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What is tax-deductible mortgage interest?

Ask an Expert: Cait Holmes

You have the option to have your mortgage interest considered “tax-deductible” depending on how you use the property.

Property generates rental income
When it comes to rental properties and your mortgage interest, you are able to claim back all (or a portion) as the interest is considered part of the operating cost for a rental. What you get back will depend on the proportion of the space rented and the length of time the property was generating rental income.

Property is your primary residence
Writing off mortgage interest on a primary residence is known as the Smith Maneuver, whereby you turn your mortgage into an investment loan. On average, utilizing this method will allow a typical 25-year mortgage to be fully tax deductible in 22.5 years.

Here’s what to do:

• First you need to get a readvanceable mortgage. This type of loan combines your mortgage with a home equity line of credit.

• The purpose of this is that, as you pay down your mortgage, your HELOC will increase. This allows you to borrow more money again as the mortgage is being paid down.

• You then utilize the HELOC and borrow to invest.

• Now that you have made your HELOC an investment loan, you can claim the interest you pay as a deduction against your income.

The risks

Keep in mind, problems can arise if a homeowner spends the funds as opposed to reinvesting them. Tax refunds have to flow through the investment cycle in order to realize the benefits of paying down the mortgage – and making as much of the interest tax deductible as possible.

Additional short-term risk includes your cash flow as there is always the possibility that interest rates will rise, thereby driving up the cost of borrowing at the same time as markets falter, resulting in a negative client monthly cash flow for a brief period of time.

Next steps

Before changing your mortgage or doing any investing, it is important to consult your certified financial planner and your mortgage professional to ensure you are making the right moves to best suit your needs and situation.

Cait Holmes is a mortgage broker in the qathet region.

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