To One Million.... Are We There Yet?

Since I peeked into the future using no appreciation of the real estate, for fun, and for fun only, I thought I would use the CMHC forecast of nationally 6.90% expected price increases for real estate and see what happens.

Again, this is for fun and for fun only.

Using our current Net Worth and Current Asset Value, and using the 6.90% expectation we get the following:

1. Our current assets are valued at $2,229,891. This can be seen here. 6.90% appreciation for 2007 would be $153,862.47 growth. Add this to our current asset value and we get $2,383,753.40.
2. Thus, our current Net Worth of $504,905.30 now becomes $658,767.77 for 2007.
3. But wait! Remember this post? It was figured that we would earn 4.75% by mortgage pay down right? At the end of that post it was determined that we would have $528,911.76, so we need to add this in too. So add $153,862.47 to $528,911.76 and we actually get a true 2007 Net Worth of $682,774.23.

So lets keep going, assuming the 6.90% figure stays constant through 2008 and we reduce our mortgage liabilities by 4.75% again:

1. Our current assets would be valued at $2,383,753.40 in 2008 and at 6.90% growth again it would grow $164,478.98. So by December 31st 2008 our assets would be $2,548,232.30.
2. Thus our Net Worth one year from now of $658,767.77 from 2007 now becomes $823,246.75 in December 31st 2008.
3. But wait! Remember this post? It was figured that we would earn 4.75% by mortgage pay down right & lets use that 4.75% again. So our Net Worth of $658,767.77 times 4.75% is $31,291.47... add that to $823,246.75 for a true Net Worth in December 31st 2008 of $854,538.21.

Lets keep going.... this should be our final one - for 2009:

1. Our current assets are valued at $2,383,753.40 in Dec 2008. 6.90% appreciation for 2009 would be $175,828.02 growth. Add this to our current asset value and we get $2,724,060.30.
2. Thus, the Net Worth of $823,246.75 now becomes $999,074.77 for Dec 31 2009.
3. But wait! Remember this post? It was figured that we would earn 4.75% by mortgage pay down right, so lets use that 4.75% again. Our Net Worth of $823,240.75 times 4.75% is $39,104.22..... add that to $999,074.77 and we get $1,038,178.90 Net Worth.

So our Net Worth in December 31st 2009 should be $1,038,178.90 using the CMHC forecast. But this is just for fun. This is unlikely to happen as we are in the late stages of this real estate cycle and surely the market will downturn, meaning we will have to wait much longer than 2009 to reach our goal. But we are prepared for that as these are all long-term holds.

We're Making Our Home Mortgage Tax Deductible - Thanks to Our Rental Properties

Ok so our biggest mortgage right now is on our home right? And guess which mortgage is NOT tax-deductible.... Our BIGGEST ONE, OUR HOME (AKA Property Number 8)!!!! Arrrggggghhhh. Frustrating isn't it?

I remember reading about the Smith Manouver on Ozzie Jurocks' website and I remembered reading about it in the bookstores. Specifically I recalled it under "ask an expert" on financing who was Harvey McCallum the mortgage broker. Anyways, it never meant much to me because I never really had a home before. I mean, we had a small condo, but we never bothered to implement this 100% tax-deductible & 100% LEGAL tactic because, frankly, we knew we would be moving out... just weren't sure exactly when. So we didn't bother. We just sucked it up, paid the interest to the bank and never claimed the interest as tax-deductible. We took our lumps for a couple of years. Well, that was then and this is now.

Now we have a huge mortgage and a gorgeous home. And we want it to be tax-deductible!
So here's how we've accomplished this:

