The Basics of the Smith Manoeuvre: Convert Your Mortgage into a Tax Deductible Loan
In the United States, mortgage interest is tax-deductible on your principal residence if you meet certain qualifications. However, aside from a rental property, mortgage interest isn’t tax-deductible here in Canada.
But that doesn’t mean that there aren’t a few cool personal finance tricks that you can use to improve your tax situation, and that includes turning your mortgage interest into something that could be tax-deductible.
The Smith Manoeuvre is one strategy Canadians can use to their advantage. In this article, I’ll explain what the Smith Manoeuvre is all about, and how you can use it to create a tax-deductible investment loan, where the interest payments become tax deductions. Ready? Let’s get started!
What is the Smith Manoeuvre?
The Smith Manoeuvre is a strategy that Fraser Smith developed as a financial planner. It worked well enough that he wrote a book about it in 2002. Its basic premise is to make your mortgage tax-deductible, but it can do so much more for your personal finances than just that.
First of all, in order to properly execute a Smith Manoeuvre, you need to have a readvanceable mortgage such as the Scotia Total Equity Plan (STEP) or BMO’s Readiline. You need to have a readvanceable mortgage for this to work because it relies on using your home equity to restructure your finances.
With a readvanceable type of mortgage, the available credit on your Home Equity Line of Credit (HELOC) increases with every dollar paid down on your mortgage principal. This is the basis of the leverage that you will use with the Smith Manoeuvre strategy.
With a Smith Manoeuvre, you then use this increasing credit line to invest in income-producing stocks, preferably in the form of Canadian dividend-paying companies, since the dividend returns from these companies have favourable tax status. But, you can choose to invest in other vehicles, such as mutual funds or exchange-traded funds (ETFs).
For this loan to be tax-deductible, you must invest in a non-registered investment account. RRSPs, RESPs, and TFSAs do not qualify. You also cannot make any non-investing purchases with the HELOC money. This is to keep a clean paper trail for the CRA, and to show that the entire loan is for investment purposes.
It is essential that you follow this procedure correctly, or you could find yourself in trouble – and owing money to the government.
Executing the Smith Manoeuvre in 5 Steps
To illustrate how the Smith Manoeuvre works,
1. Obtain a readvanceable mortgage from a Canadian mortgage lender. Ideally, the mortgage will contain a fixed portion that is paid down monthly with a blended payment of principal and interest.
2. Whenever you make a regular payment on your traditional mortgage (non-tax deductible), your principal balance decreases, and you can pull that amount from your Home Equity Line of Credit (HELOC) limit.
3. Use the funds pulled from the HELOC to invest in a non-registered equity investment, like a dividend-paying stock or an ETF. Stocks that pay dividends are ideal because dividend income receives preferential tax treatment. Also, you can choose to receive the dividend income as a regular cash payment, giving you more money to pay off the mortgage.
4. You will pay interest to the mortgage lender on the money you pull out of the HELOC, but you’ll be able to deduct the interest from your taxable income, which will result in a tax saving. Theoretically, you should see a net gain as long as the equity investment produces annual returns greater than the percentage of interest you’re paying on the mortgage.
5. Apply any income tax refund you receive, as well as any dividend payouts from the non-registered investment back onto the mortgage as a lump sum. This will help you pay down your mortgage more quickly, freeing up funds from your HELOC to invest.
This cycle of regular mortgage payments, followed by a transfer of funds from your HELOC to your non-registered investment account can continue until the full balance of your mortgage has been converted into an interest-deductible HELOC.
The End Result of the Smith Manoeuvre
Once you’ve fully converted your mortgage into an interest deductible loan, your investment portfolio should be much larger than if you had waited until you paid off your mortgage to invest.
Remember, more time in the market means more opportunities for growth.
Of course, you’ll still have a large mortgage balance, though it is now fully tax-deductible. Here are some options you will have once you’ve completed the Smith Manoeuvre:
- You could sell a portion of your stocks, equal to the debt, to pay it off.
- If the dividends are more than covering the interest expense, you may be better off never paying off the debt, since you have a net gain.
My preference with the Smith Manoeuvre is to reap the benefits of both options. Leave your investment portfolio untouched.
Continue paying an amount equal to what your mortgage payment was, but use it to pay down the HELOC. This could be further accelerated by also using dividend proceeds remaining after covering the interest expense.
