Taxes have the potential to cut into the profits on any investment and real estate is no different. Investors who take the time to understand the complexities of the modern tax landscape have the potential to make significant tax savings. Here, George Lawton, CPA, CA, CEO, North American Home Finance Inc., outlines two tax strategies that can be utilized by Canadian investors.
This first strategy enables investors to make part of their mortgage tax deductible. In Canada, investors are allowed to transfer the proceeds from a home mortgage loan over to a loan used to buy a rental property, which is then tax deductible.
“Say an investment property is purchased for $500,000 with a mortgage for $400,000 in year one, says Lawton. “When the market value of the investment property has increased and the mortgage is paid down the property could be either refinanced or sold. Let’s assume that in year five the investment property is sold for $600,000 for a profit of $100,000 plus the proceeds of the pay down in the mortgage for another $35,000. If, after fees and capital gains tax, $90,000 was realized from this sale, these funds could be used to pay down the mortgage on your principal residence. If that mortgage is set up to allow a re-advance, the $90,000 could be re-invested. Now that the interest on the $90,000 portion of the home mortgage would be tax deductible as it was used to purchase the investment.”
“The effect of arranging your investments this way would create no additional risk and it would start to save taxes, which could be used to further pay down the home mortgage or invest.”
The second strategy enables investors to reduce taxes by setting up a company or family trust from which to operate their investments.
“Many of us would like to take advantage of all of the best tax planning strategies available but don’t realize that there is usually a minimum level of income or asset base that is required before the accounting and legal cost of setting up those planning options become worth the tax savings,” Lawton says.
“One simple tool that can be used by Canadians is the “Section 85” roll over. This refers to a tax deferred roll over in Section 85.1 of the Tax Act and allows a Canadian to transfer real estate holdings and other kinds of investments into a company without paying any recapture or capital gains tax at that time. If a family is looking to grow their investment holdings and then begin to manage those assets for the next generation, the section 85 roll over approach can allow for the deferral of tax at the outset. Over time it can allow a family trust to be created, which could be used to manage the ownership of the new holding company for the long term. Investors should seek professional advice from a Chartered Professional Accountant (CPA) or tax lawyer before implementing any tax strategy.”
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