balance), and then transfer out the balance back to my personal account? I know most LOC allows you to take out the funds right after you deposit in. It’s almost like resetting the LOC repayment. So realistically, I will keep building up the LOC and accelerate principal repayment on my personal mortgage. I have about 30K limit.. so that will be good for a couple years.

    And after my mortgage is paid out, I will start depositing rent cheques into the cash damming LOC (but you said that I shouldn’t deposit rent cheques into the cash damming LOC). And why is that?

    And how should I repay the cash damming LOC? After all my personal debts are all paid out?

    Your input is greatly appreciated!! Thanks!

    My email is: vendbc@hotmail.com

    Would love to continue our correspondence via email.. if that’s ok with you.

  41. 42. Richard

    We had to end when it was just getting good! I am considering doing this with my rental property as well, to help get my personal mortgage down lower. My main question is, is there any benefit to doing this if my rental property already has a negative cashflow?

  42. 43. Nathan

    Pretty sure I am going to implement the cash flow dam on my rental property.

    One question I’d like to ask that seems unique to my situation.

    My rental property mortgage is a 5 year fixed (with only 16 months left) at a rate of 4.94%.

    My primary residence mortgage is at 3.60% and is variable for another 2 years.

    Am I better off using the cash dam money to pay down my rental mortgage because it’s at a higher interest rate or should I pay down the primary residence to reduce my non-deductible debt?

    Thanks in advance..
    Nathan

  43. 44. Nathan

    not sure if it would matter…but for my situation listed above – my rate on the HELOC is 3.50%

  44. @Nathan,it really depends on what your goals are. Personally, I tend to prolong tax deductible debt, while paying off non-ded (bad debt) as soon as possible. The cash flow dam, should you use it, will allow you to use a HELOC to pay for rental expenses, while flowing all your rental income towards your principal mortgage. Remember that both the interest on your rental mortgage and the HELOC (providing you use it for business) is tax deductible. Once you use the HELOC towards the principal mortgage, it’s not tax deductible.

  45. 46. Ed Rempel

    Hi Richard,

    Whether your rental is in positive or negative cash flow does not change the benefit of the Cash Dam. In both cases, you can convert part of your home mortgage to tax deductible equal to your rental expenses each month.

    If your cash flow is negative, then you will have to continue subsidizing the rental from your own cash flow, but you can still do the Cash Dam.

    Ed

  46. 47. Ed Rempel

    Hi Nathan,

    Wow, those are high mortgage rates. I would suggest to consider paying the penalty to get out of both mortgages and refinance at today’s low rates before starting the Cash Dam. Then you can also get readvanceable mortgages (assuming you don’t have them now).

    I would suggest to call both mortgage providers to confirm what the penalty is. You can get a 1-year fixed between 2.5-2.6% today. Depending on your penalty, if it is only 3-months’ interest, then you would still save about 1.25%/year over the next 16 months till your mortgage would come due.

    On the variable, the penalty is almost always just 3 months’ interest and you can get a variable at 2.15% today, which is about 1.5%/year lower than your current mortgage.

    Once you refinance and get good rates, then it is more obvious that paying down the non-deductible mortgage is the better choice.

    The other thing to keep in mind is that your rates today are not that important of a factor. The Cash Dam will convert your non-deductible mortgage to deductible over time and the interest is deductible not only this year. Once you convert it, it is deductible every year that you own that property.

    Even if your penalty is too high and it is not worth refinancing today, you will likely have your mortgage for many years. The tax savings over 20 years (say) can be quite a bit more than the interest differential in the next year or 2 until your mortgage comes due.

    Ed

  47. 48. Ross

    If you combine the cash flow dam and the SM, does that mean you capitalize the interest from the readvanceable mortgage to pay your expenses (utilities, insurance, property taxes) on your own home, since your home is your office?

    Also, what can you expense with the SM? I am thinking of purchasing a computer, since I need it to purchase my dividend stocks. Does this qualify as an expense? I will speak with my accountant of course, but I am trying to get an idea of what I can and can’t do.

  48. @Ross, if you have a home business, then you can claim the home office as a business expense.

    However, if you are simply using your office to invest, I do not believe you can claim it as an expense – unless you are a full time trader. But full time traders would need to claim their gains as income instead of cap gain.

  49. 50. Jim

    Hi guys, I found the above article and comments to be very insightful. My questions stray from the above a little.

    I am starting a portable welding business soon and would very much like to implement this strategy; the business is very capital intensive early on.

    Could I use my up-front capital purchases as an expense?

