If you’re a real estate investor or a homeowner looking to optimize your cash flow, accelerate personal debt payoff, and reduce your tax liability, cash damming for rental properties could be your perfect strategy. This technique is particularly beneficial for rental property investors who want to convert non-deductible personal debt, like the mortgage on a principal residence, into tax-deductible business debt. The best part? Aside from the interest on the line of credit (LOC), cash damming doesn’t create new debt. Once the mortgage on the principal residence is paid off, the income that was being used for mortgage payments can be redirected to pay down the mortgages on your rental properties, buy more real estate to leave a legacy, or improve your family’s lifestyle or for further investment. In this blog, we’ll explain what cash damming is, who it benefits, how it works with rental properties, and provide a detailed example to help you understand its full potential.

What is Cash Damming?

Cash damming is a financial strategy allowing homeowners and real estate investors to convert non-deductible personal debt (like a principal residence mortgage) into tax-deductible debt for rental property expenses. The core idea behind cash damming is to:

1. Pay down personal mortgage debt quickly using rental income, and
2. Fund rental property expenses using borrowed funds, like a line of credit (LOC), where the interest is tax-deductible.

Once the personal mortgage is paid off, the freed-up rental income can be redirected to enhance your family’s lifestyle, invest in additional properties, or save for the future—all while benefiting from tax-deductible interest on the LOC.

Who is Cash Damming For?

Cash damming works well for:

• Real Estate Investors with Multi-Unit Properties: Investors who own at least two-income properties, like duplexes or triplexes, will benefit the most, as higher rental income creates more efficiency in the strategy.
• Homeowners Looking to Pay Off Debt: Those who want to quickly eliminate their principal residence mortgage.
• Tax-Conscious Investors: Those in higher tax brackets can take advantage of tax-deductible interest from rental property-related debt.
• Disciplined Investors: This strategy requires sound financial management and consistent tracking of rental income, expenses, and borrowing to maximize tax efficiency.

What is Cash Damming?

Cash damming involves two primary steps:

1. Use Rental Income to Pay Down Your Principal Residence Mortgage: Instead of using rental income for rental property expenses, you redirect it toward making double payments or larger payments on your principal residence mortgage, reducing your personal non-deductible debt faster.
2. Borrow for Rental Property Expenses: To cover rental property costs (mortgage payments, property taxes, insurance), you take out a line of credit (LOC). The interest is tax-deductible because the LOC is being used for income-generating purposes (maintaining rental properties).

Over time, as you reduce the balance on your personal mortgage, the money you use to make those payments can be diverted to improve your lifestyle or fund additional investments. No new debt is created beyond the interest on the LOC, and you continue to benefit from tax deductions.

How Does Cash Damming Work with Rental Properties?

Cash damming works best with multiunit rental properties or properties generating significant rental income. Properties with lower rental income, like condos, may not provide enough cash flow to make the strategy as effective.

Example of Cash Damming:

Scenario:

• Principal Residence Mortgage: $700,000 balance at a $3,450/month payment.
• Rental Properties: Three properties generating $5,100/month in rental income each.
• Total Rental Income: $15,300/month.
• Total Rental Expenses: $11,100/month (mortgages, taxes, insurance).
• Line of Credit (LOC) Interest Rate: 6.95%.
• How It Works:
• The investor applies the $15,300 rental income to the principal residence mortgage, making double payments of $6,900/month. This accelerates the mortgage payoff, cutting the original 25-year mortgage to 10-12 years, significantly reducing interest costs over time.
• The investor borrows $11,100/month via the LOC to cover rental property expenses. The interest on this borrowed amount is tax-deductible, providing substantial tax savings. Over a year, the investor may pay approximately $7,000 in interest, which they can deduct on their tax return.
• Tax Savings: At a 47% tax rate, the investor would receive approximately $3,290 in tax refunds from the interest deduction, further boosting their cash flow.
• Once the mortgage on the principal residence is paid off, the investor can redirect the $15,300 rental income toward improving their lifestyle, reinvesting in other properties, or saving for future financial goals.

The Pros and Cons of Cash Damming

Pros:

• Accelerated Mortgage Repayment: Using rental income to make double payments on your principal residence mortgage can significantly reduce the time it takes to pay off the balance, freeing up more income for other purposes.
• Tax-Deductible Interest: Interest on the borrowed funds (LOC) used for rental property expenses is tax-deductible, reducing your taxable income and saving you money on taxes.
• Lifestyle Improvement: Once the personal mortgage is paid off, the rental income that was being used for mortgage payments can now be redirected to create a better lifestyle for your family or to build more wealth through new investments.
• No New Debt: Other than the interest on the LOC, there’s no additional debt, and your financial obligations remain manageable.
• Ideal for Multi-Unit Properties: This strategy works best for rental properties generating higher income, such as duplexes, triplexes, or other multiunit buildings.

Cons:

• Interest Costs on LOC: While the LOC interest is tax-deductible, you still pay interest on borrowed funds, which adds to your overall financial costs.
• Requires Strong Financial Management: You must keep track of all borrowed funds, rental income, and expenses, ensuring everything is documented correctly to comply with tax regulations.
• Less Efficient for Single-Income Properties: Cash damming may not be as effective for properties with lower rental income, like single-unit condos, as the cash flow may not be sufficient to justify the strategy.

Cash damming is an excellent strategy for real estate investors who want to pay off their personal mortgage faster, take advantage of tax-deductible interest, and improve their family’s financial situation. The best part? After the personal mortgage is paid off, the rental income can be used to create a better lifestyle or fund additional investments. Suppose you have multi-unit properties or significant rental income. In that case, cash damming can be a powerful tool to help you reach your financial goals sooner without creating new debt (except for the tax-deductible LOC interest). For a personalized approach, consult one of our Mortgage Brokers to see how cash damming can benefit your specific situation.