Paying off Personal Mortgage or Investing through Professional Corporation?

[danomed]

Hello,

I have a question that has been debated through a variety of sources without any good answer. My accountant was of no help (and we are changing ours this year) and a CFP was also vague but recommended investing instead of paying off the mortgage.

The situation is this:

Scenario 1
You are paid through your professional corporation and pay income tax in the highest personal income tax bracket. You have excess PERSONAL funds after all personal expenses each year (say $80k excess). You use these excess funds and pay off your mortgage with your lump sum option. Say you can then pay your mortgage off in 5 years instead of 12 years. Keep in mind you are taxed 46% (blended) on that income so your corporation had to earn ~148000 for you to have that money. Your mortgage rate is 3.69%.

Scenario 2
Instead of paying yourself that extra 148000 each year, you keep it within the corporation and invest the money. You then have an extra ~$125000 to invest each year (148000 x 0.155 corporate tax rate). You continue to pay your mortgage using personal income after taxes but at a slower rate.

My accountant argued that your mortgage is an after tax expense so it is better to pay this off instead of investing this money. I can see the rationale if you don't have a preferred tax rate within a corporation. The CFP states investing is the best option as you already saved $43500 each year in taxes already and interest rates on mortgages are so low and investment growth can exceed this interest. The issue is that you have to balance any capital gains taxes you have in the corporation as well......

What would you do and why?

[ksgill]

Hello,

I have a question that has been debated through a variety of sources without any good answer. My accountant was of no help (and we are changing ours this year) and a CFP was also vague but recommended investing instead of paying off the mortgage.

The situation is this:

Scenario 1
You are paid through your professional corporation and pay income tax in the highest personal income tax bracket. You have excess PERSONAL funds after all personal expenses each year (say $80k excess). You use these excess funds and pay off your mortgage with your lump sum option. Say you can then pay your mortgage off in 5 years instead of 12 years. Keep in mind you are taxed 46% (blended) on that income so your corporation had to earn ~148000 for you to have that money. Your mortgage rate is 3.69%.

Scenario 2
Instead of paying yourself that extra 148000 each year, you keep it within the corporation and invest the money. You then have an extra ~$125000 to invest each year (148000 x 0.155 corporate tax rate). You continue to pay your mortgage using personal income after taxes but at a slower rate.

My accountant argued that your mortgage is an after tax expense so it is better to pay this off instead of investing this money. I can see the rationale if you don't have a preferred tax rate within a corporation. The CFP states investing is the best option as you already saved $43500 each year in taxes already and interest rates on mortgages are so low and investment growth can exceed this interest. The issue is that you have to balance any capital gains taxes you have in the corporation as well......

What would you do and why?

I'd pay off the mortgage. It's a personal preference as I don't like to owe money if I can help it.

[adeel]

well, what kind of return are you earning on your investment in scenario 2?

By and large, that is going to dictate what makes more sense.

[nogoro]

in many cases, when investing passively thru the prof corp, the income is not taxed at the low corp rate, so you need to clarify this with an accountant who is familiar with your type of prof corp.

I am looking at having the corp lend me $ to purchase my principal residence (this is apparently allowed, but you can't do this for an investment property), and I repay the corp similar to a mortgage. Obviously the $ ends up back in the corp and ultimately will have to serve as a retirement nest egg (by then it will be a regular corp and not prof corp)

[hsedin]

in many cases, when investing passively thru the prof corp, the income is not taxed at the low corp rate, so you need to clarify this with an accountant who is familiar with your type of prof corp.

I am looking at having the corp lend me $ to purchase my principal residence (this is apparently allowed, but you can't do this for an investment property), and I repay the corp similar to a mortgage. Obviously the $ ends up back in the corp and ultimately will have to serve as a retirement nest egg (by then it will be a regular corp and not prof corp)

You may want to check the time period you have to repay the loan by as CRA will view the loan as income on the portion that is not paid (with the CRA prescribed interest rate- currently at 1%) within a certain allowable time period. I am not exactly sure of the time frame but I don't think you are allowed to loan the money over say 5 years even.

Perhaps an accountant would like to clarify? I have only heard this from others but never tried to find out the exact answer.

[adeel]

in many cases, when investing passively thru the prof corp, the income is not taxed at the low corp rate, so you need to clarify this with an accountant who is familiar with your type of prof corp.

I am looking at having the corp lend me $ to purchase my principal residence (this is apparently allowed, but you can't do this for an investment property), and I repay the corp similar to a mortgage. Obviously the $ ends up back in the corp and ultimately will have to serve as a retirement nest egg (by then it will be a regular corp and not prof corp)

You may want to check the time period you have to repay the loan by as CRA will view the loan as income on the portion that is not paid (with the CRA prescribed interest rate- currently at 1%) within a certain allowable time period. I am not exactly sure of the time frame but I don't think you are allowed to loan the money over say 5 years even.

Perhaps an accountant would like to clarify? I have only heard this from others but never tried to find out the exact answer.

The loan would have to be structured as a home purchase loan, which is something that can be done under the income tax act, as long as a few conditions are met, including proper repayment terms, must be a loan made in capacity as an employee (and not as a shareholder), and it must be available to all employees

I believe interest does nto necessarily need to be charged on the loan, but in which case there would be a taxable benefit based on the CRA's prescribed rates. However, their prescribed rate is now 1%, meaning a corp can essentially advance an interest free home loan at a cost of only a 1% taxable benefit, which is quite a good deal

[actng]

is it possible to sell the home to the corporation and have the corporation carry the mortgage? can the OP pay the corporation nominal rent each month?

