Canadian real estate purchasing strategy to deduct interest costs

I have a liquid net worth of 400k, generally invested in a diversified
group of equities, bonds, and PM funds (fully paid for; ie. no margin
used yet). I'm planning on purchasing a $150k propert, putting 25% as
a downpayment, and was originally considering putting the rest on a
25-year mortgage without touching my investment portfolio - basically
I'd pay ~690 per month @4.8% for a 25year mortgage (interest payments
would originally cost roughly $475/month). In Canada, the mortgage
interest payments aren't tax-deductible, but the interest payments on
one's investment account (nonRSP) are deductible. So I thought of an
alternate strategy, which would be to take out roughly 120k as borrowed
cash from my investment portfolio (ie. not sell any of my securities)
and thus use that as a margin loan for the remainder of the portfolio,
and apply the 120k towards the house. This way, instead of paying
interest on a mortgage loan, I'd pay margin interest instead, which
should be fully deductible. The current margin interest rate is 4.72%.
Does this strategy make sense? I don't think I'd be taking on extra
risk, since the net cash and equity position would remain the same,
except the the loan would be coming from the brokerage firm instead of
a mortgage lender. I calculated that the net savings would be roughly
2300 in the first year (assuming 40% tax rate).

One concern would be interest rate risk; if rates were to rise, the
margin interest paymetns would go up. But would it be possible to
hedge that by buying or selling an interest rate futures contract?

Re: Canadian real estate purchasing strategy to deduct interest costs

wrote:
> I have a liquid net worth of 400k, generally invested in a diversified
> group of equities, bonds, and PM funds (fully paid for; ie. no margin
> used yet). I'm planning on purchasing a $150k propert, putting 25% as
> a downpayment, and was originally considering putting the rest on a
> 25-year mortgage without touching my investment portfolio - basically
> I'd pay ~690 per month @4.8% for a 25year mortgage (interest payments
> would originally cost roughly $475/month). In Canada, the mortgage
> interest payments aren't tax-deductible, but the interest payments on
> one's investment account (nonRSP) are deductible. So I thought of an
> alternate strategy, which would be to take out roughly 120k as borrowed
> cash from my investment portfolio (ie. not sell any of my securities)
> and thus use that as a margin loan for the remainder of the portfolio,
> and apply the 120k towards the house. This way, instead of paying
> interest on a mortgage loan, I'd pay margin interest instead, which
> should be fully deductible. The current margin interest rate is 4.72%.
> Does this strategy make sense? I don't think I'd be taking on extra
> risk, since the net cash and equity position would remain the same,
> except the the loan would be coming from the brokerage firm instead of
> a mortgage lender. I calculated that the net savings would be roughly
> 2300 in the first year (assuming 40% tax rate).
>
> One concern would be interest rate risk; if rates were to rise, the
> margin interest paymetns would go up. But would it be possible to
> hedge that by buying or selling an interest rate futures contract?

You should probably consult a lawyer about that. Here is how I
think it works (but I'm not an expert on this). It doesn't matter
whether your loan is from the bank or a margin loan from your
stock broker. What is important is what the money is used for.
So if you borrow on margin from your broker and use the money
to pay the mortgage, then the loan wasn't used for investment
it was used to pay another debt and interest is not deductible.
What you could do is sell $120k of equity, pay the mortgage then
go to the bank and get another $120k loan (you can mortgage your
house to get a better interest rate on this new loan) and this
time the loan isn't used to buy a house (you already own your
house) it is used to buy $120k worth of equity from your broker
so interest are deductible.


Alain Fournier

Re: Canadian real estate purchasing strategy to deduct interest costs

wrote:

> ... the interest payments on
>one's investment account (nonRSP) are deductible. So I thought of an
>alternate strategy, which would be to take out roughly 120k as borrowed
>cash from my investment portfolio (ie. not sell any of my securities)
>and thus use that as a margin loan for the remainder of the portfolio,
>and apply the 120k towards the house. This way, instead of paying
>interest on a mortgage loan, I'd pay margin interest instead, which
>should be fully deductible. The current margin interest rate is 4.72%.
> Does this strategy make sense? I don't think I'd be taking on extra
>risk, since the net cash and equity position would remain the same,
>except the the loan would be coming from the brokerage firm instead of
>a mortgage lender. I calculated that the net savings would be roughly
>2300 in the first year (assuming 40% tax rate).