• 1) We're taking out a 2nd mortgage on Property SIX. There's plenty of equity as the house is valued at $185,000 and the mortgage currently is $126,000. With the help of a private lender through our amazing mortgage broker, we can go all the way up to 85% of the value of the home. We only took $25,000.00. That should do it for now. I'll get back to this $25,000 in a sec.....
• 2) Just to recall, remember how we got Property SIX? We pulled out $60,000 in the form of an inter-alia mortgage that was done by another WestCoast private lender who took equity from both Property One and Property Two. This was our down-payment for This sixth property, Property SIX. This duplex has been zoned as a duplex and has had a long-term tenant in the upstairs unit who pays all cash each month, and now the downstairs tenants pay $1150 a month. Total $1685 monthly. There is no question whatsoever that this is an investment property, right? And the $60,000 was used as a down payment on that INVESTMENT (property) right? Thus, all the interest on this $60,000 private mortgage is 100% tax deductible as it fits the legal parameters for CRA (Revenue Canada). So that one is fine....
• 3) This is where I need to keep organized notes and this post is part of that. Ok, here we go... Harvey McCallum says, "You own a $300,000 home with an existing mortgage of $150,000. You own a rental with a mortgage that pays you $900 a month rent. Each month you receive the $900 rent - pay it on your home mortgage. The $900 will go to reduce the principal - increase your equity - and decrease your mortgage payout. But now how are you going to pay your rental mortgage? Well . . . lets take out a floating 2nd mortgage against your home so you can dip into it when you need money. Which will be every month. By the way the floating 2nd is tax deductible because the money is borrowed for the purpose of paying your rental mortgage not your home mortgage." So how does this relate to our situation? Firstly we are setting this $25,000.00 new money aside that we pulled from Property SIX. We are setting it aside so we can use it, just as Harvey says, to pay our rental mortgage on Property FIVE. Then, we are using the rental income from Property FIVE to service our home mortgage, Property EIGHT. And to correct Harvey's numbers and relate it specifically to ours, our $485,000 home is our Primary Residence (our home) with a mortgage damn near $400,000. Our rental property is $185,000 with a first mortgage $126,000 and now a second of $25,000....
• 4) Once we have enough equity built up in our HOME, then we will do a 2nd MTG (MTG is short for mortgage) there... and payout the original 2nd MTG on Property SIX. We want this 2nd MTG against our HOME (that hasn't been set-up...yet....as there needs to be enough equity) to get bigger and bigger and eventually replace our original 1st postition MTG of currently approx $400,000. Then, at the time when the 2nd MTG fully absorbes the 1st MTG and there only remains a 2nd high interest tax deductible MTG on our home, we will convert it back to a first for the lowest rate & payments possible.... And yes, this would be STILL BE tax-deductible too :)
• 5) More from Harvey, "I can hear the wheels turning . . . why would you want to use a higher interest rate, probably higher but not always, 2nd to pay your rental mortgage. One reason . . . it is better, all most always, to have a higher deductible mortgage then a lower non-deductible mortgage.
  Over time you will have paid off your home 1st mortgage and be left with a floating 2nd that can now be rewritten as a lower first mortgage and still be tax deductible.
  Why an investor should not do this - YOU HAVE SO MUCH MONEY YOU DON'T CARE. I would argue if you have so much money do it anyway and make a charity very very happy . . . oh and you will get a tax receipt."

Ok so that's the plan and that's how it is gonna go down. I'm posting the following below, just in case over time I lose the links as this is good proof for legal requirements:

Who wants to have a tax deductible mortgage in Canada?

The Supreme Court of Canada have paved the way, with proper planning, for mortgage interest to be tax deductible.

Most people do not write off the interest on their mortgage. Yes many homeowners write off a portion of their mortgage payment as it relates to a home office space. But that is not the same as writing off the interest on their mortgage.

Your principal homes mortgage interest is deductible, when the borrowed money is used to earn income from a business or investment that has an expectation of making a profit, even if your home is the pledged security.

How the funds are spent determines interest deductibility of your mortgage, not the collateral. If a direct link can be established between the loan and its business/investment use, it is immaterial that the security for the loan is a mortgage against your principal residence.
Example: You have money invested in the equity market, and you want to buy real estate. Assume you liquidate the equities, buy real estate all cash, then mortgage the real estate and reinvest the borrowed funds in equities. Could you then write off the mortgage interest, arguing the proceeds were used to buy stocks rather than the house?

That was the issue facing the Supreme Court of Canada, in a decision handed down September 28th 2001.

Some background:
On October 27th, 1988, John Singleton had $300,000 in his business capital account. The court noted, he wanted to use $300,000 of his equity to assist in the purchase of a house. He then borrowed that same amount, in the form of a mortgage on the real estate he just purchased, to refinance his partnership capital account. He did all that on the very same day.
When the dust settled, Singleton had a new house,a mortgage on the new house, and $300,000 back in his capital account.

Singleton deducts the mortgage interest on his 1988 and 1989 tax returns.. The government disallows the deduction. Singleton sues - he loses in the Tax Court of Canada - wins the next round in the Federal Court of Appeals.- in October 2001 the Supreme Court of Canada sides with Singleton.

