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 The
Companion Advisor: Techniques
& Methods
Consider a Debt Swap during down times
Concerned about your investments
and wondering what to do to help in these topsy-turvy times?
Contributed by Tim
Cestnick
Managing Director, Tax Smart Services at AIC in Burlington, Ontario
A Companion Advisor Article
The idea has to do with converting your bad debt into
good debt. There are three characteristics of debt that you need to look
at:
- The interest rate on the debt (high interest or
low);
- The purpose of the borrowing (for personal consumption,
to acquire depreciating or appreciating assets);
- Whether the interest is deductible for tax purposes.
Take your credit card debt as an example. It's generally
the worst kind of debt. Why? Because the interest costs are high (often
19% or more), we typically use credit cards for personal consumption
or to buy depreciable assets and the interest costs are not usually deductible.
Now, what about your home mortgage? It's a better type
of debt because the interest costs are much lower and you're buying an
asset that you likely expect to appreciate in value over time. You can't
usually deduct your mortgage interest (unless your home is used in your
work), so you lose out on this front.
Finally, consider a third type of debt: Money borrowed
to invest. In this case, your interest costs are lower, you're buying
assets that should appreciate in value over the long term and the interest
costs are generally deductible. This type of debt is arguably the best
type of debt.
Here's the strategy. Consider selling some of your non-registered
investments that have dropped in value, use the cash proceeds to pay down
some of your bad debt, then take out a new loan to replace those investments
you've liquidated. By doing this, your total debt loan will remain the
same, but unlike the old debt, you've paid down, the interest costs on
the new debt should be deductible since you're borrowing to invest.
The benefits of this strategy are clear.
- You'll trigger some capital losses that, to
the extent that they can't be applied against capital gains this year,
can be carried back to prior years to recover taxes paid, or can be
carried forward indefinitely to save tax in the future.
- You'll manage to swap bad debt for good debt
by making some interest costs tax deductible, creating tax savings.
- You'll have the opportunity to re-consider
where you're investing your money and to buy at a time when many securities
are on sale.
For more information on this
subject, consult with your Fiscal Agents representative or call (905)
844-7700.
By Tim
Cestnick, Managing Director, Tax Smart Services at AIC, and author
of "Winning the estate planning game: Estate planning strategies
for Canadians", "Winning the Education Savings Game" and
"2003 Winning the Tax Game"
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, Fiscal Agents Money Management Newsletter
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