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If you’re looking for new capital to build a significant investment or retirement portfolio while giving you a tax break, perhaps you should think cottage country. It’s great to have a vacation getaway, somewhere to relax and enjoy well-deserved time off with family and friends. But did you know you can also use the equity in your cottage to expand your investment portfolio and save on taxes?
When you leverage the equity in your cottage to back an investment loan, you can deduct the interest, providing there’s a reasonable potential for income from the property – interest, dividends, rent or royalties. On your tax return, you claim a deduction for the interest paid as a carrying charge – significant because the interest cost can fully offset other income without restriction at your marginal tax rate. The higher the income, the bigger the benefit. |
Example:
Let’s say your annual income is $63,000. The cottage is valued at $300,000, and you arrange a $100,000 loan, using the equity in the cottage as collateral. The money is invested in the marketplace in a non-registered account, with the potential for earning dividends and interest. The interest paid is deductible and is used to reduce the $63,000 taxable income without restriction.
Investment Details
| Amount invested |
$100,000 |
| Interest cost of investment loan (at 5%) |
$5,000 |
| Before-tax return of investment (at 8%) |
$8,000 |
| Before-tax return on the investment |
$3,000 |
|
|
|
Investment earnings
| |
Interest |
Devidends |
| Taxable income before investment |
$63,000 |
$63,000 |
| Taxable interest income |
$8,000 |
|
| Taxable dividend income (45% gross-up) |
|
$11,600 |
| Less interest cost of investment loan |
($5,000) |
($5,000) |
| Revised taxable income |
$66,000 |
$69,600 |
| |
|
|
| Tax on revised income |
$16,535 |
$14,473 |
| Tax on income before investment |
$15,492 |
$15,492 |
| Tax on investment income |
$1,043 |
($1,019)1 |
| |
|
|
| Gross return on investment |
$8,000 |
$8,000 |
| Less interest on investment loan |
($5,000) |
($5,000) |
| Less tax on investment income |
($1,043) |
$1,019 |
| Net after-tax return on investment |
$1,957 |
$4,019 |
| Return on investment ($100,000) |
1.96% |
4.02% |
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1Dividend tax credit exceeds increase in taxes resulting in a reduction in tax.
Note: The annual tax-deferred gain on $100,000 equity invested in the stock market should also be factored in, as well as the evaluation of risk and return, which fluctuates in the marketplace. Ask your tax advisor to prepare possible scenarios to assess potential costs and savings.
When you consider the tax savings, together with the potential of current investment returns, the result can be quite attractive, depending on investment income source.
Take another look at the potential for enjoyment from your family cottage. It could be used to create more than just fun in the sun. Leveraging the property’s equity may provide a new avenue for investment growth and tax savings, leading to increased wealth.
Evelyn Jacks is President of The Knowledge Bureau and author of 40 best-selling books on personal income taxation, including her latest, Essential Tax Facts.
This article of a general nature. Neither the author, The Knowledge Bureau, its employees, its subcontractors or others associated with The Knowledge Bureau can take responsibility for any results, positive or negative, taken by any persons. While the author received a fee to write this article, she is not in the business of providing advice on investment products and is not registered and licensed to do so, nor does the author have any compensatory relationship, or beneficial ownership regarding the sale of investment products discussed herein.
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