This case boiled down to one issue: were the borrowed funds used to earn income from his law firm, or finance his home purchase? Put another way, should the same day transactions be viewed as a series of connected activities, or each a distinct tranaction? The Supreme Court of Canada ruled they are distinct seperate transactions.

The Honourable Mr. Justice Major said, "It is an error to treat this as one transaction - the transactions must be viewed independently." The direct use of the borrowed funds was to refinance Singleton's capital account. Treating the borrowed funds as used for financing the purchase of the home ignores what Singleton did, ie used the borrowed funds to replace the funds required for his capital account at the firm.
Structuring your affairs to shrink your tax burden is 100% legal, the Courts have ruled that Singleton could write off his mortgage interest.

The way is paved for homeowners, who apply the same principles, to make non-deductible principal mortgage interest tax deductible.

When you are ready to explore the possibility of making your own mortgage tax deductible give me a call. Who should call: everyone self-employed, everyone who owns a business, everyone with investments, and anyone who wants a tax rebate at the end of the year. Best of all it is free.

Proper professional advice before proceeding is a must.

A taxpayer borrows moneyIs the interest deductible? When is borrowed money considered personal use or to earn income? This question was asked in 1988 by John Singleton and answered in September 2001 by the Supreme Court of Canada.
The Loan
In 1988, John Singleton, a partner in a law firm, withdrew $300,000 from his partnership capital account. He used the funds to purchase a house. Singleton then mortgaged the house by borrowing $298,750 from the Bank and deposited the money into his partnership account, along with $1250 of his own money.
The Fun Begins
When time came to do his tax return, Singleton deducted $3,688 of interest on his 1988 tax return and $27,415 on his 1989 return. Singleton believed the borrowed funds, not the withdrawn funds, were used for investment purposes. A required distinction to understand this question and answer. Of course the tax guys disagreed and disallowed his deductions.
Very Appealing Case
Singleton appealed to the Tax Court of Canada, but his case was dismissed. He then appealed to the Federal Court of Appeal which allowed his appeal by a majority decision. Not wanting to be less appealing the Tax Guys look for a friendlier decision from the Supreme Court of Canada.
The Decision
By a five to two decision, the Supreme Court dismissed the Tax
Guys appeal.

The Court held the opinion that Singleton used the borrowed funds to invest in his partnership. Therefore, the direct use of the funds was for the purpose of producing income, making the interest deductible.
Tax Planning Mantra
The Court quoted the mantra of tax planning in making the decision. Taxpayers are entitled to structure their transactions
in a manner that reduces taxes; the fact that the structures may be complex arrangements does not remove the right to do so.

The Court was unequivocal in its view that the funds were borrowed to refinance Singleton's capital account. It stated:

Viewing the transactions as one simultaneous transaction, thereby treating the borrowed funds as used for financing the purchase of the home, ignores what the respondent actually did: he used the borrowed funds to replace the funds required for his capital account at the firm..

Mortgage Financing Options

I picked this off of Harvey McCallum's mortgage site which gives a ton of great information. Since I have a lot of different types of mortgages, I thought I would add this to my online diary to remember the consequences of rates and the choices in financing one has:

Here's the most important parts that I want to highlight. It is so simple, yet I often go chasing new products, rates etc...

• Important point #1: Goal - have the renter pay off your mortgage!
  His suggestion - pay the mortgage off fast, set up the rental property to make your home mortgage tax deductible and apply your tax rebate to the principal.
  Is it worth paying a penalty to get out of the wrong mortgage? Probably! Only one reason to pay a mortgage penalty - to save money.
• Important point #2: Don't Throw Your Money Away On . . . Interest (Non-Deductible Kind)
  The most important quality of any mortgage strategy is how much payment is applied to interest and how much is applied to principal.
• It is obvious that mortgage A, same rate as B and the same payment as C, will pay your mortgage off the fastest, with the least interest, and the most principal. Accomplished without increasing payments above a fixed 5 year rate. If lowest payment is your goal B is for you.
• Mortgage A will take several years off the amortization where as mortgage B will take the full 25 years.
• With mortgage A many lenders allow you to miss a payment giving you credit for the over payments you have made. Mortgage A and B are available as of ( Dec 15/2002).

Cashback is Crazy

Or so it has been said. Not in my opinion and the way we utilize this oft' ignored mortgage feature that the big banks offer.

The reason so many frown upon the cashback mortgage is because of the way it is generally marketed. So many bankers offer it to first-time homebuyers as a means of paying for furniture and start-up expenses for a new home. Is this a terrible idea for the first-time homebuyer to use a cashback mortagage? Yes, 100% agreed! Don't use it for consumer items!!!!

