When it comes to alternative investments, mortgages are an excellent choice for many investors. There are numerous advantages to investing in the Canadian real estate market, and those seeking an alternative to traditional investment strategies are well aware of these advantages. When investing in mortgages through a Mortgage Investment Corporation (MIC), you may have missed a few tax advantages.
How are these Real Estate Investments Taxed in Canada?
Mortgage investment corporations (“MICs”) are investment management firms that hold a portfolio of loans secured against Canadian real estate. They typically earn most of their revenue from interest and mortgage borrower fees. MICs are subject to a special tax regime under the Income Tax Act (“ITA”), in which MICs distribute income generated by the MIC to shareholders in the form of a dividend that is generally taxed as interest income in the hands of Canadian-resident taxable investors (i.e., the preferential tax treatment normally applicable to dividends does not apply).
Dividend Taxation for MIC Shareholders
Dividends received by MIC shareholders are generally considered interest income under the ITA. MICs can generally deduct amounts paid to shareholders as dividends from their taxable income; as a result, in practice, MICs are rarely subject to significant Canadian income tax because it is customary to distribute all or substantially all of a MIC’s income in a given year.
According to the ITA, shares of MICs are “qualified investments” (subject to certain exceptions) for most deferred income tax plans, including Registered Disability Savings Plans, Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Education Savings Plans, Deferred Profit Savings Plans, First Home Savings Accounts, and Tax-Free Savings Accounts, making it potentially an appealing investment for retail investors.
Tax Benefits of Investing in MICs
There are many tax benefits to investing in MICs, including:
1- “Flow-Through” Status
The “flow-through” status on income taxation, capital gains, and interest income is one of the most significant advantages of investing through a MIC. MICs are given preferential tax treatment under the Income Tax Act of Canada. This means that when a Mortgage Investment Corporation receives income from mortgages it has invested in, the gains are distributed first to the shareholders or investors rather than being taxed first. This “flow-through” benefit applies to interest income from investments and money in the MIC’s bank accounts. This “flow-through” model benefits investors by preventing them from paying double taxes on their investment income.
2- Deferred Income Plan Benefits
A Mortgage Investment Corporation with “qualified investment” status enables investors or shareholders to invest in MICs using a self-directed deferred income plan such as an RRSP, RESP, TFSA, or RRIF. The interest received can then be deposited directly into one of these accounts, and the estimated interest received by these plans will be tax-free.
These benefits are contingent upon the Mortgage Investment Corporation’s “qualified investment” status. However, penalties may apply if the MIC’s investment is deemed a “prohibited investment” under Canadian tax law. If the MIC does not meet the Canadian Tax Act’s requirements, the interest may be taxed before it reaches the investors. In other words, you’ll face double taxation on any capital gains or interest income.
As we previously stated, mortgage investments are an excellent alternative. However, this only holds if the Mortgage Investment Corporation managing the funds is a “qualified investment.” Before investing in any MIC, consult with a tax specialist or financial advisor. If everything goes well with your chosen MIC, this alternative investment strategy will be well worth it. You will benefit from several advantages due to the “flow-through” taxation status and the establishment and use of a deferred payment plan.
The Bottom Line
While investing in MICs offers various tax benefits, including flow-through taxation and deferred income plan compatibility, thorough research and professional guidance are crucial. Consulting with a tax specialist and financial advisor can help ensure you choose a “qualified investment” MIC, maximizing the benefits and minimizing potential risks of this alternative investment strategy. By understanding the intricacies of MIC taxation and seeking professional guidance, you can make informed investment decisions and unlock the potential advantages of participating in the Canadian real estate market through MICs.
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