What Is Rental Cash Damming?
Cash damming is a strategy to convert the personal debt, whose interest is not tax-deductible, to business/investment debt, whose interest is deductible.
This technique uses the cash flows from a rental property to gradually convert personal mortgage debt into more tax-efficient debt to cover the rental property expenses.
This is achieved using the cash flows from the rental to pay down the non-deductible primary residence mortgage. The equity is then drawn out via a line of credit to pay the rental property’s expenses.
Who Is In The Best Position To Take Advantage Of Rental Cash Damming?
The rental cash damming strategy is ideal for homeowners who have a mortgage on their principal residence with at least 15 years remaining on their amortization, and who also own (or plan to own) a residential investment property.
There are other variations on the cash damming technique that may be appropriate for Canadians who are self-employed, and/or wish to invest in the capital markets, but for the purpose of this article, we will focus exclusively on the benefits for real estate investors.
Seek Professional Guidance Before Attempting…
Although cash damming has been technically approved by the Canada Revenue Agency, the actual implementation of the strategy has a few moving parts, and it’s highly recommended to seek guidance from a mortgage professional who understands and can advise on more advanced financial techniques.
To find out more, we caught up with Jason Henneberry, founder of Strategy Hub, for his advice on important considerations when deciding if rental cash damming is an appropriate strategy for portfolio growth.
“Most homeowners don’t realize their mortgage is perhaps the most powerful and flexible financial tool they have at their disposal”, says Jason. “The problem is most Canadians just don’t know how to use it to their advantage.”
Over the course of his career, Jason has helped hundreds of families implement advanced financial techniques, and he recently launched a new homeowner education series about rental cash damming, which can be found on Strategy Hub here.
How Does It Work?
The concept behind the strategy is commonly understood among Canada’s affluent homeowners.
The financial technique has been utilized for decades by wealthy Canadians to support the tax-efficient management of debt, and to maintain their financial advantage.
According to Jason, “Cash damming has grown in prominence in recent years as a tried-tested-and-true methodology for real estate investors seeking to generate additional tax benefits, which can be used to pay down their mortgages faster and get further ahead financially”.
Instead of directly using the income generated by the investment property to cover the rental expenses, the cornerstone of the rental cash damming approach is to use the rental income to pay down the real estate investor's primary residence mortgage as a first step, and then borrow the funds required to cover the expenses on the rental property.
The result is a rapid paydown of their non-deductible primary residence mortgage, which is essentially converted into a tax-deductible investment loan that is used to run their landlord business.
The converted debt generates new incremental tax benefits that can be used to pay off their mortgages faster, and ultimately reinvested to build additional wealth for the future.
Cash Damming Fundamentals
Before implementing the strategy, you’ll need to make sure you have a few key things in place, including dedicated bank accounts and a mortgage that allows you to re-borrow your principal as you pay it down.
Cash damming requires:
- Two separate bank accounts to keep deductible and non-deductible cash flows separate.
- A re-advanceable home equity line of credit that is secured by the primary residence.
The cash damming approach uses the gross rental income to:
- Pay down your non-deductible primary residence mortgage.
- Draw from the line of credit to service the rental property expenses.
- Use the tax refunds from the strategy to pay off your mortgages faster.
With this methodology, investors and rental-property owners pay off their primary residence mortgage in record time and finance one hundred percent of their landlord business expenses.
Their overall debt load remains the same, but it becomes more tax efficient. Over time, the additional tax refunds and interest savings that are generated by the strategy can add up to tens of thousands, even hundreds of thousands of dollars in savings over the life of their mortgage.
Giving Credit Where Credit Is Due.
It’s worth noting that to make this strategy work, a real estate investor or rental property owner should have a high credit score. This is because the lender products that are required to execute the strategy are only available to AAA borrowers in order to qualify for this type of mortgage structure.
Being able to access lending products that offer more advanced features and functionality is one of the main reasons it’s so important to maintain a solid credit rating.
One technique used by savvy investors to ensure their credit score remains pristine and as high as possible is through regular monitoring and diligent investigation of any outliers. It’s not uncommon for personal finances to impact professional goals and, by extension professional life.
What Are The Advantages Of The Rental Cash Damming Strategy?
The single biggest advantage is tax savings.
Specifically, this approach allows rental property owners and investors to re-organize their cash flows more efficiently to:
- Reduce their primary residence mortgage by rapidly paying it down with cash flow from the rental portfolio.
- Convert non-deductible personal debt to more tax-efficient business debt.
- Apply the tax-deductible interest charges as new deductions against their income.
- Generate free tax refunds and apply for those refunds as additional pre-payments on their mortgage to accelerate their amortization.
- Re-invest the savings to build additional wealth for their future.
Having helped many families put this strategy to work, Jason has a few tips for sourcing guidance and support on how best to get started… “I highly recommend investors seek guidance from professional advisors who understand the mechanics behind the strategy before implementing the cash damming technique”.
- A Mortgage Broker will be able to help you select the right mortgage structure that allows for expedited repayment terms, and automatic re-advancement of principal to streamline the debt conversion process.
- If you don’t already own a rental property, or are planning to purchase a new rental, your local Realtor should be able to help you source properties to maximize the cash flows that can be applied to the strategy.
- Check with a certified tax professional to make sure you are cash damming tax-deductible rental property expenses to ensure 100% eligibility of your deductions and refunds.
- It’s also worth noting, for self-employed individuals and market investors, that it’s possible to cash dam business and other investment expenses that may be suitable for interest deduction; whenever in doubt, it's always a good idea to confirm your eligible expenses with a tax professional first.
Keep in mind this strategy takes time. There’s no magic bullet, so patience is essential. For this technique, the debt conversion process typically takes between 6-12 years. While the overall benefits of the strategy can knock years off your mortgage and save you tens of thousands in interest and taxes. Cash damming requires proper planning, self-control, and steadfast implementation.
In Conclusion,
Cash damming may appear straightforward in theory, but it can be complicated in practice. As with any financial strategy, it's important to make sure you fully understand how it works, and the many steps required to successfully execute the technique. For optimum results and to ensure proper implementation, it’s best to seek guidance from a mortgage professional and a tax specialist who fully understand the strategy.
To learn more about how cash damming works and other advanced financial strategies, or to connect with Jason directly, please visit https://www.mystrategyhub.ca/
