Separate the rental income from the expense borrowing
Keeping borrowed funds and their use identifiable helps show what the loan paid for. Rental income can be directed towards personal obligations while a separate borrowing arrangement funds particular rental expenses.
This does not make every rental expense or mortgage payment eligible for a deduction. Your accountant or qualified tax advisor needs to assess the expenses and the interest treatment for your circumstances.
A $1,000 example: personal debt falls while rental-expense borrowing rises
Suppose $1,000 of rental income reduces personal-debt principal and $1,000 is borrowed to pay rental expenses reviewed by your tax advisor. Personal debt falls by $1,000 while the separate borrowing increases by $1,000.
Before interest, fees and tax consequences, total debt is unchanged. This example explains the movement of the money; it is not a tax-saving calculation or a recommendation.
Following the money
How cash damming changes the use of borrowed funds.
In this example, $1,000 of rental income pays down personal debt and a separate $1,000 loan pays rental expenses. The total debt stays the same before interest and fees.
Interest, fees and tax consequences are separate. Your tax advisor needs to assess the expenses and intended treatment.
Records need to show what the borrowed money paid for
Separate accounts can help with recordkeeping. Their names do not determine whether interest is deductible. The records need to link borrowing to its use, and mixing borrowed money with other funds can complicate that tracing.
The deduction conditions still need to be met. Have your tax advisor assess the arrangement instead of assuming that account separation creates a tax benefit.
Compare borrowing costs and repayment requirements
Cash damming needs credit on suitable terms, records you can maintain and a plan to repay the new borrowing. It can add interest costs or payments. If funds are being paid into a personal mortgage, its prepayment conditions matter too.
Your tax advisor assesses tax treatment; your mortgage advisor examines the financing and payments. Both need to fit the debts you already carry and the reason you are considering the arrangement.
Read about the Portfolio Financing Review for financing across existing rentals, or equity and refinancing for borrowing against a property.
