Personal Finance

Why are you not supposed to pay off tax deductable income?

  • Last Updated:
  • Feb 23rd, 2018 3:44 pm
[OP]
Banned
Jan 14, 2017
8 posts
5 upvotes

Why are you not supposed to pay off tax deductable income?

Can someone tell me why I've been told and read several times that that you shouldn't pay off a rental property's as fast as possible? I don't understand the logic behind this.

I understand that the interest is tax deductible but from my point of view it doesn't make sense to pay a dollar in interest to save 15 cents on your tax bill.

For example. I have a rental property with a mortgage of $175k and an additional balance on my heloc (for the downpayment) of $40k The interest paid on my Heloc for 2017 was $1,495.00. I can deduct this interest from my income but it doesn't save me $1,495.00 from my tax bill. It saves me $200 based on my tax bracket. So if I'm able to pay off the heloc portion entirely today why shouldn't I? Why should I pay $1495.00 In interest to save $200 off my taxes? Even if I was in the highest tax bracket possible the tax savings wouldn't make up for the interest paid.

From my point of view paying off my heloc would do the following

A) Save me $1295.00 in interest each year
B) Not that I need it but it would free up some cash flow not having to make monthly payments to my heloc

What am I not understanding?
14 replies
Deal Fanatic
Nov 22, 2015
5790 posts
5299 upvotes
colossk1 wrote: Can someone tell me why I've been told and read several times that that you shouldn't pay off a rental property's as fast as possible? I don't understand the logic behind this.

I understand that the interest is tax deductible but from my point of view it doesn't make sense to pay a dollar in interest to save 15 cents on your tax bill.

For example. I have a rental property with a mortgage of $175k and an additional balance on my heloc (for the downpayment) of $40k The interest paid on my Heloc for 2017 was $1,495.00. I can deduct this interest from my income but it doesn't save me $1,495.00 from my tax bill. It saves me $200 based on my tax bracket. So if I'm able to pay off the heloc portion entirely today why shouldn't I? Why should I pay $1495.00 In interest to save $200 off my taxes? Even if I was in the highest tax bracket possible the tax savings wouldn't make up for the interest paid.

From my point of view paying off my heloc would do the following

A) Save me $1295.00 in interest each year
B) Not that I need it but it would free up some cash flow not having to make monthly payments to my heloc

What am I not understanding?
I think you've got it... If you don't have any other debts, you should indeed pay off the HELOC whether or not the interest is tax deductible.

Most people have other debt obligations; it doe makes sense to pay down non-tax-deductible debts first.
Last edited by KanataKG on Feb 19th, 2018 8:19 am, edited 1 time in total.
Banned
Jul 18, 2016
2014 posts
781 upvotes
In most cases, paying off higher interest debt first is the best idea. The tax deduction effectively reduces your interest rate. Only you know if the net effective interest rate is higher or lower than your other debt.
Deal Addict
Jan 15, 2017
4130 posts
3636 upvotes
I can't tell you the number of times I have heard, "It doesn't cost me anything cause I can write it off on my taxes." A sure sign that this person has no idea on taxes.

OP, you understand it.
Member
Dec 26, 2013
470 posts
159 upvotes
Ottawa
Perhaps the person is suggesting you pay off your primary mortgage first since the interest isnt tax deductible, or he/she is saying to invest your payments in something rather than paying down your mortgage/heloc, since your interest on these is probably around 2-3%? I make minimum payments on my mortgage, the rest goes into CCP RESPS and RRSPS.
Member
Aug 17, 2006
489 posts
253 upvotes
Toronto
OP, you're right. You still lose money by having a loan.

I would suggest you pay off the loan UNLESS you plan on getting a non deductible loan for any other reason in the near future (ie your buying a new home in the near future so you save for the down payment or new mortgage instead of paying down your existing mortgage). Better to have a deductible loan than a non deductible loan.
Deal Guru
Feb 9, 2009
11291 posts
9796 upvotes
Some people don’t pay it cause they can invest in other things that can make more money (rental or stocks or a business, etc).
Member
Feb 13, 2015
215 posts
81 upvotes
Toronto
Pay off your debts, unless you can invest and make substantially more to offset any savings with interest deduction etc.

