Tax Implications Of Refinancing Your Rental Property

hi everyone welcome to my real estate tax tips channel my name is cherry chen a chartered professional accountant located in ontario canada my mission is to become the google map for hardworking canadians seeking financial freedom now one way to achieve financial freedom is by investing in real estate one of the benefits of real estate investment is the ability to use leverage to invest in your favor what it means is that when you first purchase a rental property you get to borrow from the bank a mortgage to help finance your purchase you don't put up the entire hundred percent of the money you put up only the down payment when the property values appreciate the banking system also allows you to refinance the property to extract a portion of the appreciation early without immediate tax implication it's kind of like your own piggy bank you may use the funds to purchase more properties you may use the funds to repay your initial investment whatever you want to do the tax implication may be different now today we are going to discuss the little non-tax implication on refinancing your rental properties before i get started make sure you subscribe to our youtube channel and turn on the little notification button below so you can stay on top of the latest text tips if you have any questions or comments leave them in the comment section below and we will get back to you now let's get started over the years many real estate investors have questioned what are the tax implications when i'm refinancing a rental property should i sell my rental property to cash out or should i refinance my rental property to take some of the equity out let's begin by looking at how refinancing works say you purchased a property two years ago for five hundred thousand dollars since then the market has been doing really well and your property value shot up to eight hundred thousand dollars assuming you qualify for financing refinancing the property to eighty percent loan to value can give you an additional two hundred and forty thousand dollars for your next investment suite isn't refinancing the real power of real estate investment most investors wonder are there any tax implications when i refinance my rental property would i need to pay cla a portion of the refinance money i got out of the property the answer is it depends tax impact on refinancing the rental property when you own them personally versus when you own them in the corporation are very different if you own the property personally there is no immediate tax implication when you refinance the property however you need to pay attention to how you use the funds from refinancing in canada you're only allowed to deduct the interest on money borrow for investment purposes like mortgage interest that you incur to earn rental income that mortgage interest is tax deductible but if you use the funds to pay down your principal residence mortgage the interest related to the refinanced money that is the 240 thousand dollars from our example earlier is not tax deductible i generally tell my clients to use those funds to pay off the initial line of credit that they use to finance the purchase of the rental property or use it for the down payment on their next investment property just so that they would be able to continue to deduct their mortgage interest by continuing to use the funds for investment purposes you can keep entire mortgage interest expense tax deductible the bottom line is really that there is no immediate tax implication when you refinance the property that you own in your personal name however there could be interest expense deductibility issue depending on how you use the funds sometimes the interest expense can be tax deductible sometimes the interest expense may not be tax deductible if you use the fund just to pay down your primary residence mortgage or for this new trip just a word of caution though just because there is no immediate tax implication from refinancing your property it doesn't mean that there is no cash flow impact refinancing is just a form of cashing out early the amount available for you when you sell the property is reduced by the amount you have taken out early from refinancing essentially you're just taking money out earlier way earlier now let's use an example to explain say you purchase a rental property for and fifty thousand dollars a number of years ago with an initial mortgage of two hundred thousand dollars you've refinanced the property a few times over the years and currently the mortgage has an outstanding balance of five hundred thousand dollars and now you decide to sell it for eight hundred and fifty thousand dollars remember you purchase the property a number of years ago for two hundred and fifty thousand you just decide to sell it for eight hundred fifty thousand dollars so cap from a capital gain tax calculation perspective you take the net proceeds of 850 000 subtracted a regional purchase price of 250 000 your capital gain is 600 000 now your capital gain inclusion rate right now it's only fifty percent so only fifty percent of the capital gain is taxable so only three hundred thousand dollars is taxable and assuming that you are earning the highest marginal tax rate in ontario you're paying tax at 50 so roughly tax cap tax payable on the capital gain is 150 000 50 on the 300 000 for 150 000 now you might have thought that oh if i take 850 000 minus my 150 000 that would that should be really what you would receive in terms of net cash available at the end but the reality is from the cash flow from sale is really calculated from based on the net proceeds 850 000 and the mortgage outstanding at the time of sale at the time of closing and if our example is 500 000 dollars your tax payable is still 150 000 your after tax cash available from sale is only 200 000 on the other hand if you have never refinanced before and never pay down the mortgage at all the initial mortgage of two hundred thousand dollars and you still pay the same hundred and fifty thousand dollars uh tax because tax calculation is the same whether you fight refinance your property or not you take 850 000 minus the mortgage outstanding at the time of sale of which is 200 000 and then minus the tax payable the net cash available from sale is 500 000 as you can see there is a delta of three hundred thousand dollars the delta it really comes from you extracting and refinancing the property early and extracting that three hundred thousand dollars out early and so the cash flow impact is very different from the capital gain tax calculation now we just cover the tax implication on refinancing the rental property if you were to own the rental property in your personal name the next step is to