    If I understand correctly, I would cut a check from my HELOC to pay my $2,000 / month business expenses. Then, as income rolls in I could withdraw the income to do with as I please, this includes paying down my mortgage (if I want). I assume the only complexity in doing this with a partnership is the split of expenses (50/50 etc..).

    Is the key here to only “loan” the business money for expenses?

    If implementing the SM and CFD (Cash Flow Dam) would I need a sub-account on my HELOC?

    Thanks in advance!

  50. @Jim, I believe you can use the HELOC for your biz and claim the interest as long as it’s not incorporated. As well, make sure to keep your personal and biz expenses separated via sub accounts etc. Once they get mingled together, it can be challenging to separate them during audit. I recommend you consult an accountant for the finer details.

  51. 52. Jim

    Thanks FT.

    Thinking from a bookkeeping perspective, would this be classified as a loan repayment or a draw on owners equity?

  52. 53. sharp21

    Just to clarify, the cash dam works by paying the business expenses through the Heloc, which pays the mortgage faster, but then the principle paid down by your personal mortgage payment is ALSO borrowed from the Heloc to invest with ala SM?
    S.

  53. 54. GC

    Hey FT, Ed.
    Can I use the cash damming with a HELOC attached to my rental property as I don’t have a HELOC with my principal residence.
    Would it look like the following:
    When I get the rent cheque, put it in my personal chequing account and make a lump payment to my principal mortgage.
    Then take money from the rental HELOC and put it into a separate chequing account to pay the mortgage interest, condo fees, repairs, property taxes, rental insurance. Can I also pay off the rental mortgage with this? I didn’t think I could claim all of the interest on the HELOC if I’m paying the rental mortgage?

    Would the main advantage be paying down my personal residence quickly, and being able to claim the interest on the HELOC? Basically just a transfer of the mortgage….
    Does it make sense to do this when my principal residence rate is 2.1% (prime – .90) and the HELOC is at 3.5% (prime + .50)?
    Any comment on capitalizing the interest from the rental HELOC?

    Thanks, GC

  54. 55. Accidental Landlord

    Hello All,

    I’m interested in hearing the responses to GC’s question above, as well as to a slightly different situation below. I’m wondering whether this means that I can make the principle portion of my rental property tax deductible as well??

    Here’s the scenario:

    I own a primary residence and a rental property (condo – former residence). The condo has $60,000 left on the mortgage, and brings in $1600/month in rent. I currently deduct the operating expenses (mortgage interest, condo fees, property tax, insurance, maintenance…) from the rental income.

    Now, if I were to take out a line of credit and pay off the $60,000 mortgage, would any payments I make to the line of credit be tax deductible as well??

    Thanks!
    Accidental Landlord

  55. @GC, sorry, must have missed this one. My understanding is that you can use a loan to pay off another loan and still retain the deductiblity. So, in saying that, it appears that you can use a HELOC to pay off your rental mortgage and still retain deductibilty in the HELOC. Note though, do not use that HELOC for personal expenses… investments only. I would recommend making a quick call to an accountant to confirm though.

    @ Accidental Landlord, same as GC. If you take out a line of credit that’s solely for investments, then you can use it to pay off your condo investment mortgage and still deduct the interest from the LOC. That is providing that you never withdrew from your condo to purchase your new principal residence in the first place. If you did, then that’s a whole new kettle of fish!

  56. 57. sunmoney

    After learning about SM strategies, including Rempel Maximum, I’m trying to figure out it is better to have an incorporated business, or a sole proprietorship?

    As tax rates for corporations are much lower than for sole proprietorships (which use personal tax rates I believe), when does one strategy beat out the other?

  57. 58. Nathan

    Sunmoney,

    That is a loaded question. I will be interested to hear if anyone has an answer.

    Nathan

  58. 59. sharp21

    Im pretty sure that you can only do cash damming with a SP.
    S.

  59. @sun money and Nathan, afaik, the cash flow dam only works with a business that is not incorporated.

  60. 61. sunmoney

    @FT and Nathan,
    Right I understand cash flow dam works with SP only. What I’m wondering about is that if someone was to open a new business, would it be better to open a SP (so that they could implement cash flow dam) or a corporation (so they pay less tax on business income)?

    Has anyone studied this to see under what conditions which scenario is better financially?

  61. 62. Ed Rempel

    Hi Sunmoney,

    Comparing Cash Dam to investing in a corporation, both strategies have merit. The better one is different in each case, depending on how much of the strategy you can do.

    The topic is complex, but here are some high points.

