Q. I have an investment property that I rent out. Now that I’m retired, I would like to use the income to supplement my retirement income. That would leave me with no money to pay the expenses on the property (mortgage payment, maintenance, utilities, etc.).
I’m wondering two things: One, can I borrow all my expenses from my personal home equity line of credit (HELOC), thereby making all of the expenses and interest tax deductible?
And, two, looking into the future, let’s say I have now done this for two years and the expenses are $20,000 per year. I now have a debt of $40,000 in my LOC. The interest costs are now double they were in year 1. Is all of that interest tax-deductible for year 2, or only the interest for year 2 expenses?
A. Many rental property owners end up in a similar situation as you in retirement, Garry—that is, a point at which you need to access some of the value of your rental property, one way or another.
If you literally have no money to pay the expenses, as in no remaining investments to draw down upon, I think you need to consider if and when to sell the rental property. If it is a matter of not wanting to draw down on other investments, I think you should consider what other investments you have available.
If you have non-registered investments, and think you can earn a higher rate of return by leaving the investments in place than the interest rate on your line of credit, you may come out ahead by borrowing to cover your expenses, as you suggest. There are problems with this approach, though. Interest rates are at all-time lows that will not persist forever. Eventually, interest rates will rise. Stocks are also at all-time highs. Returns over the next 10 years may not be as high as over the past 10 years. You are also retired, aging, and whether it is due to decreasing risk tolerance or eventual decreasing ability to manage your investments, this may be an unsuitable long-term approach for a retiree.
If you have Tax-Free Savings Account (TFSA*) investments, there may be more of an argument to borrow than to draw down your TFSA, given TFSA returns are at least tax-free, but I would still think twice about effectively borrowing to invest in retirement.
If your only investments are tax-deferred Registered Retirement Savings Plan (RRSPs*), Registered Retirement Income Funds (RRIFs), or similar tax-deferred investments, borrowing may be more compelling, as this approach may help you avoid paying higher tax rates on registered account withdrawals. But even then, I think it should only be used temporarily. Rental property owners may someday need to sell their rental properties. Likewise with homeowners who do not have enough investments to support their retirement spending. Planning for eventual real estate sales and trying to determine the timing is an important part of planning retirement.
If you borrow to pay the rental property expenses, Garry, make sure you keep good records. You should have a line of credit that is not used for personal use at all and only used for the rental property. The interest on the borrowed money used to fund the rental property expenses is tax-deductible. You asked if it was tax-deductible in the year incurred only, and the answer is that it is deductible as long as you own and rent out the property. It is a rental property expense just like property tax, insurance and other carrying costs (including your mortgage interest, but not the principal repayments).
Retirees may be limited in their ability to borrow on a line of credit, as banks like to lend money to people with incomes. Seniors with no income may not be able to borrow as easily against real estate. Another important consideration is that lines of credit often have fine print that allows the bank to reduce the limit at any time—so you cannot necessarily count on room in your line of credit being available forever.
If you accrue a line of credit balance, consider the benefits of converting it to a mortgage with combined principal and interest payments. This will cause higher monthly payments than the required interest-only payments on a line of credit, but it will also bring down your interest rate.
If you consider selling the property, Garry, whether now or in the future, you need to consider the tax implications. Deferred tax is a big sale deterrent for rental property owners in my experience, but it comes with owning any non-registered investment, whether that’s real estate, stocks, bonds, or mutual fund shares.
Borrowing against a rental property instead of selling can be appealing, given that it allows you avoid what could be as much as 27% tax on the appreciation in the property, and as much as 54% tax on the recapture of your historical capital cost allowance (depreciation) claimed over the years.
Rental property investors in retirement need to compare their potential net retirement income from rent and borrowing against the equity, to the potential income they could earn from investing the after-tax proceeds somewhere else.
As you contemplate supplementing your retirement income with borrowing against your rental property, do so with a focus on the long run, considering all personal factors and your other financial assets and debt, and be sure to revisit your strategy over time.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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