Refinancing Rental Propertires

[VaughnandTwila]

Could someone please comment if they know how refinancing of a rental property is viewed in Canada Revenue Agency`s eyes. I would like to refinance a property but I am concerned that this may raise a red flag due to the fact that my net positive cash flow will drop and I will be claiming quite a lot more interest on my taxes. I do however believe that this is a better option than selling the property, paying the capital gains and then repurchasing another one that is more heavily financed.

 

[George]

QUOTE (VaughnandTwila @ Jan 8 2008, 02:03 PM) Could someone please comment if they know how refinancing of a rental property is viewed in Canada Revenue Agency`s eyes. I would like to refinance a property but I am concerned that this may raise a red flag due to the fact that my net positive cash flow will drop and I will be claiming quite a lot more interest on my taxes. I do however believe that this is a better option than selling the property, paying the capital gains and then repurchasing another one that is more heavily financed.

Good evening,

The CRA is generally speaking more concerned with what you did with the proceeds on refinancing. In other words, if you personally own the property and use the proceeds for vacation/big screen TV/other personal reasons then at least a portion of the interest costs will be non-deductible. Alternatively, where the proceeds are used for fixing up a property or to acquire another investment then the interest would most likely be deductible.

You are correct that the CRA likes to see higher profits on investments and this could potentially affect their perception as to your intentions with the property (for example, are you holding the property on account of "income" or "capital"). They are also considering your portfolio though as compared to a single property in isolation.

In itself, refinancing a property is certainly not a tax sin.

Warm regards...

George

 

[Jkaufman]

QUOTE (VaughnandTwila @ Jan 8 2008, 12:03 PM) Could someone please comment if they know how refinancing of a rental property is viewed in Canada Revenue Agency`s eyes. I would like to refinance a property but I am concerned that this may raise a red flag due to the fact that my net positive cash flow will drop and I will be claiming quite a lot more interest on my taxes. I do however believe that this is a better option than selling the property, paying the capital gains and then repurchasing another one that is more heavily financed.


My understanding is that if the monies from the refinance go towards a similar investment there are no current tax consequences. If you however use that money for the purchase of something personal then you must pay the capital gain at this time. Otherwise you will just pay the capital gain at the time of sale.

 

[VaughnandTwila]

QUOTE (George @ Jan 8 2008, 06:43 PM) Good evening,

The CRA is generally speaking more concerned with what you did with the proceeds on refinancing. In other words, if you personally own the property and use the proceeds for vacation/big screen TV/other personal reasons then at least a portion of the interest costs will be non-deductible. Alternatively, where the proceeds are used for fixing up a property or to acquire another investment then the interest would most likely be deductible.

You are correct that the CRA likes to see higher profits on investments and this could potentially affect their perception as to your intentions with the property (for example, are you holding the property on account of "income" or "capital"). They are also considering your portfolio though as compared to a single property in isolation.

In itself, refinancing a property is certainly not a tax sin.

Warm regards...

George

Thanks for your response it was very helpful!

 

[ToddStokowski]

Hi Jkaufman, just a quick follow up.

Your understanding is not correct, capital gains will never have to be reported on a refinance, only on the eventual sale.

The issue on the refinance is the eligibility to deduct the interest on the extra money after the refinance took place.

Hope that helps.

Todd

 

[VaughnandTwila]

QUOTE (Jkaufman @ Jan 9 2008, 09:31 AM) My understanding is that if the monies from the refinance go towards a similar investment there are no current tax consequences. If you however use that money for the purchase of something personal then you must pay the capital gain at this time. Otherwise you will just pay the capital gain at the time of sale.


Hello and thanks for your reply. Do you know if it is possible to claim a capital gain without liquidating the property? My thoughts are if you can have an appraisal done and pay the capital gains tax on the increase to date then it should be OK to refinance and claim the additional interest. Once the capital gains tax has been payed the CRA should not mind if the proceeds are used for personal purposes. Right???

 

[ToddStokowski]

You can not create a gain without transferring Title to someone else. Maybe you can transfer the property to your spouse or your company to accomplish this. This may create mortgage penalty issues and other issues bigger that what you are trying to achieve.

You are right in your logic about paying taxes up front, but I don`t see the benefit only concerns. Maybe I don`t understand your goals.

CRA has no problem if you refinance the property. They only ask that you do not deduct the interest on the additional cash received on the refinance if you use these funds for personal reasons.

Does that help?

Todd

 

[VaughnandTwila]

QUOTE (ToddStokowski @ Jan 9 2008, 11:29 AM) You can not create a gain without transferring Title to someone else. Maybe you can transfer the property to your spouse or your company to accomplish this. This may create mortgage penalty issues and other issues bigger that what you are trying to achieve.

You are right in your logic about paying taxes up front, but I don`t see the benefit only concerns. Maybe I don`t understand your goals.

CRA has no problem if you refinance the property. They only ask that you do not deduct the interest on the additional cash received on the refinance if you use these funds for personal reasons.

Does that help?

Todd

Hi Todd, the idea is to re finance the rental property that was purchased years ago and has significant equity in order to purchase a more expensive personal residence.

Thanks! ----Vaughn----

 

[ToddStokowski]

As long as you qualify for both mortgages (refinancing the rental and your new principal residence), you can do so with triggering a capital gain on the rental property until it`s sold even though the extra cash from the refinance is used to purchase your principal residence.

The key is that you are not allowed to deduct the interest on the portion of the refinanced mortgage that is new.

For example, if your current mortgage on your rental property is, say $150,000 and your increase it to $250,000, the interest that is deductible against rental income is 15/25 of the interest. The remaining 10/25 is not deductible.

If I was doing this, I would consider the extra $100,000.00 as part of my personal mortgage.

You could, as another option, sell your investment property, pay the taxes and put as much equity into your principal residence as possible, finance a new rental property (or the existing one, by way of a few transactions) to the maximum allowed by your Bank. This way, you are able to deduct all the interest on the rental property mortgage and reduce your personal (non deductible) mortgage to its maximum. You can also add in a HELOC on your principal residence to allow for future investment opportunities (always ask for money from the bank when you don`t need it).

The cost is that you are paying taxes now. The benefit is the ability to deduct interest. An analysis would be required to see the cost/benefit.


Todd Stokowski, CA

 

[TorontoMike]

Hi Todd,

i am also a CA in toronto and own about 5 properties and growing...what do you know about cash damming (smith manoveure) as it relates to owning real estate whereby converting your personal mortgage to deductible debt on investments? I have been organzing my properties and associated debts to try and take advantage of this technique recently. It seems reasonable to me to have a HELOC pay for the operating X`s of the properties and to funnel the income or gross rents net of the mortgage payment against my personal residence mortgage. I just wanted some input from another real estate investor to see if others are doing this and if so are there any pitfalls/risks that i might not have considered?

Thanks in advance,

Mike