    1. The Cash Dam only works if you are NOT incorporated. It converts non-deductible debt to deductible debt based on the amount of business expenses you have. If you have a consulting business, you may have very little in expenses, so the benefit is small. Other types of businesses have higher expenses, so it would be a bigger benefit.

    We had a contractor client that made $100K, but he had $500K gross with $400K in expenses (including subcontractors). That means we could convert $400K of debt to deductible each year. We converted his mortgage and a large RRSP loan to tax deductible in less than a year. Converting an RRSP loan to deductible is cool!

    The savings here are the the interest deduction. If you convert a $400,000 mortgage @2.5% interest to tax deductible, you can deduct $10,000/year for as long as your business is active and make enough profit to deduct it against.

    If you are also doing Smith Manoeuvre or Rempel Maximum, then you would already be converting your mortgage to tax deductible. The Cash Dam will convert it faster, but then the savings from the Cash Dam are for a shorter time period.

    2. Investing inside the corporation – Corporations have a lower tax rate of about 15.5% on the first $500,000 of active business income, but not investment income. A good strategy sometimes is to leave money in the company with the lower tax rate, which gives you a larger amount to invest.

    This strategy is a tax deferral – not a tax savings. It works generally to the extent that your company generates profits that you plan to invest and not use for your lifestyle.

    For example, let’s say your company has a profit of $200K, but you only need $100K for your lifestyle expenses. This means you can leave the extra $100K in the company. You will pay 15% corporate tax, which leaves you $85,000 to invest.

    If you had taken that $100K out of the company, you would have paid tax at your marginal tax rate, which could be 33% or 46%. If you are in the highest tax bracket (46.4% in Ontario), then you would only have $54,000 left to invest vs. $85,000 if it is in the corporation.

    This sounds great at first, but this is only a deferral. At some point, you will want to withdraw the money and then you have to pay the extra 31% tax.

    In addition, investment income in a corporation is always taxed at the highest possible rate unless you pay it out to yourself personally. Usually, you would end up paying personal tax on the investment income.

    Looking at the numbers makes it clearer. This is a very over-simplified example, but gives you the concepts.

    You can invest $85,000 inside the corporation of $54,000 outside. After 7 years, let’s say your investments doubled. So you could have $170,000 inside the corporation or $108,000 outside.

    Now you sell. Inside the corporation, you would have $170,000 which you withdraw and pay 31% tax on. (The corporation gets a refund of 15% and you pay 46% personally.) That leaves you $117,000.

    You would probably pay personal tax on the capital gain of $19,500 ($85,000/2×46%), which would leave you $97,500.

    Compare this to owning the investment personally, where you have $108,000 to invest. You pay capital gains tax of $12,500 ($85,000/2×46%), which leaves you $95,500.

    You end up with similar amounts. Note there was a tax deferral, but when you eventually withdraw, you pay tax the extra tax on the higher amount that the investments grew to. In both cases, you would probably pay personal tax on the investments.

    Normally, investments in a corporation should be very tax-efficient. Some corporate class mutual funds allow you to invest with little or no tax until you sell in the future.

    This strategy works better if:
    A. You have a quite a bit of money that you do not spend and can leave in the company.
    B. You can expect to have future years in lower tax brackets when your business is still active, so you can withdraw money then.
    C. Your business is the type that you plan to pass on the next generation. If the business stays active after you retire, you can keep the deferral going far longer.
    D. You have family members that you may be able to split income with.

    There are a variety of other factors that affect the decision of whether or not to use a corporation. For example:

    - Risk of being sued (business of personal), since the corporation provides some protection.
    - Tax planning. Options to pay yourself optimal amounts every year, plus giving you the choice of salary, dividends or profit sharing.
    - Possible income splitting to family members, using different share structures, an “estate freeze”, or a profit sharing plan (EPSP).
    - EPSP also allows you to effectively opt out of CPP, which is a poor investment.

    Accountants tend to know the main issues, but tend to focus on which one results in lower tax in year 1. They tend to not know about EPSP, Cash Dam, Smith Manoeuvre, Rempel Maximum, or effective investments inside a corporation, and accountants often don’t realize that CPP is a bad investment.

    You need to look at tax over your lifetime and to what degree you can benefit from each strategy to see which one works better for you.

    Ed

  62. 63. sunmoney

    Thanks Ed, I see there are a lot of variables in play. This EPSP is new to me, I will look it up.

  63. 64. Eduardo

    Applying the cash damming maneuver using rental properties. What happens when I sell one of properties? Do I need to keep track separately in different LOC for each property?
    Has anyone has experienced that?