If you are getting 10-12% yearly on your investments, you may find its more profitable (and probably risky) to get that return and not pay down a 4% mortgage. It all depends. Now if your investments were only getting you 6%, it might not be worth it. Or if you have credit card debt at 18%, you will save most by paying it off first.
Deal Addict
User avatar
Dec 24, 2007
1543 posts
1840 upvotes
BC
What matters is the after-tax rate of interest on your debts:

1. If the loan interest is tax deductible (eg. your combined tax rate is 30%) and your interest rate is 5%, then your a.t. rate would be 3.5%
2. if the loan interest is not tax deductible (eg. personal debt) and interest rate is also 5%, then your a.t. rate would be 5%.

So, depending upon your other debts and interest rate, you pay down the debt with the highest a.t. rate, in this case personal debt with at. rate of 5%. In a lot of cases, people have other debts with non-deductible interest and it would make sense to pay off those debt first.
Deal Addict
User avatar
Dec 8, 2010
2468 posts
885 upvotes
OP the point is that, assuming you can make money with the money, you're better off re/investing that money instead of paying off the debt.

Say your property cashflows by $500 a month. What do you do with that $500 - put it into the mortgage, or buy dividend paying stocks? Or save up a downpayment for your next rental? Or spend on capital improvements so you can get more rent?

If the cost of borrowing is 3%, but you can make 7, 10, 15% by using that money to buy more assets... you should buy more assets and keep the debt.

The only time it comes crashing down is in a recession/inflationary period (ie, when your tenants move out all at once because you don't hold diversified investments, or when the cost of carrying the debt becomes greater than the income generated by the debt and you can't afford to shoulder the extra temporarily until things calm down again).
Deal Fanatic
Jul 1, 2007
8492 posts
1616 upvotes
OP, you're mistaking something that someone said for advice that applies to everyone. Advice that applies to every single financial situation doesn't exist. Everyone's different.
Money Smarts Blog wrote: I agree with the previous posters, especially Thalo. {And} Thalo's advice is spot on.
Deal Addict
Feb 21, 2004
1461 posts
220 upvotes
Montreal
OP, that statement should be understood as Don't pay off your rentals mortgage UNTIL it is the last debt you have.

Fiscally speaking, you always want to cover your non-deductible debts first and then attack the deductible ones. THis is what is sometimes referred to good debt vs bad debt.

Going back to your original statement, it is somewhat true for the vast majority of folks out there....that have a mortgage. In Canada, mortgage interest fees on your principal residence is not tax-deductible as it is the case in Trump-land. Therefore, for the VAST majority of folks, you are better off to pay off your principal residence mortgage FIRST and then go after the other one (unless the rates are drastically higher of course)

So the statement is somewhat accurate, at least for the 99% of whatever rate of Canadians that still carry a principal residence mortgage (including me)
Member
Sep 20, 2006
245 posts
80 upvotes
It's mostly been said, but you should be comparing the option of paying down the deductible debt with the best alternative use for those funds. The fact that you can deduct the interest means the effective rate of return you get from paying down the debt is less than the actual mortgage/LOC rate. You're likely better off paying down other non-deductible debt or possibly better off investing those funds in something else if there is a higher expected return, so long as you're comfortable with the amount of leverage you have. Without this last part you would just borrow as much as possible to invest, but obviously there's a limit to the amount of leverage that is prudent.

Even with no mortgage left on the principal residence I'd likely still choose not to repay my deductible debt because I expect a higher return from the stock market.
Deal Addict
User avatar
Mar 9, 2012
3575 posts
2245 upvotes
Kitchener
You're not missing anything. The more money you make (in your case, due to less interesting charges), the more money that you're taxed. Many people miss one point, it's better to make more and be taxed on it than to make less and not be taxed on that. Even if the tax rate is high, you still have more money for yourself.

That said, though, if you had a rental property you could always refinance the property to maximize interest paid, minimize principal paid, in order to save the most taxes, which you could save to potentially save to pay of your mortgage in one full swoop maybe before the 3rd refinance. Remember that the first year you own a rental property the interest paid is quite large, while in the final year it is almost none-existent. I am guess that is what these people mean.
Why can't we all just get along?
Sr. Member
Dec 14, 2004
850 posts
137 upvotes
Waterloo
A simpler piece of advice when looking at debt retirement is pay off your debts in order of your descending effective cost of borrowing. Factors that affect cost of borrowing include your marginal tax rate, interest rate, and eligibility to write off said investments. Of course, there is also the opportunity cost of paying off the debt instead of reinvesting but many times the return on that reinvestment is unknown.

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