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February 13, 2019 | The Fallacy Brothers

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Drew and Jonathan Scott are interesting. Born in Alberta, moved to LA. Serial entrepreneurs, risk-takers, entertainers. They’ve done everything from manage a bikini store and been mall cops to flipping houses, recording country music, selling a cruise tour and of course, creating the Property Brothers TV franchise wherein they appear as a realtor and a contractor. On that show they make dewey young couples orgiastic with real estate consummation. Oh yeah, they also do roadshow seminars on how to get rich by trading houses in, say, the east end of the GTA.

Blog Dog Steve’s buddy attended one of those steamy sessions.

“Essentially the scheme was to use real estate to bring you wealth,” he reports. “All simple too. Can’t fail. I was new to hearing this type of scheme because there simply aren’t any get rich quick schemes out there. It takes time.

1. Buy a home and rent it. Renter pays the mortgage and eventually you sell and make a big pot of money.
2. Before you sell that house you remortgage the house for max value and then sell. This avoids capital gains taxes from the future “guaranteed to go up” sale. (I threw in the cautionary “but what if it goes down!”)
3. Then you repeat the process.

“My disclaimer first off is, I haven’t seen the actual talk.  That being said, this sounds like the ultimate ponzi scheme. Units have exploded in the area with values appreciating +30% in the past few years. The drawback is that there are hundreds more, if not thousands in the pipeline.

“The idea of sucking all equity out of a home simply to avoid taxes could leave a greater fool with little liquidity in the event of an economic shock, no?  Job loss, renters wrecking the place, interest rates returning to their upward trajectory, etc. Plus the owner still carries the home insurance, mortgage interest, loss of potential gains in locking up investable money, etc. This probably don’t end well, but the Property Brothers will be fine.”

So, is this a legit strategy?

Well, yes, there are ways to avoid paying big taxes on a rental property that’s escalated in value. For example, you should own it for a number of years – not a number of months. That way any profit can be claimed as a capital gain, not business income. If the CRA thinks you bought the place just to flip – even if rented for a year or so – it might decide this was a commercial deal and add the windfall amount to your usual taxable income. Ouch. It gets taxed at your marginal rate.

But if the profit’s a capital gain, 50% is tax-free with the remaining amount added to your income. The size of the cheque to Justin drops by half.

Of course, when selling an investment property you can also add to the ACB (adjusted cost base) the land transfer tax and other closing costs incurred when you bought, plus deduct the realtor commission from the sale proceeds. Capital improvements (but not repairs) are eligible as deductions from the selling price, and help reduce the capital gain amount.

One caution: during the time you own the property don’t let your accountant depreciate it for annual tax purposes. That causes a ‘recapture’ of depreciation when you come to sell and that = more tax.

Now, how about the Property Brothers’ mortgage-it-to-the-hilt strategy? Is it true if you slap a big loan against the property before you sell, sucking all the equity out that you’ll reduce or eliminate the capital gains tax?

Of course not.

Mortgaging a rental property will let you remove equity, for sure (just like borrowing against your home), and the amount taken will not be considered taxable income. It’s a classic move for many who have been long-term owners of apartment buildings, for example. But heaping on a loan has no effect on the tax payable when you dump the property. They made that up. Financing real estate does not add to nor subtract from the adjusted cost base. The CRA couldn’t care less.

So if you buy a house to rent then sell after a decent period for a profit, cap gains will apply to the difference between the purchase price + closing costs, minus capital improvements and commission. If you borrowed all the equity prior to the selling date,  you just have to pay it all back (plus a mortgage break fee) upon closing.

Maybe Drew & Jonathan should stick to being  hurtin’ heartthrobs:

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February 13th, 2019

Posted In: The Greater Fool

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