The two largest expenditures most people face are income tax and the mortgage on their home. While the principal portion of your mortgage payment at least creates equity, the interest you pay is simply lost forever, just like income tax. Recognizing this, we have designed an innovative and effective strategy to significantly reduce both of these major expenditures. Our Tax-Deductible Mortgage Strategy, or TDMS, is a way of re-classifying your debt to accomplish two things:
1) Make your mortgage interest tax-deductible, lowering the total after-tax cost.
2) Using the additional funds generated to pay it down sooner, saving interest costs in the long run.
We do this by “unlocking” the equity in your home and using it to convert your mortgage to a tax-deductible investment loan. Mortgage interest is generally not tax-deductible. However, interest on debt created to generate income - or even the potential for income – can be deducted for tax purposes, which considerably lowers the overall cost of the loan.
How It Works
Most banks allow you to borrow up to 80% of the value of a property. This is often entirely taken as a mortgage but, alternatively, can be set up as a Line of Credit, or even a combination of the two. If your property has increased in value and/or you have paid the debt down below this 80% threshold, that means you have available equity. The TDMS uses this equity to convert the mortgage to an investment loan over time.
1. Create an investment account using a LOC set up against available equity.
2. Pay an annual 6% distribution on a monthly basis and put this directly against the mortgage principal.
3. The additional equity created is used to max out the LOC with the proceeds going into a “tax-clearing account” to keep everything precise and separate for tax purposes.
4. The LOC interest is paid out of this distribution and the remainder is invested.
By repeating this process every month we can rapidly convert the outstanding mortgage to an investment LOC, and because the interest we pay on this is tax-deductible the total amount of debt decreases much faster than it would otherwise. The exact figures will vary depending on the mortgage details and your personal tax bracket but, in general, it should be possible to pay your mortgage off completely up to 50% faster than using regular methods.
Here's an Example
If you own a property worth 400k with a 250k mortgage amortized over 30 years at 3.5% you will ultimately pay over 400k including interest. But wait, it gets worse. If you are in the 39% tax bracket, that will actually mean you have to earn 660k before-tax to pay it off.
However, by implementing the TDMS the mortgage would be paid off in just 17 years, saving 167k in actual payments, 232k in before-tax earnings. Obviously, that is a huge financial benefit and is only based on a relatively low interest rate. At a higher rate, the savings would be even more substantial.
Now, as if that wasn’t enough to make the strategy worthwhile, if you also happen to own a rental property it is possible to super-charge the whole process for even greater savings. The concept uses the rental property in a similar way to the investment account but, instead of making a 6% distribution, the monthly rental income is used to pay down mortgage principal. The additional equity flows through to the tax-clearing account, just like before, and now that account is also used to pay the rental expenses (mortgage, property taxes, insurance, etc.). This means the rental numbers all work out exactly the same as they would have otherwise and there is typically no need to remortgage the rental property. The home mortgage, though, is converted at an even faster rate than before.
It is easiest to implement the TDMS when your mortgage is up for renewal, although it is usually still viable at any point as long as we factor in the cost of terminating your current mortgage when making our projections. When breaking a mortgage you usually face a 3-month interest penalty (which is not usually enough to worry about) but we also need to consider any interest rate differential.
This strategy is quite complex and must be implemented very precisely to ensure complete tax deductibility. We charge $2,950 + GST for the initial setup of the mortgage structure and activation of all requisite cash flows.
Within the investment account we use our tried and true Risk Parity strategy to produce consistent, positive returns under virtually any economic conditions.
While the TDMS certainly adds a new level of complexity to your tax situation, our in-house tax department is well-versed in accurately reporting the necessary details. Also, we handle all CRA consultations for our tax clients and automatically organize all the relevant supporting details of the strategy.
There are no magic solutions when it comes to effective tax planning, but that doesn’t mean you can’t create huge savings. We are constantly striving to find new ways to improve our clients’ financial situations within the framework provided by CRA, and aggressively innovative methods such as the TDMS can have a huge impact on your overall net worth. We welcome you to come in for a consultation so we can analyze your situation and see if this approach could be right for you.