  64. 65. Ed Rempel

    Hi Eduardo,

    If you sell a property, you need to pay off the Cash Dam credit line. If you don’t, then it stops being tax deductible. This is similar to the mortgage against that property.

    You are right that you need to keep track of each property separately. With real estate, each property is tracked separately on your tax return. Most other assets are pooled by CCA class, but real estate properties are each tracked separately.

    Ed

  65. 66. Eduardo

    Thanks, Ed. Just for further clarification:
    - properties must tracked separately;
    - the expenses associated with a property sold become non tax deductible;
    - can a single Cash Dam LoC be used for all properties?
    - how would you recommend a multi-property should be structured?

  66. 67. Janet

    I get the concept of cash damming but am questioning whether or not it is enough just to own a rental property and fill out your statement of real estate rentals with your personal tax returns to CRA; or do you have to have an unincorporated business to use cash damming?

    I own rental properties and registered a business for the purpose of cash damming but then came across IT-434R of the Income Tax Act: Rental of Real Property by individual which states in para 4;

    “Where it is not part of, or incidental to, an existing business, the renting of real property by an individual is not, in itself, indicative of a business operation. It will be regarded as a business operation only when the landlord supplies or makes available to tenants services of one kind or another to such an extent that the rental operation has gone beyond the mere rental of real property…..” It goes on to mention that you would have to provide services above and beyond items such as maintenance, window washing, repainting, head, utilities, snow and garbage removal, or maintenance of appliances and furnishings.

    So now I am confused as to whether or not I should have registered a business for my rental properties at all, how I should proceed with my taxes (personal or business income), and as to whether or not I can use “cash damming” without the registered business???

    Am I incorrect in my interpretation of the Income Tax Interpretation Bulletin? Any guidance would be greatly appreciated.

  67. 68. Capital Investor

    Has anyone tried this calculator to assess the value of a cash dam?
    http://www.cashdam.ca/Page490.html

    I can’t seem to figure out what goes in the Annual Taxable Income expected field. The spreadsheet says this is based on line 260 of your income tax return but that sounds like that would apply if you were a small business owner. For rental properties would this amount be my rental property income or household income? I would suspect it should be rental property income soy ou can calculate how much you can pay down against your principal mortgage.

  68. 69. Ed Rempel

    Hi Eduardo,

    I just noticed your post. Yes, you can use a single Cash Dam line of credit for multiple properties. The issue will happen if you sell a property. Then you need to know how much of the Cash Dam credit line relates to the property sold, since that amount becomes non-deductible when you sell the property. You should pay this amount down on the Cash Dam credit line, if you can.

    For example, let’s say that you have 3 rental properties and over 5 years you have used all the rent to pay an extra $100,000 down on your mortgage (in addition to your regular mortgage payments) and you have reborrowed that $100,000 from the Cash Dam credit line to pay the rental expenses on the 3 properties.

    Then you sell one property. Now you need to track all the transactions and compound interest for the 5 years so that you know how much of the $100,000 Cash Dam credit line relates to the property you sold.

    You can do this either by having 3 separate Cash Dam credit lines or you can have a spreadsheet to track it and calculate the split.

    Ed

  69. 70. Ed Rempel

    Hi Janet,

    It does not matter whether or not you register a business name for your rental property.You can do the Cash Dam either if you have a rental property or if you have a business.

    The interpretation bulletin you mentioned (IT-434R) explains when someone with rental properties that and related business is actually running a business, rather than just owning a rental property. However, either way you can do the Cash Dam. So just forget the business name.

    In your case, it sounds like you just have one rental property and no other business, so you would just use the Cash Dam strategy to pay your rental property expenses.

    Ed

  70. 71. Ed Rempel

    Hi Capital,

    The Annual Taxable Income is only used to determine your tax bracket. It is line 260 of your return – your Taxable Income.

    In addition to your tax bracket, you separately enter the expenses related to your business or rental property that you can pay from the Cash Dam credit line. It is the expenses related to the business or rental that are relevant – not the income from them, since the Cash Dam is a process of borrowing to pay the expenses.

    Ed

  71. 72. Capital Investor

    Thank you for the quick reply Ed. Based on your response that the income does not matter and I noticed in a previous reply that you also mentioned it does not matter if your cash flow is positive or negative, I have two follow up questions:

    1. How does the negative cash flow affect my tax return especially if the cash dam is creating the loss? Does it simply reduce my taxable income further?

    2. Does CRA have an issue with declaring losses annually?

  72. 73. huhu21

    Hi FT and Ed,

    I hope i am not too late to ask question here, as I am so excited to learn about this techique as I found this will help me to pay down my principle residence faster

    but I am stuck at the point to understand the final concept..ie. the repayment of LOC. I have read thru different articles to learn this technique and still didn’t have a clue. Can you guys kindly help me please?