Where it can be useful is for the real estate investor. The good news about cashback mortgages is that it puts cash in your pocket immediately. If you use that money to buy another asset such as dividend producing stocks (ie bank stock that spins off income in the form of dividends-remember always strive for income producing assets AND appreciable assets!) or if you use the cashback money for an RSP contribution, well then it is a remarkable means of gaining wealth and enhancing Net Worth.... quickly. And the tax benefit is tremendous.

That's the situation our partnership faces at this moment. This partnership hasn't been mentioned here before. I haven't included this partnership in any of the figures in our Net Worth blog. It is a few additional condos in London 50% partnership. Check out our situation:

1) Cashback mortgage on our smallest condo. This jumps the rate to 6.75% and we are locked in for 7 years. However the bank puts $4,130 in the bank account. Downside is we are locked in for 7 years at a high rate......BUT thats what we were always planning on doing anyways right, holding the properties for the LONG-TERM?

2) Cashback mortgage on our other slightly larger condo in the same building. This time the bank puts $6,230 in the bank account. Downside is we are locked in for 7 years at the same high rate OF 6.75%......BUT thats what we were always planning on doing anyways right, holding the properties for the LONG-TERM?

3) Cashback mortgage on the other final unit that has very little mortgage and thus a smaller cashback. This time (its smaller) the bank will put $1,680 in the bank account. Downside is we are locked in for 7 years at the same high rate OF 6.75%......BUT thats what we were always planning on doing anyways right, holding the properties for the LONG-TERM?

CONCLUSION: Adding up all the greenery & we get a total of $12,040 in the bank account. Thus, $6,020 each (partnership 50%).

The Good News: $6k each to invest it in RSPs or you pay down RSP loan, or pay down primary mortgage on personal residence. Whatever we want.

More Good News: Added up our expenses of condo fees, mortgage payments & property taxes and added up our partnership rental income. I've also added up the costs of the big loan payment that served at original down payment. The tenants pay for all of this each month, so in a way its all free.

Even More Good News: The longer we hold the property, the more it goes up in value over time.

Best News of All: The higher interest rate & higher interest cost is tax-deductible and the cashback income is tax-free (the government considers it the same as they would a 'gift card').

BAD NEWS: We can't sell the property before 7 years, or else we owe all this money back....but.....our plan all along was to hold the properties for the LONG-TERM right, so no worries?

MORE BAD NEWS: Our rate sucks, so that means the mortgage wont get paid down as quickly. However the property still goes up just the same in value so we should still make good money in the LONG-TERM.

Where Will Our Net Worth be in 2008?

Assuming house prices stay flat for the remainder of the year, and simply focusing on mortgage paydown I took a sneak peak into our 2008 Net Worth using a mortgage calculator.

It would be interesting IF house prices stay flat as this would defy the blogisphere which is obsessed with our global housing "Bubble". It would also defy the professionals such as CREA who are calling for 6.9% property appreciation on a National level. Who to believe? Don't care. All I know is that we've selected some Prime real estate and the mortgages will be going down and we are holding LONG-TERM, through the cyclical ups & downs.

Anyways here goes:

Property Eight will be reduced from $383,500 to $379,973.11 in January 3rd 2008 = contribution to Net Worth of $3,526.89
Property Seven will be reduced from $140,400 to $139,880.75 in January 2008 = contribution to Net Worth of $519.25
Property Six will be reduced from $128,000 to $126,863.44 in January 2008 = contribution to Net Worth of $1,136.56
Property Three will be reduced from $89,717 to $88,928.94 in January 2008 = contribution to Net Worth of $788.06

We will be converting some of Properties ONE, TWO and FIVE into very small cashback mortgages in which the cashback will improve our Net Worth by $10,000 (approximate I rounded this off). The drawback to this of course is that the interest rate goes higher.

Three of our unsecured loans will be eliminated entirely. That produces $8,035.70 that goes right to our Net Worth.

Adding up all the above greenery totals $24,006.46 and adding that to our current Net Worth of $504,905.30 will make our January 2008 Net Worth $528,911.76. A 4.75% gain in Net Worth in just mortgage paydown alone.

Again, this does not include any appreciation whatsoever. Will revisit this in January and see where we are in actual comparison. I did this post as a reminder that mortgage paydown adds to the bottom line Net Worth as I often focus so much on the capital appreciation of investments.