For our purposes;Cash-Flow is defined as gross rent, in our example $2,500 per month, minus all of the cost to own the investment property (legal, carrying cost or interest charges, general repair or maintenance and taxes)
Example No.1:
Property 1. $200,000.00
Rent: $1,250 per month
Interest cost:
Taxes: $200.00
Maintenance: $200.00
Vacancy: $100.00
Management: $100.00
Positive cash–flow $650.00
As you can see by this first chart, without an interest cost (mortgage), we have created income, which is taxed at the individuals highest marginal tax rate. If they bought two homes this would create $1,300 a month of positive cash flow or $15,600.00 of new income to be taxed by our friends in Ottawa. There is a time and place to create new income, but we are trying to create an income stream down the road, not today because you presumably already have income. The message is clear; you must use leverage to create wealth.
We create Negative cash flow by adding an interest component to the above equation. In other words, we finance the purchase. So, instead of purchasing these homes free and clear, we finance 80% of their value. This impacts my client in two very important ways.
Example no.2:
Property 1. $200,000.00
Rent: $1,250 per month
Est. Interest cost: $1,000.00
Taxes: $200.00
Maintenance: $200.00
Vacancy: $100.00
Management: $100.00
Negative cash–flow ($350.00)
It creates a Negative Cash Flow of ($350.00) per month per home or a tax deduction of $8400.00 per year. This will give you a refund of $4,000.00 at tax time.
You still have $320,000.00 of capital to invest because you are now using the Bank’s money to buy these two properties.
This legitimate tax strategy will allow you to buy more property using as little of your own equity as possible. Taking the above the example to the extreme, this couple could continue to buy homes until their entire $320,000.00 of equity is consumed.
*I recognize that this is a very aggressive strategy to use for your investment properties but I want to illustrate my point. If this couple purchases ten investment properties with negative cash flow of $350.00 per unit, they would create a loss for tax purposes of $42,000.00 (10 homes $350.00 per month of negative cash flow * 12 months). Assuming a 48% marginal tax rate, you would receive a refund of $20,160.00.
To illustrate the point – the government can assist in the investment property process but understand this point, creating a cash flow loss of this magnitude is not suggested or necessarily easy to accomplish. While this property investment strategy may not work for all investors; it clearly demonstrates that there is a right way and a wrong way to finance real estate investments.
So back to our example, to think full circle in finance, we need to look at the complete picture.
This client should sell their existing home and buy the new home in the country free and clear. After they close and move into the property, I would arrange a new secure line of credit which is designed to allow interest only payments. The flexibility of the line will permit a slow deployment of their capital as real estate opportunities come into the marketplace. Generally, 75% of the value of their home or, $300,000.00 will accomplish their 5- year plan.
Before making any significant financial decisions, always make sure to take the time to review all of your options with a trusted professional. If you have any questions, comments or concerns, feel free to comment below or to e-mail the MonsterMortgage.ca team at info@MonsterMortgage.ca
From here on in everything is set up perfectly. The interest on every dime they borrow is 100% deductible, even down to their down payment which will now be coming from their line of credit. They will have created the perfect tax advantaged investment. The negative cash flow created is fully deductible from other income earned in that tax year.
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