Principle pay down on your mortgage is taxed as income…. you better be prepared for it! Let’s review at what it could look like.
Real Estate Proforma Hidden Cost Example
$𝟒𝟏𝟒/𝐦 𝐢𝐬 𝐡𝐨𝐰 𝐦𝐮𝐜𝐡 𝐲𝐨𝐮 𝐰𝐨𝐮𝐥𝐝 𝐥𝐢𝐤𝐞𝐥𝐲 𝐩𝐚𝐲 𝐢𝐧 𝐭𝐡𝐞 𝐬𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝐛𝐞𝐥𝐨𝐰 (𝐲𝐨𝐮𝐫 𝐟𝐢𝐫𝐬𝐭 𝐲𝐞𝐚𝐫, 𝐭𝐡𝐞 𝐧𝐮𝐦𝐛𝐞𝐫 𝐠𝐞𝐭𝐬 𝐛𝐢𝐠𝐠𝐞𝐫 𝐞𝐯𝐞𝐫𝐲 𝐲𝐞𝐚𝐫 𝐚𝐟𝐭𝐞𝐫
If you owned a $1,000,000 property in a holding company and put 20% down you would have an $800,000 mortgage. If the mortgage was at 6% with a 30 year amortization you would make $57,556 in mortgage payments and pay down $9824 of principle your first year (surprising eh?!).
In a holding company filing in British Columbia income from real estate is taxed at 50.67%. Your first year that would mean owing $4977.88 in taxes on your principle pay down. Monthly this breaks down to $414.8.
It is important to note that this cost will grow every year. Your 5th year of ownership you would pay down $13,251 in principle which would break down to $559.53 per month.
Your 20th year you would pay down $32,519 in principle which would cost $1373 per month in income taxes.
How to Offset Rising Real Estate Costs
1) Re amortize your mortgages over time
This can keep your principle pay down lower (which is not necessarily a good thing) and lower your annual income tax costs for the property.
2) Work with a good accountant and discuss methods of reducing your annual income taxes.
An example would be depreciating your property. This has benefits and disadvantages and should be considered cautiously and with professional guidance.
Remember, when you are paying taxes on principle pay down you are paying taxes on profit! This is a good thing so don’t lose sight of making money! The challenge is that paying off your mortgage creates equity in your property. Outside of niche mortgage products you generally cannot access your equity without refinancing (which can often be expensive) or selling.
**The example above is for a holding company which has the highest tax rate on income generated from real estate. For investors owning in their personal name your principle pay down will be taxed at your marginal tax rate.