When I talk to people who buy rental properties the main reason they make this type of investment is to earn income from the rent, get a tax deduction on the rental mortgage and in the long term the expectation that the value of the rental property will go up.
They won’t talk about the ongoing maintenance & upgrade costs, the rising property taxes or the renter who decides he isn’t paying last month’s rent because the furnace doesn’t work. Nor do they recognize that 5% of the selling price plus GST will go the real estate agent when they sell the property.
Over time if done right this works for many people. The problem lies with putting all your eggs in the real estate basket. Will the market be where you want it to be when you wish to sell?
In contrast, when an individual borrows money to buy mutual funds for example, they trust that the funds assets are diversified into different areas like financial stocks, commodities, cash and even bonds. Mutual funds can of course be purchased with as little as $50 while it is impossible to buy those same individual investments with as little cash.
This is not to say that mutual funds are a better investment than rental properties. However, one can buy different type of stocks via mutual funds with relatively little money.
If you are a rental property owner, one can assume that you are a long term investor.
Consider this also: Stock markets prices fluctuate. Some days the price goes up, while other days it goes down. If you own rental property, would you know the daily price of your house? Of course not, because you are in this investment for the long term. Likewise, mutual funds need to be viewed in the long term, at least 7 years, or you may be disappointed.
Lets talk about tax deductible interest on the leveraged purchase of mutual funds. If you read media articles about deductible interest and restructuring debt, there may be some confusion. Go to www.cra-arc.gc.ca/menu-e.html and type in IT 533. You can pull up the October 2003 Bulletin regarding Interest Deductibility and Related Issues in a number of formats. In particular I suggest you refer to Sections 31 and 18 of the Bulletin.
“Where an investment does not carry a stated interest or dividend rate such as some common shares, the determination of the reasonable expectation of income at the time the investment is made is less clear.
Normally, however, the CCRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends. Nonetheless, each situation must be dealt with on the basis of the particular facts involved.
These comments are also generally applicable to investments
in mutual fund trusts and mutual fund corporations.”
Ask your chartered accountant or tax specialist to review this section with you.
The key is to ” Tracing/linking borrowed money to its current use ” (see section 18 of IT533)
“Ms. G acquired property H with $100 of borrowed money, the entire amount of which remains outstanding. Ms. G subsequently disposed of property H for $100 and used the proceeds of disposition to acquire property I for $60 and property J for $40. In linking the borrowed money to its current use, 60% ($60/$100) would be allocated to property I and 40% to property J.”
As with all investments always get a second option from a qualified professional. See my blog, know the risks, and refer to the “Legal†link at the top left of my website.