If you’re carrying a mortgage on your principal residence or other personal debt, you already know the downside: the interest you pay isn’t tax-deductible. At the same time, you might be earning income from a business, rental property, or investment portfolio and paying taxes on the income earned every year. This is where the cash damming strategy can be a powerful tax planning tool.

The cash damming strategy isn’t about taking on more debt. It is about using your cash flow differently so that, over time, more of your debt becomes tax-deductible.

What is Cash Damming?

Normally, most people use their business, rental, or investment portfolio income to cover expenses and then make mortgage payments with whatever is left over. With cash damming, your perspective must change and you flip that approach.

Instead of paying expenses with cash, you would borrow (often through a line of credit) to cover those eligible business, rental, or investment-related costs. With the generated income you earn, you would use it to pay down your personal, non-deducible debt, like your mortgage.

Your total debt may actually stay the same but the type of debt changes. Over time, you are replacing personal non-tax-deductible debt with tax-deductible debt tied to earning income. This shift in the type of debt can reduce your taxable income and lower your overall tax bill.

Not just for Business Owners

Cash damming isn’t just for business owners. You can also apply it personally if you earn investment income. If you receive dividends, interest, or rental cash flow, you can direct that income toward paying down personal debt. At the same time, borrowed funds can be used to invest or to cover investment-related expenses. As long as the borrowed money is clearly used to earn income, the interest may be deductible. This approach can improve the after-tax efficiency of your investments while helping you reduce personal debt faster than you might otherwise.

Keeping Records to Ensure Interest Deductibility

For cash damning to work properly, you need to be able to clearly show that borrowed funds were used to earn income. That means keeping good records to track how money moves through each account. To keep it simple, many people choose to use separate accounts for the borrowed funds to keep things clean and easy to track. The key is to be able to trace every borrowed dollar to an income-producing purpose.

Is This the Right Strategy for You?

Cash damming can be effective, but it is not a fit for everyone. Before jumping in, you will want to think about whether your mortgage allows for extra payments without penalties, whether you qualify for a suitable line of credit (i.e. interest cost on a line of credit vs. mortgage), and how comfortable you are with carrying long-term investment or business debt (lines of credit tend have an indefinite time horizon compared to mortgages). You should also consider your cash flow. If interest rates rise or income fluctuates, you need enough flexibility to stay comfortable.

When used appropriately, the cash damming strategy can help you reduce taxes, pay down your mortgage faster and make better use of your business or investment income. It is a strategy that rewards discipline and planning and one that should always be reviewed with a qualified tax and financial professional before you get started.