Smith Manoeuvre Pros and Cons
If executed properly, the Smith Manoeuvre can provide the leverage you need to take advantage of the equity markets as you build wealth with borrowed money. But there are significant risks, and not everything is under your control. To help you understand what you’re getting yourself into, here’s a list of Smith Manoeuvre pros and cons:
- Build a large stock portfolio while you pay off your mortgage
- Leverage time in the market to realize capital gains and dividend income
- Ability to convert the standard mortgage into the tax-saving machine
- Claim your mortgage interest paid as a tax deduction
- Increase your net worth quickly
- Not for beginners. To be successful requires investment knowledge
- Must be comfortable using leverage to invest (borrowed money)
- If housing prices drop, you could find yourself in a negative equity position
- Requires a lot of financial discipline and oversight.
- Withdrawing from your investment can reduce your tax deductibility
- Increased risk if your investments drop in value
Further to the last ‘con’, if the stock market drops in value, there is a risk that the returns on your investment could be less than the interest you are paying on your tax-deductible mortgage.
In the short term, this is a very real possibility. After all, anything can happen in one or two years. One doesn’t have to look too far into the past to find a severe market downturn – March 2020, at the onset of the COVID-19 pandemic, and the 2008 financial crisis are two good examples.
However, over the long term, the stock market should perform well above where mortgage interest rates have been for the past several years. The point I’m making, however, is that there are no guarantees.
Smith Manoeuvre FAQs
Below are the answers to some frequently asked questions about the Smith Manoeuvre.
Where can I find examples of Canadian dividend-paying stocks?
I mentioned earlier that dividend stocks are an ideal investment for executing the Smith Manoeuvre. If you’re wondering which stocks pay dividends in Canada, I recommend checking out the Dividend Aristocrats. It’s a list of companies that have a track record of consistently paying a dividend to shareholders, and increasing that dividend on a regular basis.
If you’re not ready to purchase individual stocks, iShares has a Dividend Aristocrats ETF that you can purchase. You can read more about the requirements of a Dividend Aristocrat here.
What should I do with my income tax refund?
The short answer is that you can do anything you’d like with your refund. However, if you want to get the most from the Smith Manoeuvre, it’s recommended that you apply your tax refund as a principal reducing payment against your mortgage. This will increase the available credit limit on your HELOC, and the amount that can be transferred back into your investment account.
Can I use my RRSP or TFSA for the Smith Manoeuvre?
No. You must transfer the money pulled from your mortgage into a non-registered account only. This is because you are already getting a tax benefit from your registered investments (RRSP, TFSA). The Canada Revenue Agency won’t allow you to double-dip on tax deductibility.
How much can I borrow against my home equity?
Current mortgage rules allow you to borrow up to 65% of the value of your home as a readvanceable mortgage, or HELOC. You can borrow up to 80%, (a minimum 20% down payment is required) but the additional 15% has to be in the form of a term-reducing mortgage. So, for a home valued at $300,000, you can have a mortgage balance as high as $240,000, and a HELOC credit limit of $195,000.
Smith Manoeuvre Resources
The Smith Manoeuvre can be complicated, so you’ll want to do some additional research before you start. Perhaps the best place to go is right to the source. Robinson Smith is the son of Smith Manoeuvre founder Fraser Smith. He now runs the family business and has consulted hundreds of Canadians on implementing the Smith Manoeuvre.
On his website, you can buy the official Smith Manoeuvre book, sign up for the Smith Manoeuvre Homeowner Course, and access the Smithman Calculator, a tool that lets you create your own personal scenarios.
Final Thoughts on the Smith Manoeuvre
If you’re interested in doing a Smith Manoeuvre, I recommend that you get the book and then speak to an investment professional, like a certified financial planner, before you proceed. You may also want to discuss your plans with a tax accountant. This can be a complex strategy and you need to be comfortable with a large amount of leverage since the prices of your stocks jump up and down in value.
I have used the Smith Manoeuvre in the past and it has worked well for me. You’ll need to determine if it’s right for you. If it is, it might be one of the best financial moves you make, allowing you to convert your biggest loan into a highly efficient tax-saving machine, and build a large investment portfolio at the same time.
This is the first time I’ve seen it written that Smith Manoeuvre investments can’t be bought within a TFSA. Can you provide some more info as to why this may be? Thanks
Just as with RRSPs, you cannot deduct the interest paid on an investment loan used to purchase investments within a TFSA.
Here’s a link from Jonathan Chevreau of the Financial Post…
You can do it with the TFSA you just have to have other non-registered investments. You sell them, invest the proceeds in the TFSA and replace the investments with money from the smith maneuver.
