Rental Cash Damming 101, Part 1
August 10, 2023 | Posted by: Harold Hagen
What Is Rental Cash Damming?
Cash damming is a CRA-approved financial strategy aimed at transforming non-tax-deductible personal debt into tax-advantaged business or investment debt. This strategy leverages the income generated by a rental property to systematically shift personal mortgage debt into more tax-efficient categories, specifically to handle the expenses associated with the rental property.
The process involves channeling the rental income towards paying off the primary residence mortgage (not the rental expenses), which are typically not eligible for tax deductions. Consequently, equity is accessed through a Home Equity Line of Credit, which is then employed to cover the costs related to the rental property.
Cash damming has garnered substantial recognition in recent years as an established, CRA-approved financial strategy for real estate investors to unlock additional tax advantages. These advantages can be utilized to expedite principle residence mortgage payments, propelling them even further towards their goal of mortgage freedom.
Who Is In The Best Position To Take Advantage Of Rental Cash Damming?
The rental cash damming strategy is most advantageous for individuals who own a principal residence with outstanding mortgage debt and remaining amortization period of at least 15 years. You also own (or would consider owning), a residential investment property.
While there exists alternative adaptations of the cash damming approach that cater to self-employed Canadians or those interested in capital market investments, our current focus within this article will solely emphasize the advantages pertinent to real estate investors.
How Does It Work?
The fundamental concept behind this strategy is well understood among Canada's affluent homeowners. This financial technique has been employed by wealthy Canadians for decades to effectively manage debt in a tax-efficient manner, thereby maintaining their financial edge.
Rather than directly utilizing the income generated by the investment property to cover rental expenses, the core principle of the rental cash damming approach involves utilizing rental income as the initial step to pay down the the real estate investor’s principle residence mortgage.
Subsequently, the funds to cover rental property expenses are borrowed back from the accruing home equity.
The result is a rapid paydown of their non-deductible primary residence mortgage, effectively transforming it into a tax-deductible investment loan, which is then used to manage their landlord business. This converted debt generates fresh incremental tax advantages, empowering them to accelerate mortgage repayment and ultimately reinvest in building additional wealth for their future.
Although cash damming may seem straightforward in theory, its practical implementation can be complex. Like any financial strategy, it's crucial to have a comprehensive understanding of its workings and the numerous steps needed to execute successfully. For the best outcomes and to ensure implementation that is CRA compliant, we highly recommended seeking guidance from both a knowledgeable mortgage professional and a tax specialist who have a deep understanding of the strategy.