    Here is my situation:

    a) I get rental income $2200
    b) rental expense: $1522.77 + rental mortgage principal $1158.30

    = Rental income – rental mortgage principal= $2200-$1158.30 = $1041.70, which i can use toward the principle residence’s mortgage as prepayment

    c) Use Homeline of credit (LOC)to pay off rental expense (strata fee, property tax, insurance, and utilities) and mortgage interest,

    therefore:

    i) principle residence goes down over time, with additional payment made every month, from portion of rental income
    ii) rental mortgage get paid with LOC for expense and mortgage interest get paid from portion of rental income

    iii) LOC goes up over time (which the interest to pay the rental expense would be able to deduct tax)

    but my question is…since it shouldn’t be extra money spend in the cash damming technique., Am i missing something? Where do I get money to pay off LOC? or Am i supposed to pay off LOC?

    I am so puzzled. Can you guys help me out please? Thank you kindly in advance

    Marco

  73. 74. Capital Investor

    Hi Ed,

    I am wondering when it would be recommended to lock-in the LOC portion of my cash dam. Currently I have $40K floating at prime + 0.5% with interest only payments that I capitalize by borrowing off the LOC for the monthly interest payments. With rates as low as 2.79% the difference between the floating rate (3.5%) and 2.79% would save me $300/year in interest ($40K X 0.71%). However, by fixing the $40K into a amortized mortgage I would now be making principle payments. I am thinking I can re-capitalize those payments by borrowing off the LOC to make the payments so in the end I am really not using any rental proceeds to pay down the LOC which is as designed because I am allocating 100% of my rental proceeds to my principle mortgage which is not tax deductible. Is this a recommended strategy or should I keep the LOC as floating so I only have to make interest only payments?

    Thank you!

  74. 75. nabeel

    I’m thinking about using cash damming for my microFIT project. Have essentially financed the cost of the installation using a segregated subaccount on my NBC All-in-One.

    Are there any concerns about using the cash damming strategy when my only business expense is interest on the loan used to pay the sole incoming-generating property?

  75. 76. ottawaGUy2

    Ed,
    Could you please answer post#74?
    I am in the same situation, I have $80000.00 HELOC which I am thinking to convert into mortgage since I am not paying it soon (tax deductible debt).
    How to conduct this transfer (HELOC to Mortgage) so it will pass future audit check specifically with National Bank AIO (all in one)?

  76. 77. Ed Rempel

    Hi Capital Investor #72,

    I just noticed your post. Yes, claiming the interest deduction would give you an additional expense. If you have losses year after year, CRA may question whether you are really trying to make money. Are you renting your property below market for some reason, such as renting to a family member or friend? Is your business a legitimate business?

    If you can show you are renting your property at market and are legitimately trying to make money, but your property just keeps losing money, then showing losses year after year should be fine.

    Ed

  77. 78. Ed Rempel

    Hi Marco,

    The amount you can convert to tax deductible is much larger than you think. In fact, the total you can convert with the Cash Dam is $2,681.07. This is the total of your rental expenses plus your rental mortgage principal. Reborrowing the mortgage principal is refinancing an existing tax deductible debt.

    You can reborrow the entire $2,200 (or $2,681.07 if you have enough credit available). Pay the full rent onto your home mortgage in addition to your normal payment, and then you should have $2,200 (or more) available credit to reborrow in the credit line.

    Does that answer your question?

    Ed

  78. 80. Ed Rempel

    Hi Ottawa Guy2 & Capital Investor,

    Converting your tax deductible credit line back to a mortgage is a good strategy that we use sometimes. It saves you money from a lower interest rate. The downside is that your total payment is higher, but you can make up for this by reborrowing the principal on the rental mortgage again.

    If you don’t reborrow the principal, then whether or not to do it is a question of cash flow and whether you want to pay off this debt or keep your cash flow focused on other priorities.

    If you reborrow the principal again, you can still maintain tax deductibility if you can trace that this cash was used for tax deductible purposes. For example, you could use the credit that becomes available in your rental credit line to reduce the Cash Dam credit line on your home.

    The only real downside of this is complexity. You have quite a few transactions each month and you have to track them. If the interest savings are worth your time and effort to do this (and you know what your are doing), then it is an easy decision.

