By Evelyn Jacks, President and Founder, Knowledge Bureau
Buying a first home can be a financial and emotional challenge. It’s a big decision, especially with the threat of rising interest rates and the introduction of new mortgage stress tests that will compel new homebuyers to prove they can afford today’s interest rates, plus 2% more, to buy that first home, or prove they can pay the rate applied to a five year fixed rate loan. The good news is that the tax system may be able to ease some of that pain.
There are five key tax planning strategies you can use to master your investment in your first home and in the process, build an important cornerstone of wealth that may eventually be completely tax-exempt:
RRSP and the HBP
Many people don’t realize that their Registered Retirement Savings Plan (RRSP) contains a special tax feature for first-time home buyers, appropriately named the Home Buyers' Plan. It allows first-time home buyers (or those who have not owned a home in the current year or preceding four years) to withdraw up to $25,000 per spouse from their RRSP on a tax-deferred basis, for the purpose of buying or building a home.
The tax-deferred withdrawals may also be made for the purpose of building or purchasing a compatible home to meet the needs of a disabled person and in this case the first-time buyer requirement is waived.
No tax is withheld on these withdrawals, which may be taken as a lump sum or through a series of withdrawals throughout the year, provided the total does not exceed $25,000. The application for withdrawal is Form T1036 Home Buyers' Plan (HBP) Request to Withdraw Funds from an RRSP. You can use the money for any purpose, as long as you actually buy or build a qualifying home.
It’s important to note that if the funds are not repaid into the RRSP, you will have a tax consequence. Full repayment must be made over a period not exceeding 15 years, beginning in the second calendar year after the withdrawal. If not repaid, you’ll have to include the withdrawn amounts in your income and pay the resulting tax. Consult your tax advisor for more information on how these amounts are calculated.
To qualify for this tax credit, the eligibility criteria are similar to the RRSP-HBP; you and your spouse or common-law partner must not have lived in another home owned by you or your spouse in the year of acquisition, or in any of the preceding four years. A qualifying home is a housing unit located in Canada that either already exists or is being constructed.
There is also special relief for disabled people; the Home Buyers’ Amount is available to an individual eligible for the Disability Tax Credit (DTC), or to the individual purchasing the home for the benefit of a related DTC-eligible person.
The credit may be claimed by either spouse, providing the home is registered in their name. Where one spouse does not need the full amount of the credit, the remainder may be transferred to the other spouse. Credit sharing is possible under other arrangements, such as when siblings purchase a home together; if each is a first-time buyer, the maximum $5,000 claim may be made by either purchaser or may be shared between them.
The maximum claim is $5,000, resulting in a non-refundable credit of $750 ($5,000 x 15%). Because the credit is non-refundable, to benefit, the taxpayer must have federal taxes payable.
Paying off the mortgage with tax assistance
If you want to pay down your mortgage more rapidly, and reduce high up-front interest costs, which are generally not tax- deductible, you can increase your payment frequency to bi-weekly, or even weekly.
Another strategy is to invest your tax refund into your mortgage. You’ll optimize your refund if you make an RRSP contribution first, reducing your taxes that would otherwise be payable.
A third option is to take money out of your Tax-Free Savings Account (TFSA) to pay down the mortgage. You can always recontribute a sum equivalent to the amount withdrawn, as long as you do so after the end of the year when the withdrawal was made.
A fourth approach is to make your mortgage interest deductible, which you can do if you use part of your home for business purposes or a rental. Alternatively, consider taking an investment loan, backed by the equity built up in your home. As long as you don’t invest in a registered account, your interest on that loan will be deductible as a carrying charge and the money reinvested in the market can help you leverage and diversify your investment in the home. Make sure you go through the numbers with a financial professional carefully – you want to be sure you can meet all your obligations and that market performance can reasonably exceed your after-tax borrowing costs.
Selling your principal residence – Tax-free
If you have to sell your home because costs have risen, take solace in the fact that accrued increases in your home’s value will be tax exempt, provided you meet certain criteria:
- You never claimed Capital Cost Allowance on the home as a deduction against business or rental income
- You didn’t make significant structural changes to accommodate a tenant or business venture;
- You’re not in the business of flipping real estate for profit.
Clever financial moves
Making an investment in a principal residence can be one of the best investments you can make to build your family’s wealth, and it might prove to be one of the best tax moves, too.
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