The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: damyst on February 19, 2017, 04:45:37 PM
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A friend introduced me to an investment that has a negative gearing component (although they didn't use the term). The idea is that, by some mechanism that I don't fully understand, I'd be able to deduct a portion of the investment amount from income*, and have the investment generate income down the road when I'm likely to be in a lower tax bracket.
1. Does anyone know for certain whether this is safe to do in Canada? It seems most countries don't allow it.
2. Any other questions to consider before investing in something like this?
For context, the investment would represent 2-3% of a portfolio that's mostly in plain old diversified ETFs and employer-sponsored retirement funds.
* to clarify, this would not be a registered retirement investment. The income write-off would originate from "operating loss".
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2. Any other questions to consider before investing in something like this?
Well you don't understand how the investment works or if it's legal. Why would you even bother considering putting your money into it? 2% - 3% of my portfolio is a lot of cash and not something I'd waste.
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Could I ask what the investment instrument is exactly?
I'm guessing those losses are generated as investment expenses, business losses, or negative capital gains (capital loss)? The form that the loss takes is important for its long-term legality.
It's impossible to say without further information, but on first glance it reeks of an overpriced fund that's marketed to very high income people to exploit a grey area or grey term in the tax act.
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Well you don't understand how the investment works or if it's legal. Why would you even bother considering putting your money into it? 2% - 3% of my portfolio is a lot of cash and not something I'd waste.
Could I ask what the investment instrument is exactly?
I'm guessing those losses are generated as investment expenses, business losses, or negative capital gains (capital loss)? The form that the loss takes is important for its long-term legality.
I don't have full details of the instrument yet - will post them here if and when I do.
The source is one of the larger exempt-market dealers in the country and they're extremely unlikely to be marketing anything outright illegal. I'm more concerned about secondary risk factors, e.g.:
1. Generating too much unwanted interest in my finances from the CRA.
2. Ending up with a tax situation complex enough to require expensive professional accounting services and/or too much of my own time.
Thanks for sharing your views - they're very sensible and more or less what I expected to hear.
Still curious to know whether anyone has experience with negative gearing strategies in a Canadian context.
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Negative gearing just means that your investment costs are greater than your investment income.
The loss can be deducted from your taxable income, so you gain a tax benefit equal to your marginal rate.
When you go to sell the investment down the track, hopefully you will have made a capital gain that not is enough to cover all the losses in the intervening years, but is also taxed at concessional capital gains tax rates.
Tax rules differ from country to country, but this is how it works in Australia.
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Tax rules differ from country to country, but this is how it works in Australia.
Australia is very conspicuously the exception, in that negative gearing is well established in the housing market there.
Search Google for "negative gearing" and you find almost only Australian content. Makes me wonder whether the same principle is known by a different name elsewhere.
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After a quick bit of research I think I understand how the fund does this. It's basically a borrowing-to-invest strategy that's wrapped into a single product so you don't directly see the borrowing. It's also perfectly legal. Given the marketing to high income individuals though, I'm willing to bet the costs are out to lunch on the product itself, but it's easy to replicate on your own if you have some self-directed investing experience.
For example, let's say you open a self-directed Margin Account with Questrade. You will pay interest at 5.2% which is 100% tax deductible. On $250,000, it would reduce your taxable income by $13,000 a year. If you invest the $250,000 into the iShares Canadian Growth Index which yields 0.62%, you would only realize $1,550 in annual tax-advantaged dividend income.
If you earn $250,000 a year in Ontario with no other deductions, you would reduce your annual tax bill from $97,500 down to $91,200. Basically you save $6,000 in taxes, but paid $13,000 in interest. Hopefully the capital gains portion of your investment more than makes up for this amount and you will be better off because down the road when you realize the capital gains income, you will be in a lower tax bracket.
I would certainly consider a strategy along these lines in an undervalued market, but to me it's a little risky after a 8 year bull market as I don't want to be caught upside down on my margin.
Hope this helps.
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Thanks Rich Moose, this helps a ton! The asset in this question would probably be of the real property variety.
As I promised previously, I'll post further details if/when I get them.