    For example, you save $300/year of tax deductible interest, so your net savings are perhaps a bit over $200/year. To save this, you convert your rental credit line to a mortgage, borrow the payments from your home Cash Dam credit line, then use the available credit in the rental credit line to reduce your Home Cash Dam credit line. It’s a few transactions each month, but you can get used to them quickly.

    In short, the only disadvantage is complexity and time to do the transactions. Otherwise, it is a simple interest savings.

    Ed

  79. 81. huhu231

    Hi Ed,

    Thanks for the help.

    So to clarify,

    1) I would borrow $2200 or more ($2,681.07 max as rental expense+principal) from Home Line of Credit (rate @ P+0.5%)
    2) then pay $2200 rental income directly to my monthly / bi-monthly mortgage to lower the principal, plus my normal monthly mortgage payment, therefore getting $2200?

    but 3) how do I pay off the $2200 I borrowed from LOC? or should i even be paying that off? That’s the part I get stuck Ed.

    Can you kindly let me out please? Thank you

    Marco

  80. 82. RJ

    I have started looking at getting into duplex rental properties. I guess I could start using the cash flow dam for any and all rental expenses above the duplex mortgage and then turn around and combine it with a smith manoeuvre on my primary residence. No?

    Any chance you can take a look at some questions I have regarding a smith manoeuvre as well? Thanks!

    http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-2.htm/comment-page-10#comment-132805

  81. 83. Ed Rempel

    Hi Marco,

    I think you’re getting it now. You pay $2,200/month rent onto your home mortgage, plus your regular payment. Together, this should be at least the $2,681.07 that you can Cash Dam.

    Then you borrow the $2,681.07 from the credit line linked to your home mortgage to pay all your expenses.

    What is happening is that the tax deductible Cash Dam credit line keeps building up, while your non-deductible mortgage is paid down at the same rate.

    Assuming your income is high enough to benefit from the tax deductions, your focus should be to pay off your non-deductible mortgage. Once its paid off, your credit line should be roughly what your mortgage would have been if you had not done the Cash Dam. At that point, you can either allocate your mortgage payments to pay off the credit line, or you could keep the tax deductible credit line and use the extra cash from not having to make your mortgage payment to invest for your retirement.

    Once your mortgage payment is paid off, you will need to use most of it to pay your credit line interest. You may want to convert it to a mortgage (and still claim the interest), to slowly pay it off and save interest.

    Think of it as we keep your mortgage the same size, but make more and more of it tax deductible until all of it is tax deductible. At that point, you can either keep it or pay it off, just like you would have if this amount was still part of your mortgage.

    Ed

  82. 84. Goldberg

    My mortgage rate is 2.25% variable for another 3.5 years.

    My LOC is 3.5%, even if deductible, it comes to about 2.25% at best.

    For someone in my situation, what’s the point of it for now?

    Also how can you borrow from it to pay for your regular expenses (as discussed in post #83)… my understanding is that only interest on investment loans were deductible… if you are not investing it, but rather spending it, CRA would reject it.

  83. 85. Ed Rempel

    Hi Goldberg,

    The Cash Dam works only for people that have a business that is not incorporated, or a rental property. It converts their home mortgage into a credit line deductible against the business or property.

    In your case, the benefit may not be a lot but there would still be a benefit. Any amount you convert becomes tax deductible every year in the future, as long as you own that business or rental property and still carry that credit line. In more normal interest rate environments, the after tax cost of the credit line would be noticeably lower than your mortgage rate.

    Ed

  84. 86. Tom

    Hi Ed,

    Glad to see this thread’s still alive! I had a question – I’m considering the cash dam for a residential solar PV (solar panel) installation (microfit program in Ontario). I see mention of the “disappearing source rules” but don’t know how this applies to the solar installation. Say I spend $40k on the installation, and bring in $4k per year on a 20 year government contract. I’ll depreciate the capital cost down as much as possible to minimize taxes, and at the end of the 20 years say I have a system worth effectively zero. Assuming I used my $4k/year income to pay off my residential mortgage and I still have the full $40k HELOC, can I continue to deduct HELOC interest off my personal income even though I now have a zero-income, zero-value asset (the panels)? Is this a disappearing source? Appreciate your insight – I’ve been googling cash dams left and right and found your comments here have been more helpful than anything else!

    Tom

  85. 87. Ed Rempel

    Hey Tom,

    The Cash Dam will work for you, but not the “disappearing source” rules. These rules do not apply to depreciable property, such as the solar panel. The interest would be deductible until you stop getting income.

    You could also use the $4K for any other purpose, such as perhaps investing it. With today’s low interest rates, paying down your mortgage may not be the best use of the income.

