Cash Damming on a Rental Property: How It Works and When It Doesn't

Cash damming converts non-deductible rental property mortgage interest into deductible HELOC interest — but the readvanceable mortgage structure, CRA rules, and HELOC carry cost need to align for it to be worthwhile. This strategy involves using a Home Equity Line of Credit (HELOC) to pay off your mortgage, effectively turning your mortgage interest into tax-deductible investment income.

What is Cash Damming?

Cash damming is a financial strategy used by Canadian rental property owners to convert non-deductible mortgage interest into deductible interest. This is achieved by using a HELOC to pay off the mortgage on an investment property, allowing you to deduct the interest paid on the HELOC as an expense against your rental income.

How Cash Damming Works

Here's a step-by-step breakdown of how cash damming works:

1. Obtain a readvanceable mortgage, which combines a mortgage and a HELOC. The mortgage covers the purchase price of your rental property.
2. Use the HELOC portion to pay off the mortgage balance.
3. The interest paid on the HELOC is now tax-deductible as it is considered an investment expense against your rental income.

Benefits of Cash Damming

Cash damming offers several benefits, including:

• Tax savings: By converting non-deductible mortgage interest into deductible HELOC interest, you can reduce your taxable rental income.
• Flexibility: A readvanceable mortgage provides the flexibility to access funds as needed without having to reapply for a loan.

Drawbacks of Cash Damming

While cash damming can be beneficial, it also has its drawbacks:

• Higher interest rates: HELOC interest rates are typically higher than mortgage rates, which can offset the tax savings.
• Complexity: The strategy involves managing two separate financial products and understanding the tax implications.

Cash Damming vs. Traditional Mortgage

The following table compares cash damming with a traditional mortgage:

Cash Damming and the CRA

The Canada Revenue Agency (CRA) has specific rules regarding cash damming. To qualify for tax deductions, you must:

• Use the HELOC funds to invest in income-generating assets.
• Maintain proper documentation of your investments and expenses.

When Cash Damming is Not Worthwhile

Cash damming may not be the best strategy in certain situations:

• If you have a low rental income, the tax savings from deductible interest may not offset the higher HELOC rates.
• If you prefer the stability of fixed mortgage payments over the flexibility of a HELOC.

Key Takeaways

Cash damming can be a powerful strategy for rental property owners looking to reduce their taxable income. However, it's essential to weigh the benefits against the drawbacks and consider your financial situation carefully. Here are some actionable steps:

1. Evaluate your rental income and expenses to determine if cash damming is financially beneficial.
2. Consult with a financial advisor or tax professional to understand the implications of cash damming on your specific situation.
3. Consider the long-term goals for your investment property and whether cash damming aligns with those goals.

By understanding how cash damming works and when it's appropriate, you can make informed decisions about managing your rental property finances effectively.