It’s not uncommon for you to owe money to the Canada Revenue Agency (CRA) after you file your personal tax returns. Especially if you neglected to do them for a few years. And like any other unexpected expense, you need to tighten your belt buckle, work even harder, and try to find ways to eliminate the debt before you rack up lots of interest charges and late penalties.
You may find that other immediate obligations are more pressing, so if you are unable to settle the tax debt immediately, it is best to keep in touch with the CRA and let them know your plan. to reduce and eliminate debt. They have some flexibility. (It’s a good way to manage all debts, not just tax debts.)
Sometimes we come across owners whose tax debt is so large that it cannot easily be paid in the normal course of life. The end result is debt that can’t be negotiated, with a creditor you can’t afford to ignore.
Over the past few months, we have dealt with several landlords who have found themselves in this situation. In these cases, the CRA’s smallest debt was $40,700 and the largest over $200,000. In each case, the debtor also owed money elsewhere – and had large credit card balances and other unsecured debts. The scale of the problem was far beyond the norm.
This seems to happen more often to small business owners and the self-employed. Ordinary people are not immune, however; we recently encountered a family with an unexpected tax debt of $32,000 incurred as a result of the sale of an investment property and the triggering of a taxable capital gain.
You would think that all of these people could just dip into their personal line of credit or take out a loan to pay that off, but those solutions weren’t available to them.
Luckily, if you’re a homeowner and have a decent amount of equity, sometimes a creative mortgage financing solution can help clean things up, even if the amounts owed are large, bank accounts have been seized or even liens have been placed on your property.
Ways home equity can be used to pay off very large CRA arrears
Keep in mind that when there is a large debt with the CRA, very few traditional lenders want to do a mortgage refinance before the debt is fixed. In such a situation, there are several ways to use the equity in the property to pay off the CRA debt:
- If you already have a home equity line of credit (HELOC) and there’s enough room to pay the tax debt, this can make a lot of sense. Basically, you just write a check and you’re done. The interest rate is probably around prime + 0.5%, and that could be as good as it gets in these situations. This will solve the immediate problem; then you need a plan to reduce your HELOC balance by saving aggressively and paying it down. Or, ultimately, you may decide it makes sense to refinance and transfer the HELOC balance into your mortgage.
- Borrow money from a family member or close friend, pay off the debt, then consider refinancing your mortgage and repaying your benefactor.
- Borrow money from a second private mortgage lender, pay off the debt, then refinance later. How long you wait to refinance depends on the strength of the case, which lender currently holds your first mortgage, and when that mortgage will expire. A few “B-lenders” have second-best financing options, which may suit this approach.
- Refinance the first mortgage with a “lender B” (alternative lender). Ideally, the new mortgage amount is large enough to be fully repaid by the CRA and cover all fees and other debts.
- When there is not enough equity to pay the ARC in full, it may be time to negotiate a settlement. My own experiences along these lines involve trustees who will file a consumer proposal on behalf of the debtor. Others report that they have had success with qualified tax accountants.
The right solution will depend on the circumstances of each situation. It is also important to note that there are circumstances where homeowners will not be good candidates for a potential traditional loan, regardless of how we resolve the immediate issue. This often happens when:
- Their income does not meet the stress test qualification rules and they may need to work with alternative lenders allowing higher debt service ratios
- They are self-employed with income that is difficult to verify by traditional methods
- Their personal credit history has closed the door to traditional lenders (e.g. multiple insolvencies or recent late mortgage payments)
So let’s look at the scenarios where each of these approaches is most appropriate.
Scenario 1. The owner’s finances and credit are in good shape. The only problem is a large CRA debt that no traditional lender wants to do a mortgage refinance for until the debt is fixed.
This lack of interest from traditional lenders is common when CRA debt is large. The CRA is a very powerful creditor who, in certain cases, can have preference over all other creditors. This means we have to solve the ARC problem first, then find the right loan to get the lowest possible costs.
The cheapest solution is to consider asking a family member or close friend if they will lend you money for a short period of time (option 2 above). Funds may only be required for a month or two. If you go this route, your real estate attorney should be involved to protect your benefactor’s interests. As soon as you can prove to an institutional lender that there is no tax debt to pay, then it is possible to refinance in the traditional way and pay off your emergency loan hero.
Scenario 2. If you don’t have anyone who can bail you out with a loan, you’ll move on to the second option, which is to work with an experienced mortgage broker who can find a suitable lender willing to give you a second mortgage. Ideally, this mortgage will be opened without a prepayment penalty. This is difficult to find with a private mortgage, so if the conditions do not allow the loan to be opened immediately, opening it after a few months is also a good option.
As with the first option, once you have proof of arrears from the CRA, you should be in good shape to refinance your primary mortgage with your current lender. It can also save you prepayment penalties, depending on your lender.
Scenario 3. Not only is there a debt with the CRA, but the credit history is poor, resulting in a low score. It will take time to bring the case back to traditional lender status. In this case, your best option is to refinance the mortgage with another lender or get a second mortgage first for a year or two. Our objective in this scenario is to determine which type of lender will support your transaction once the situation is resolved; and we will recommend the least expensive and least painful overall approach.
Scenario 4. CRA tax arrears and other unsecured debt exceed the amount of equity that can be extracted. Keep in mind, however, that if the CRA has already placed a lien on your home, it’s unlikely you’ll be able to negotiate a discounted settlement with them.
In this scenario, the owners could work with a trustee to negotiate the terms of a consumer proposal. At this point, all unsecured debt, including CRA debt, is consolidated and most proposals agree to repay a certain amount of money (usually $x per month) to all creditors within five coming years. No additional interest charges or late payment penalties.
Once the proposal has been accepted by creditors, it is possible that a mortgage broker experienced in this type of lending could arrange a second mortgage to make a lump sum consumer proposal payment, or even refinance directly with an alternative lender. to pay the reduced amount of debt.
The take-out sale
As you can see, when you own your own home, there are plenty of options to deal with large CRA back taxes that affect your borrowing power. Obviously, some real estate markets lend themselves better to this approach than others – the more equity you have in your home, the more likely one of these solutions will work.
The key is to deal with the problem as soon as possible. This situation will not get better and the CRA will not give up. Often indecisiveness and paralysis make things worse than they ever should have been.
During the process, it’s best to keep in touch with your CRA case officer and explain that you are considering different ways to raise capital to settle your debt. The process can be painful, but having the right experts on your side will make all the difference.