Self-made, single, and fabulous, that’s me. I’m a professional with a good, steady income, and recently, I reached the six-figure milestone. Sometimes it’s still hard to believe that I’ve come this far. Along the way, I’ve learned how to be a seasoned saver and a disciplined budgeter.
A few years ago, I decided to invest in real estate on my own and bought a condo in the Greater Toronto Area, just outside the downtown core. It was an easy decision because the timing, location, and spend level was right. I saw it as a great addition to my portfolio and turned it into a rental unit.
This year, I’ve decided to purchase a unit in the city for myself. But I have so many questions because I want to make sure I’m setting myself up for long-term success. I fear that I’ll feel cash poor for longer than expected.
First, how should I structure my budget? Now that I own two residential properties, should I keep my budgets for each one separate or consider them as one item? Second, are there any tax benefits I can take advantage of?
– Soon-to-be Savvy Investor
Dear Soon-to-be Savvy Investor,
Congratulations on achieving the six-figure milestone! An income of $100,000 is often cited as the optimal amount for overall life satisfaction… no wonder you’re feeling so good. Even better that you’ve learned to save and budget; those habits are the most important to financial success, in my opinion. Now that you’re ready to take your investing to the next level, there are a few things you should think about.
Think of your rental property like a business
When you’re running a business it’s important to keep detailed financial records of money coming in and money going out. So, I absolutely think you should maintain a separate budget for your rental property! Not only will it give you a clear picture of the profitability and return on your investment, but it will also make your life a lot easier at tax time. You don’t need to make it fancy – setting up a simple Excel spreadsheet should do the trick.
The money coming in part of the equation is pretty straightforward – it’s your monthly rental income. The money going out part gets a bit more interesting as there are a number of different expenses you can claim. Did you know that you can deduct any reasonable expenses incurred to earn rental income on your tax return? Make sure to take note of each so you’re not missing out! For example, costs to advertise your property, office expenses, travel expenses and motor vehicle expenses are all potentially deductible. Head to the Canada Revenue Agency (CRA) website to learn more.
Keeping detailed records of your rental expenses will be hugely helpful at tax time. Not only will it make reporting the numbers easier, but making sure you’ve captured all of the eligible expenses means you’ll likely pay less income tax. Which leads nicely into your next question.
Think of the tax benefits for home buyers
When it comes to tax benefits for purchasing a home (or a “principal residence”, in CRA lingo), the first thing that comes to mind is the first-time home buyer’s credit, which is worth up to $750. Since your first property is a rental, it doesn’t meet the requirements of a qualifying home. As long as you are considered a first-time buyer you should be able to claim it this time around.
Another benefit is the home buyer’s loan program. This program allows first-time buyers to borrow up to $25,000 from their RRSPs to use as a downpayment on a home, without having to pay withholding tax on the withdrawal. Keep in mind this is a loan and you’ll have to repay it over the next 15 years. Be sure to contribute at least $1,666 or 1/15 of the borrowed amount to your RRSPs each year or you’ll have to claim that amount as income on your tax return.
Think of your Net Worth
Before I sign off, I want to address your fear of feeling “cash poor”. I’m assuming you’re referring to the feeling you’ll have seeing the balance in your savings account take a big hit when you make your down payment. I know that can feel uncomfortable, but even though the cash is gone, your financial position isn’t really going to change. Setting up a net worth statement will help you visualize this.
A net worth statement lists all your assets (what you own) and liabilities (what you owe). Investing in real estate is simply transferring your cash from one asset (your bank) to another (a property). While your bank balance may take a hit, your net worth stays the same.
Let’s do the math. Imagine you start out with $100,000 in savings. You decide to use $75,000 for a down payment, and $10,000 in legal fees and closing costs, so your bank balance drops down to $15,000 – ouch.
You’ve now used that $75,000 to purchase a $375,000 condo, taking on a $300,000 mortgage. To account for this transaction, you’ve now added an asset of $375,000 to your net worth statement, and a liability of $300,000 for your mortgage. The net impact – adding a $375,000 asset less an $85,000 cash payment, less a $300,000 mortgage, is a decrease of only $10,000 (your closing costs)!
Here’s another way to look at it:
Net Worth Statement (for illustration purposes only)
Yes, you absolutely have less cash in your bank account. But your overall financial position is more or less the same. And, as your real estate market grows, the value of your asset grows too! Updating your net worth statement on a regular basis will help ease the anxiety of having less cash on hand, and reinforce the positive impact of your investing savvy.