    Ed

  86. 88. Tom

    Ed – many thanks! I’m considering investments as well, in particular if the correction I’ve been patiently waiting for in the equity markets ever actually happens! But at a bare minimum it would be nice to get the tax benefit. It’s not much, but I figure $4k @ 3.5% (LOC interest), or $140, at 50% marginal tax rate yields me a benefit of $70 per year, and grows by $70 per year as well. Not huge but not something I want to leave on the table either – by the end of 20 years this will be $1400 per year.. I’m assuming as well the HELOC is at the same rate as my mortgage, which is currently true since I’m locked at a higher (3.54%) rate, but if I switch the mortage to variable, the benefits are lower (if I renew at 2.4% variable, my benefit is $70 minus the interest differential on the $4k (1.1%, or $44), or a total benefit of $26/year in the first year). Of course I’ll try to get that HELOC down to prime as well (currently prime +0.5). Thanks again for your help.

  87. 89. OttawaGuy2

    Let us say you have some funds (say $30,000.00) available for 2 months before you actually need them.
    1) Is it ok to temporarily lower your credit line balance with the funds above and then withdraw when needed for original purpose?
    2) Would it stand firm against CRA audit check?

  88. 90. OttawaGuy2

    Ed,
    Could you please answer post#76 question posted below as well?

    How to conduct this transfer (HELOC to Mortgage) so it will pass future audit check specifically with National Bank AIO (all in one)?

    What record do I need to keep to show that HELOC was paid off by new mortgage which is still tax de-ductible?

  89. 91. Ed Rempel

    Hi OttawaGuy2 #89,

    No. This is exactly what you have to avoid.

    You have a tax-deductible credit line. You pay it down by $30,000 with temporary cash. That means you have reduced your tax deductible credit line. Then you take your $30,000 back out for a non-deductible use. That means $30,000 of your credit line is no longer tax deductible.

    When you have tax deductible debt, it is critical to keep it separate from non-deductible cash.

    Ed

  90. 92. Ed Rempel

    Hi Capital Investor #74 & OttawaGuy2 #766,

    Converting your tax deductible credit line back to a mortgage maintains the tax deductibility. The interest savings you pointed are real.

    Tax deductibility does not depend on the type of loan. It depends on the use of the money.

    If you have a tax deductible credit line and convert it to a mortgage, it is generally still deductible (if separate from any other debt). With a mortgage, your interest rate today could be 2.79%, instead of 3.5% for the credit line, so you save interest.

    Your payment is higher because it it P+I, but you are saving interest. However, if you reborrow the principal portion to pay for your interest (recapitalize) or reborrow to invest, then your debt can stay the same, yet you still save the interest.

    This is a good, creative strategy that is perfectly fine, if done right. We do this relatively often with retired clients that have fully converted their mortgage to tax deductible.

    Ed

  91. 93. Ottawa Guy2

    Hi Ed #91

    Could you please explain this:
    How interest capitalizing pass the audit test?

    It is almost the same as depositing some funds then withdrawing them back again.

  92. 94. Ed Rempel

    Hi Ottawa Guy,

    The general rule is that if interest on a credit line is tax deductible, than interest on the interest is also tax deductible. So you understand the concept, let’s say a company had no sales for a while and just borrowed money to pay its bills, including interest on its existing debt. The interest on the new debt would also be a business expense.

    Capitalizing interest is a way of having a credit line pay its own interest. Most banks will not allow a credit line directly to pay its own interest. They will only take the interest from your bank account. But if you then take the exact same amount back from the credit line, you create a trace to show that the money withdrawn from the credit line was used to pay its own interest.

    Ed

  93. 95. Ottawa Guy2

    Thanks lot Ed, really appreciate your clarification.
    Here is one more question:

    Keeping audit, taxation and low cost in mind!!!

    Can you fund more than one investment from the same HELOC account
    or it is good idea to keep separate HELOC account for each investments ?
    Example: SM + Rental property. When you are planning to keep both for long time.

    I am sure that adding a new HELOC account would add more cost in terms of monthly fees. Is it worth the cost?

  94. 96. Ed Rempel

    Hi Ottawa Guy,

    You should keep them separate and that should cost nothing. The interest deduction for SM appears on a different line on your tax return than the interest deduction on your rental property. Having them separate allows you to plan what is most effective to do with each. If you sell your rental property, for example, you need to be able to pay off that portion of your debt, or else it is no longer tax deductible.

    Bottom line – it is definitely best to keep them separate.

    Having separate credit lines should not cost anything. Most readvanceable mortgages allow multiple mortgages and credit lines with no cost other than the interest, as long as the total credit available in all of them is less than 80% of your home value.

