In fact, self-employed workers who are not incorporated may be eligible for such an advantage. Following a decision by the Supreme Court of Canada, combined with a new administrative position taken by Revenue Canada, these workers may now use the so called ” cash damming ” technique and therefore convert non-deductible mortgage interest on their personal residence into deductible (business) interest.
In referring to the table on the right, we note that a person who has opted to amortize his residential mortgage of $150,000 (at an average rate of 6%), over a 20-year period, will incur an imposing $106,388 of interest over the life of the mortgage, interest that could be deducted from his income, over the years.
In addition, the cost of using this strategy ranges from very little to absolutely nothing at all! So…
Usually, self-employed workers who are not incorporated use their own gross revenue (that is, their total sales or billing) to pay their current operating expenditures and they finance their major personal expenses, such as a mortgage, on their house.
By using the cash damming technique, those same people will use the gross revenue from their business to speed up payment of their personal mortgage and, from now on, will finance 100% of their operating expenditures. In so doing, they will gradually convert non-deductible interest (from their mortgage) into deductible interest (from their business loan).
Mike is a self-employed, non-incorporated worker and, in the course of his professional activities, he incurs $75,000 per year in business expenditures (lease, salaries, supplies, advertising, etc.), which, so far, are being paid from his gross business revenues of $200,000.
Mike has just bought a new house and will have to pay down a mortgage of $150,000. Once the cash damming set-up is in place, Mike will use the part of his revenues that would have normally gone toward paying his business expenditures, to make an additional mortgage payment on his personal residence.
Then, the financial institution will grant Mike a mortgage line of credit for an amount equivalent to the additional mortgage payment he just made. With this mortgage line of credit, Mike will cover the business expenditures.
Because the mortgage line of credit will have been used for business purposes, Mike will then be able to deduct the interest incurred on the line of credit, from his revenues. In effect, he will have converted non-deductible interest (from a residential mortgage) into deductible interest (from a line of credit for business purposes).
With annual business expenditures of $75,000, it will take Mike barely 2 years to completely convert his initial mortgage of $150,000 into a mortgage line of credit, simultaneously making the interest deductible for the full remaining term of his debt debt.
In this way, the interest deductions will save Mike over $47,875 net, in taxes.
Susan, a salaried employee, who purchases an income-producing property, will be able to use a different form of cash damming so that she, too, may convert non-deductible interest from her residential mortgage into deductible interest.
In fact, in such a situation, Susan will be able to use the part of her rental income which would have normally been used to pay the operating expenditures of the rental building (taxes, insurance, maintenance, mortgage payments, etc.) to make an additional mortgage payment on her personal residence. Just like Mike in the previous example, once this additional payment is made, Susan will then use her mortgage line of credit to pay current expenses on her income-producing property.
Because the mortgage line of credit will have been used for business purposes, Susan will gradually convert non-deductible interest (from her residential mortgage) into deductible interest (from her line of credit for business purposes).
Since there are other planning strategies designed to maximize the tax benefits within the cash damming technique, consult a professional who will be able to set up a strategy that is perfectly in keeping with your needs, taking into account such aspects as:
- The rules on partition of the family patrimony
- Personal and business expenditures (a car, for example)
- GST and QST collected on your sales within your business
- A situation where the spouses are co-owners
Furthermore, not all lenders are able to offer the type of mortgage, line of credit and multiple bank account set-ups required to effectively manage your cash damming movement of funds. Therefore, you may need to shop around and ask lots of questions before you find the right solution for your situation. Do not despair, the potential saving are well worth the time you take!