Revenue Canada gets picky about this. You cannot set up a credit line
secured against the stocks and say that this is debt for the stocks.
You actually have to make the purchases using the debt. You should
talk to a tax specialist. You MIGHT have to sell (some of) the
stocks, stay sold for at least a month (to prove that it's not a bogus
sale and repurchase), then buy the stocks using credit.

And the credit used to buy the stocks doesn't have to be credit
secured against the stocks. You can buy the house using a HELOC, pay
that line of credit down to zero by selling stocks, then borrow from
that heloc to re-buy the stocks, perhaps at least a month later (ask
your tax guy). The stocks bought by borrowing from the HELOC (home
equity line of credit) are now allocated against specific debt that
was taken on to make the purchase. RevCan cares about the
distinction.

By selling and re-buying, you will need to calculate your capital
gains. And there are transactional costs.


>One concern would be interest rate risk; if rates were to rise, the
>margin interest payments would go up. But would it be possible to
>hedge that by buying or selling an interest rate futures contract?

Using the HELOC strategy, you can lock in interest rates on some or
all of the line of credit. When I did this for my Toronto townhouse
purchase, we locked in our interest rate for most of the line of
credit on a three year basis. And some of that locked-in interest was
deductable against my stock purchases.

I have a complex spreadsheet that allocates each month's interest from
various debts against various "accounts" that used the credit. Three
of these columns are deductable against stock income or other income I
took on debt to earn.

One problem with using the HELOC strategy is if you have to move. I
set up a line of credit for my stocks, but we sold that townhouse. I
didn't have enough credit line to cover the deductable debt, and paid
some of it down. When we bought the next place, those stocks weren't
rebought on the new credit line, so weren't locked in as deductable.
Then we moved again. Only about 15% of my non-RRSP portfolio is
allocated against debt, and our mortgage is fairly large and
non-deductable. I could probably have handled the handoff between
various properties better.
--
Tomorrow is today already.
Greg Goss, 1989-01-27

Re: Canadian real estate purchasing strategy to deduct interest costs

Thanks for the replies, Alain & Greg. I'll call my accountant this
week, but what I'm getting is that, 1) a home equity loan or secondary
mortgage could work and have the interest deductible (as long as the
cash received is used to buy securities/investments), so I don't have
to use margin debt, and 2) There has to be evidence that the cash
incurred from such a loan is used to buy the securities; a margin loan
in itself is inadequate. So basically I'd need to sell my securities,
and use the cash to buy the home, and incur capital gains/etc....and
wait a certain period before repurchasing the securities (which would
render me vulnerable to mkt fluctuations). Is it possible for me to
hedge the risks by buying futures? Many of my investments are in
index-funds, or large-cap stocks; index and single-stock futures could
be used to purchase futures contracts tracking the securities I'd have
sold, and then selling the contracts (and buying the related stocks)
once I reobtain the cash from the HELOC/mortgage credit. This way I
can neutralize market fluctuation risks. Would CCRA frown on this? Or
would they even care?

Re: Canadian real estate purchasing strategy to deduct interest costs

Thanks for the replies, Alain & Greg. I'll call my accountant this
week, but what I'm getting is that, 1) a home equity loan or secondary
mortgage could work and have the interest deductible (as long as the
cash received is used to buy securities/investments), so I don't have
to use margin debt, and 2) There has to be evidence that the cash
incurred from such a loan is used to buy the securities; a margin loan
in itself is inadequate. So basically I'd need to sell my securities,
and use the cash to buy the home, and incur capital gains/etc....and
wait a certain period before repurchasing the securities (which would
render me vulnerable to mkt fluctuations). Is it possible for me to
hedge the risks by buying futures? Many of my investments are in
index-funds, or large-cap stocks; index and single-stock futures could
be used to purchase futures contracts tracking the securities I'd have
sold, and then selling the contracts (and buying the related stocks)
once I reobtain the cash from the HELOC/mortgage credit. This way I
can neutralize market fluctuation risks. Would CCRA frown on this? Or
would they even care?