If you own a rental property in Canada, you may be paying your rental bills with cash and missing out on a big tax benefit. There’s a smart way to make your interest tax deductible—and it’s called cash damming.
Let’s explain how this works, why it’s legal, and how you can use it the right way.
What Is Cash Damming and Why It Matters
Definition and Core Concept
Cash damming is a strategy that turns non-deductible debt (like your home mortgage or personal line of credit) into tax-deductible debt.
Here’s how it works in simple words:
- You use your rental income to pay down your personal mortgage or other non-deductible debt.
- Then, you borrow money to pay for your rental property expenses like repairs, utilities, insurance, or taxes.
- Because the borrowed money is used to earn income, the interest on that borrowed money becomes tax deductible.
How It Applies to Canadian Real Estate Investors
Many landlords pay for rental expenses out of their own pocket. But if you pay with borrowed money, and use your rental income to pay personal debt, you might get a tax break on the interest.
This doesn’t reduce your total payments, but it shifts your interest into the “deductible” zone. Over time, this can save you thousands in taxes.
The Smith Manoeuvre: How It Aligns with Cash Damming
Recap of the Smith Manoeuvre
The Smith Manoeuvre is another Canadian tax strategy where you turn your mortgage into a tax-deductible loan by borrowing to invest. It’s done with a readvanceable mortgage that gives you access to a HELOC as you pay it down.
You can read my full Smith Manoeuvre guide here.
Cash Flow Optimization Through Combined Use
Cash damming and the Smith Manoeuvre work great together:
- Cash damming uses borrowed money to pay rental expenses
- The Smith Manoeuvre uses borrowed money to buy investments
Both let you write off interest and grow wealth at the same time. When combined with a readvanceable mortgage, your rental and investment strategies can become very tax efficient.
How to Implement Cash Damming on a Rental Property
Step-by-Step: Using Rental Income to Pay Personal Mortgage
- Collect rent from your tenants.
- Use that rent to pay down your personal mortgage or non-deductible debt.
- Don’t use the rental income to pay rental bills.
This is the “dam” part—you’re diverting cash from rental use to personal use.
Borrowing for Rental Expenses to Make Interest Tax Deductible
Next:
- Use your HELOC or readvanceable mortgage to pay rental expenses.
- Make sure the borrowed money goes only to rental-related costs.
- Track every transaction clearly.
Since the loan is used to earn income (from the rental), the interest is tax deductible.
Importance of Proper Tracing and Documentation
To get the tax deduction, you must show:
- Where the money came from
- Where the money went
- That it was used only for rental or business use
This is called tracing. If your records are messy, the CRA may deny the deduction.
Who Can Use Cash Damming (And What You Need)
Ideal Candidates: Landlords and Self-Employed Individuals
Cash damming is best for:
- Rental property owners
- Self-employed people with business expenses
- Anyone with non-deductible debt and income-producing assets
Required Tools: HELOC or Readvanceable Mortgage
To use this strategy, you’ll need:
- A Home Equity Line of Credit (HELOC)
- Or a readvanceable mortgage, which gives you access to borrowed funds as you pay it down
You also need good record keeping to stay CRA-compliant.
Understanding CRA Guidelines and Tax Implications
CRA’s Position on Interest Deductibility
The CRA allows you to deduct interest if:
- The money is borrowed
- The borrowed money is used to earn income
- You can prove how the money was used
Using cash damming correctly meets all of these rules. You can read more here.
Maintaining Clear Records for Audit Protection
Keep:
- A separate bank account for rental transactions
- Copies of HELOC statements, bills paid, and receipts
If the CRA asks questions, you’ll be ready.
Common Myths and Misconceptions
“All Borrowed Money is Deductible” – False
Only money used to earn income qualifies. If you use borrowed money to go on vacation, it’s not deductible.
“Cash Damming is a Tax Loophole” – Debunked
Cash damming is legal in Canada. The CRA clearly allows interest deductions if the loan is used to produce income and proper tracing is done.
Frequently Asked Questions About Cash Damming
Can I Use It on Multiple Properties?
Yes. As long as each property has its own clean set of records, you can apply cash damming to more than one rental.
What Are the Risks?
If you don’t track properly, the CRA may disallow your deductions. Also, borrowing too much can be risky if your cash flow is tight.
Does It Accelerate My Mortgage Paydown?
Yes—if you apply rental income to your personal mortgage, your non-deductible debt shrinks faster, while your deductible debt grows in its place.
Best Practices to Maximize Tax Benefits
Use Separate Bank Accounts for Clean Tracking
Don’t mix personal and rental transactions. Keep a dedicated HELOC or account just for rental use.
Work with a Tax Advisor Familiar with CRA Audits
Not every accountant knows this strategy. Choose someone who understands CRA tracing rules and how to apply them.
Keep an Audit-Proof Paper Trail
Always save:
- HELOC statements
- Invoices and receipts
- Records showing where money went
CRA wants proof—and if you can show it, your deduction will likely stand.
Final Thoughts: Cash Damming Done Right
Cash damming is a powerful tax strategy for Canadian landlords. It helps you:
- Convert personal debt into deductible debt
- Save money on taxes
- Pay off your mortgage smarter
Just remember: borrow only for income-producing purposes, keep your records clean, and work with a qualified advisor.