If you have faced the unpleasant task of renewing your mortgage, you will undoubtedly have experienced the significant impact of the higher mortgage payment on your household budget.
The mortgage interest rates have generally increased from about 3% in 2021 to 6% today. It means you will pay an additional $200,000 in after-tax dollars to pay off your $700,000 mortgage.
On the other hand, if you could wave a magic wand and set up a tax strategy to make the interest tax deductible, your 6% mortgage becomes 3%, assuming the top personal tax rate of 50%.
For 30 years, we have helped clients implement strategies to make their mortgage interest tax deductible.
Here is a selection.
- The sale and buyback
You own personal investments worth $300,000. You sell the investment and use the proceeds of $300,000 to pay down your mortgage. Subsequently, you borrow $300,000 to repurchase the investment. The interest is now tax deductible because the borrowed money was used to acquire the investment.
- Cash damming
This is a great technique, especially for unincorporated doctors, to convert a personal loan into a practice loan. You establish two bank accounts. Your professional income is deposited into Account A, and funds are withdrawn to repay your personal loan or mortgage. The practice expenses, including office overhead and staff salaries, are paid from Account B, funded by a practice line of credit. Since the borrowed money was used to pay for practice expenses, the interest deductibility test is met.
- Sale to company
You own real estate, which costs $500,000 and has a market value of $900,000. You sell the real estate to your medical corporation, or holding company at an elected value of $500,000. Your corporation borrows $500,000 to pay for the real estate. You use the proceeds to pay down your personal mortgage. The interest expense is deductible in the corporation. By electing the transfer value of the asset at the tax cost, the transaction does not trigger any capital gains, which generally would apply if the property was disposed to a third party.
- Payment of dividends
Here is another method to maximize interest deductibility. The medical corporation borrows money to pay tax preferential dividends, such as tax free capital dividends or eligible dividends from portfolio investments to the shareholders, who use the funds to pay off personal loans. The interest is deductible in the company as long as the dividend is paid out of the company’s accumulated profits or retained earnings.
- The equity strip
This strategy works well where the doctors have funds owed to them as shareholder loans from the corporation.
Consider the following series of transactions:
- The company takes out a temporary loan of, say, $300,000 to repay the shareholder loan;
- You, as a shareholder, use the proceeds to pay down the personal mortgage;
- You take out a new mortgage on your house and invest the funds in the company;
- The company uses the new mortgage proceeds to repay the bank loan.
Nothing has changed in your debt structure, except that the house mortgage is tax deductible on your tax return.
Take a close look at your financial situation and feel free to contact us to help you devise the appropriate strategy to make your personal loans, including house mortgages, tax deductible.