    You may want to consider doing the Cash Dam in addition to the SM, since you have a rental property and are already looking at setting up separate credit lines. The Cash Dam can make your home mortgage tax deductible more quickly, in addition to the conversion from the SM.

    There is a clear benefit at no cost – definitely worth it.

    Ed

  95. 97. SBmtl

    Hi,

    Can transactions errors in the line of credit be corrected ?

    I started doing the Cash Dam on my rental few years ago. But this year I started doing expensive renovations in one of the rental using the line of credit. The problem is that I recently changed my mind and chosed to move into the appartment being renovated in thenext month. By doing this, as I understand, most expenses (all thoses which are not for repairs but ameliorations) can no longer be claimed as expenses.. Since then, not knowing what to do, I stopped using the line of credit..

    What can I do, can I make corrections ? ex. put back money, an not record interests for the period with errors (I want to keep thing simple) ?

  96. 98. Bi

    Does this cash dam strategy work if I live in my house and also rent it out? Or does it have to be solely rental property?

  97. 99. nabeel

    I currently have a separate HELOC component for deductible debt (microFIT solar panels), and “cash damming” that debt. However, I want to move away from my AIO mortgage to a regular mortgage, for many reasons (interest rate, unhappy with FI, etc.)

    If I roll this deductibe debt into the mortgage and keep meticulous records (i.e. have the amortization schedule for the entire mortgage and then an amortization schedule for the amount of the rolled-in debt, and a clear paper trail showing the rolled-in debt starting amount), would that pass a potential CRA audit?

  98. 100. FrugalTrader

    @nabeel, that seems reasonable to me, but I have never rolled debt from HELOC to instalment before. Maybe others can comment?

  99. 101. Ed Rempel

    Hi SBmtl,

    You can fix a messed up Cash Dam. There are 2 options:

    1. Aggressive option: Adjust the balance of the credit line to the amount of the tax deductible transactions you can prove and have a record to support. Put the rest into another credit line or mortgage or pay it off.
    2. Safe option: Move the entire balance into another account and start over.

    Option 1 is usually reasonable, assuming you have good records and the time frame is reasonable.

    Ed

  100. 102. Ed Rempel

    Hi Bi,

    It should be a separate property. If you have a dual-use property, you allocate interest and other expenses based on relative area. For the Cash Dam, you need a separate credit lines clearly linked to the rented area, not just an allocation.

    Having said this, we have not tried Cash Damming an allocation and I am not aware of anyone that has tried and been audited. IT-533 refers to the Cash Dam with clearly traced sources of funds, though, so an allocation is certainly stretching it.

    I hope that’s helpful.

    Ed

  101. 103. Ed Rempel

    Hi Nabeel,

    The answer to your question is: probably. You are referring to the “aggressive approach” in which you co-mingle funds, but keep a precise record of each. In general, if you records are accurate, it should be fine. However, what will you do if there are deviations, such as changes in interest rates, lump sum payments, or some other variation.

    It sounds like your real issue is dealing with the wrong financial institution. Every institution I have seen has identical rates for conventional and readvanceable mortgages. If you have someone trying to persuade you to go with a conventional mortgage, it may be a mortgage broker, since they have limited access to readvanceable mortgages.

    We have a free mortgage referral service on our web site, if you want a referral to today’s lowest rate and a readvanceable mortgage.

    Ed

  102. 104. nabeel

    Ed,

    I did fill up the mortgage referral form on your website and will explore whatever options are presented, but one of my main concerns with the AIO type of products is that the entire line (mortgage + LoC components) is shown on my credit report as a secured LoC. So, in my example, my $210K mortgage plus $36K LoC, both part of my AIO, are reported as a $246K balance on my Equifax and Transunion reports.

    I used to be a heavy CC churner, and my instant approvals are few and far between in the last 3 years of holding this NBC AIO product.

    Are there are AIO type products that do not report the mortgage component as a regular credit line?

  103. 105. Mark In Kingston

    Wow this can be a huge long run tax savings. So if I keep borrowing for the expenses after my principal residence mortgage is done, (but using it and the rental property as collateral for these Heloc debts) investing in resp/tfsa and rsp (making those debts tax deductible) is there a limit in how high I can go? Market value of the house or as much as I can borrow.

    If it matters, principal residence is worth 300 000 and my rental is worth 250 000

  104. 106. Mark In Kingston

    Because in theory the bank will lend me 80% percent of each (440000 based on today’s values) but does it really make sense to deduct interest from 440000 in debt on a 250000 property?

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