look at the if tax implication on refinancing the rental property if you own the rental property in the corporation now if you own this same property inside the corporation the tax impact can be slightly different when you decide to take out 240 000 from the property same as the very first example i used earlier similar to owning the property personally you can deduct 100 of the interest provided that you use the funds to earn income inside the corporation you can use the borrow funds to invest in stocks do private lending earn interest income or even invest in business ventures inside the same corporation or buy another investment property within the corporation structure these are all sample investment activities that allow you to deduct the additional interest incurred if you choose to refinance the property and take this 240 thousand dollars out of the corporation you may have a large amount of tax liability depending on how much the corporation owes you it doesn't matter whether you are taking this 240 000 out of the corporation for investment purpose or for personal use the same tax implications can apply let's use an example to explain let's say you initially loan sixty thousand dollars to the corporation to purchase a rental property and this corporation has only one property and owes you just this sixty thousand dollar initial investment the additional two hundred forty thousand dollars that you just got from the bank from refinancing and you would like to extract the entire amount out of the corporation unfortunately only sixty thousand dollars of the two hundred and forty thousand would come to you tax free with to repay your initial investment but if you extract more than sixty thousand dollars any additional amount is subject to your marginal tax rate in your personal name the additional the excess hundred and eighty thousand two hundred forty thousand minus is the sixty thousand dollars the one hundred eighty thousand dollars can be distributed to the shareholders in the form of dividends and shareholders would report that in their personal tax returns on the other hand if the corporation owes you 300 000 to begin with you can extract the entire 240 000 without triggering any tax implication if you're using these additional funds to invest my recommendation is to invest inside the corporation no money is directly going into the shareholders pockets no immediate tax impact but when you decide to sell the property inside the corporation the same tax liability would trigger fifty percent of the capital gain is taxable and fifty percent of the capital gain is non-taxable you can take out the 50 non-taxable amount of capital gain in your personal name no no tax implication the other 50 when you take it out you still have to go through the similar calculation look at how much the company owes you first use it as a repayment and any excess fund would be deemed to be reported would be reported as dividend and it would be added to your dividend income on your personal income tax return again if you were to cash out and take all the money from the corporation for personal use depending on your situation dividend income would have to be reported more often than not i recommend my clients to refinance a property rather than selling it refinancing compared to selling has a lesser tax impact you may even end up having the same amount of money left in your pocket after paying cla and you still get a house in the end below are some popular questions about refinancing your rental properties along with the best answers i have without knowing more about specific situations now first question i got if the first property is refinance but it is still a principal residence does does it still matter where the money goes well it doesn't really matter where the money goes it only matters when you use the money for investment purpose the interest is then deductible on the amounts that you use for investment purpose and interest deductibility really depends on the use of funds if the primary residence is refinanced and that funds are used for the purpose of investment then you can deduct the interest incurred on the money borrow to earn investment income whether it is interest income rental property income they're all deductible now second question i refinanced my first home mortgage at all payout and use those funds to buy my second home i then rented that first home to generate rental income and move into my second home would the interest from the first home be tax deductible because right now you're generating rental income well unfortunately again interest deductibility depends on the use of funds and it's the direct use of funds if the funds from refinancing the first home were used to purchase a new residential home your new primary residence then interest related to this amount is not deductible because it's not allowing you to earn any additional rental income it's only buying your primary residence home there are ways to get around it make sure that you schedule a pay consultation with us and then we'll be able to advise you accordingly now the third question if i refinance and take out what i already pay on the down payment and the property is only my personal name isn't that portion already taxed will i not be able to deduct the interest in full on the refinance amount to just repay my initial investment well the truth is that because you are you when you purchase the property in your personal name when you repay yourself repay yourself cla doesn't look at it that way cia still goes back to how you use the money if the money you took out was used for investment purpose then yes the interest is deductible as interest deductibility is based on direct use of funds however there is no such thing as repayment of what you originally invest when the property is purchased in your personal name in the corporation we already went through the example earlier on and you would still be able to repay your initial investment via the repayment of shareholder loan now that we have covered the tax implication on refinancing your rental property whether you own it in the personal name or in the corporation you get a better understanding of how refinancing may affect you and there are strategies available to make sure that you can maximize the interest deductibility of the refinance funds if you like this video make sure you give us a thumbs up and make sure you subscribe to our youtube channel below if you have any comments make sure you leave it down below so i can read it all and respond to all of your comments until next time you

Channel: RealEstateTaxTips

Views: 11,915

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Id: eeY3E5Tf3Mg

Length: 14min 46sec (886 seconds)

Published: Wed Dec 29 2021