Reduce your taxes using the cash damming technique

The cash damming technique allows you to reduce your taxes by gradually converting your personal debt, the interest on which is not deductible, into a new debt used to finance your business expenses, the interest on which is deductible.

This option is available to self-employed individuals, sole proprietorship owners, rental property owners, and partners in a general partnership.

Conditions

• Be an individual in business whose business is not incorporated.
• Earn a high taxable income.
• Hold significant personal debt (residential mortgage, car loan, credit card, etc.).
• Substantially report significant business expenses.

How it works

The cash damming technique involves the use of:

• two separate checking accounts to separate your gross income and business expenses
• a line of credit

You use your gross income to:

• cover your personal expenses
• make payments on your business debts (if applicable)
• pay off your personal debts more quickly, the interest of which is not deductible

You finance 100% of your business expenses with advances from your line of credit. Your line of credit could also facilitate the financing of a future personal project (cottage, boat, new car, etc.).

Source: https://www.desjardins.com/ca/personal/goals-life-events/saving-money-taxes/cash-damming-technique/index.jsp

Starting Point

• Personal residence: $1,000,000 value with a $500,000 mortgage (non-deductible interest).

• Rental property: $1,000,000 value with a $500,000 mortgage (deductible interest).

• Net rental income (after operating expenses, excluding mortgage): assume $40,000 per year.

How Cash damming Works

The strategy is essentially a debt conversion (debt recycling) approach:

1. All rental income goes into a separate “Cash damming” account.

2. That rental income is then used to pay down the personal mortgage (which is non-deductible).

3. To cover the rental property’s mortgage payments (principal + interest), you borrow the equivalent amount from a secured credit line on the rental property.
   Because the borrowed funds are used exclusively for an income-producing property, the interest on this new debt is 100% tax-deductible.

Year 1 Example

• Rental net income deposited into Cash damming: $40,000.

• That $40,000 is used to reduce the personal mortgage.

• The rental property borrows $40,000 on its line of credit to cover its own mortgage payments.

• The new interest generated on this $40,000 is fully deductible.

Results After 5 Years

• Total rental income redirected: 5 × $40,000 = $200,000.

• Personal mortgage reduced: 500,000 – 200,000 = $300,000 remaining.

• Rental property mortgage increased: 500,000 + 200,000 = $700,000 (but now the interest is fully deductible).

Key Benefits

• Non-deductible debt on the personal residence shrinks quickly.

• Deductible debt on the rental property grows, but creates a tax shield through deductible interest.

• Over time, the homeowner converts personal debt into business debt, improving after-tax cash flow.

Important Notes

• You must keep separate bank accounts and ensure perfect traceability.

• Rental income should never be used directly to pay the rental mortgage, otherwise deductibility may be challenged.

• Always get validation from a CPA or tax advisor before implementing this strategy to avoid issues with tax authorities.

Back to advices