[adeel]

^that would more than likely create more problems than it is worth...why not just borrow the money from the corp and pay it back over time, as you would with any other normal lender?

Plus, its never a good idea to hold valuable assets in a corp for liab purposes. PLUS, by owning the home personally as your principal residence, you wont be taxed on any gain when you sell/move, where as the corp does not get any benefit of that sort.

[danomed]

Good point about the loan from Corp! I didn't know that was possible.

I think the liability issue is sound and have been advised about that. If you have liability insurance (depending on corporation type) I would think it is safe.

This accountant advises it and he has been doing so for 30 years!
www.justfordoctors.ca

I have no affiliation with him, but someone told me about his book and I read it which made me intrigued about how to structure the mortgage and where to focus my attention towards - mortgage versus investments.

I wouldn't know what investment gains will be in scenario 2 as I am new to it, but over time, I would assume it will outperform mortgage rates currently. I got my mortgage 2 years ago and never thought rates would drop to such lows, but I am locked in at present with penalties being too high to transfer.

[djfunk]

I would be careful with the home relocation loan that was outlined above. the ITA talks about an actual move of the employee closer to a location employment by 50km's. If you already have a mortgage and are loaning yourself the money, the cra will most likely NOT view this as a home relocation. Meaning you will not benefit from having only a taxable benefit on the 1%. You'll most likely have a higher taxable benefit which would negate most of the gain through this method.

[adeel]

home purchase loan vs home relocaton loan are two similar but different concepts

[beonice]

I have a colleague who pays himself way less than his corporation earns, and then he borrows it from his corporation: apparently you can borrow for up to 364 days as long as you pay back before the year-end. He uses the borrowed money to pay down the allowable lump sum on his mortgage each year. At the end of the year, he borrows the money from his HELOC to pay back the corporation, then borrows it again a few days later.

Eventually, he paid off his mortgage years early. He still owes the money to his corp, but it's an interest-free loan, so obviously he saves a TON of money in interest charges.

I haven't done this myself, but am planning to do exactly this when I have enough corporate income to allow me to do this!

[danomed]

So I have asked a new accountant about this with extensive expertise in a variety of corporation settings.

He listed "loans" from professional corporations as the top 3 high risk flags for the CRA to initiate an audit or rejection. He said it can be done but it is very risky. As someone mentioned above, the issue is that you have to make sure the same loan is also available to all employees and it must be available for a variety of purchases. Big corporations are the ones that tend to get away with it by offering loans to employees at certain lower interest rates for computers, cars, etc. He stated a small business is playing with fire with this option.

I think I will avoid any risks and continue paying things slowly with excess salary.

I think the above post about 364 day long loans is illegal. I have asked a variety of accountants about that and that is the same as "paying yourself extra and then paying the corp back later." If they are audited they would have to pay interest on the salary taxes owing from the date of the excess payment; whether they consider it a dividend or straight salary. I thought of this already and it has been addressed by several accountants and they all advise against this.

[adeel]

I have a colleague who pays himself way less than his corporation earns, and then he borrows it from his corporation: apparently you can borrow for up to 364 days as long as you pay back before the year-end. He uses the borrowed money to pay down the allowable lump sum on his mortgage each year. At the end of the year, he borrows the money from his HELOC to pay back the corporation, then borrows it again a few days later.

Eventually, he paid off his mortgage years early. He still owes the money to his corp, but it's an interest-free loan, so obviously he saves a TON of money in interest charges.

I haven't done this myself, but am planning to do exactly this when I have enough corporate income to allow me to do this!

Only really works if its a legit loan, where by at only one point during the year you borrow a set amount, and then return it within one year of year end. You cant keep borrowing money (like 5k a month or something) and treat it like that.

So I have asked a new accountant about this with extensive expertise in a variety of corporation settings.

He listed "loans" from professional corporations as the top 3 high risk flags for the CRA to initiate an audit or rejection. He said it can be done but it is very risky. As someone mentioned above, the issue is that you have to make sure the same loan is also available to all employees and it must be available for a variety of purchases. Big corporations are the ones that tend to get away with it by offering loans to employees at certain lower interest rates for computers, cars, etc. He stated a small business is playing with fire with this option.

I think I will avoid any risks and continue paying things slowly with excess salary.

I think the above post about 364 day long loans is illegal. I have asked a variety of accountants about that and that is the same as "paying yourself extra and then paying the corp back later." If they are audited they would have to pay interest on the salary taxes owing from the date of the excess payment; whether they consider it a dividend or straight salary. I thought of this already and it has been addressed by several accountants and they all advise against this.

If it is structured correctly 364 day loan would be ok - as long as it isnt a series of loans and repayments.

Further, I dont know how the CRA would determine the fact that you have made it available to all employees - seems easy enough to fudge in the case of an audit. (Not advocating fraud, but I mean fudge like how someone would fudge a milage log - yet to meet anyone who keeps a legit log)

[halflife150]

I don't know what your risk profile is, but if you could get greater than somewhere around 3-4% return for investments in your corp pretax, would probably be better that way. Investing with $85 at 3-4% pretax equals about "investing" $54 dollars at 3.69% after tax. 3-4% seems very doable. I don't know how employee mortgage would fit on that scale though, if you decided to go that way assuming you could do it, whether it is more profitable strategy or not.