Good summary. Paying extra “dividends” onto the mortgage is not part of the Smith Manoeuvre, however. That is a related strategy called the “Smith/Snyer” that has some tax issues.
The Smith Manoeuvre, as described in the book, is just reborrowing the available equity in from your home with each mortgage payment. It follows all the tax rules.
The Smith/Snyder, which involves receiving distributions from the investments to pay extra on the mortgage, usually results in your investment loan/credit line becoming non-deductible over time.
This is because the extra payments from the investments are considered “return of capital” (ROC for short), which means you are getting some of your principal back. If you cash in the principal from your investments, you cannot expect to still deduct the interest on the investment loan or credit line.
The Smith Manoeuvre is a risky strategy because it involves leverage, but it is a very effective long term strategy to build wealth without using your cash flow.
I am a bit confused. I am almost done paying off my house. Now, if I were to take 200k from my heloc and invest it in a mutual fund with no distributions.
– How will I pay the interest on the heloc? From my salary I assume or just let it grow?
– What happens if I had to sell some of the fund eventually?
I know that is not exactly a smith maneuver since I am only borrowing a one time lump sum.
Good point Ed. If a particular investment within a Smith Manoeuvre portfolio paid out ROC, could you then directly reinvest that portion of the disbursement and only use the true dividend payment to pay down the mortgage and borrow the available equity?
Not really. The issue is that you won’t know until after the year-end when you receive your T3 slip how much of the distribution was actually a dividend or capital gain vs. ROC.
You receive your distributions all year and it is only early the next year that you would know the amount.
If you reinvest all your distributions, but then withdraw the amount that is taxable after the year-end, your tracking for CRA purposes would be questionable.
Funds that pay ROC usually have no dividends in their distributions at all. They often have a small portion that is capital gain and the rest is ROC.
Even if you could do it, your returns are probably lower. The “tax leakage” would reduce your returns when compared to focusing on very tax-efficient investments.
There are almost always higher returns if you focus on funds that have little or no distributions at all. There are quite a few funds that have rarely or never paid a distribution. Such a 100% tax-efficient fund would usually be a better choice for the Smith Manoeuvre.
The Smith Manoeuvre is often marketed as a way to pay your mortgage off much faster, but done right, it only pays it off (converts it to tax deductible )a few years quicker.
Don’t try to avoid all the tax issues from getting some money out of the investments to pay down your mortgage. It is more effective if you look at the Smith Manoeuvre as a way to build a large nest egg over time without using your cash flow and as a way to get some tax refunds along the way.
The advantages of tax-efficient, non-distribution fund investments aside, I’d really like to know if there is any way to isolate the ROC out if I’ve gone with dividend paying funds. I’m smith manoeuvring with ETFs that have a minute amount of ROC in their distributions (which are %95 dividends). I’ve accepted the tax bleed of having dividends and so I want to know if there is any CRA acceptable way of getting the dividends out without affecting the tax deductibility of my loan interest. It’s a shame to re-invest the entire distribution for only 5% when I could take it out and pay down my mortgage quicker with the dividends I’m paying tax on anyway. Can I really not take out the previous year’s ROC in the first dividend payment of the next year? Can I reduce the part of the loan that is tax deductible and then boost it up again through this kind of activity for the next year? Any help would be greatly appreciated without trying to dissuade me from my current course…..thanks!
I’m sure you were hoping for a reply from Tom or Ed, but since I’m doing the Smith Manoeuvre with a similar approach to you I thought that I would share my thoughts. As Ed said, the issue with directly reinvesting only the portion of the disbursement that is ROC “is that you won’t know until after the year-end when you receive your T3 slip how much of the distribution was actually a dividend or capital gain vs. ROC.”
However, for most ETFs, the ROC makes up a small portion of the total distribution. Based on the historical distributions, you can probably safely estimate the maximum expected ROC. Based on that, when you receive a distribution, you can pay down your investment loan by the maximum expected ROC plus a margin and use the rest of the distribution as you please (RRSP, TFSA, paying down the mortgage, etc.). When you eventually receive your T3, you can document the ROC portion used to pay down the investment loan and the portion that was non-ROC. Since you can pay down your investment loan at any time without affecting the tax-deductibility of the loan, this extra payment won’t be a problem.
For example, I’m using VCN for the Smith Manoeuvre, and I’ll be receiving a dividend of approximately $250 soon. Looking at the ROC from the previous 8 years, the highest proportion of ROC to total distribution was 3.1%, with all but 2 years under 0.5%. To be very conservative, I’ll assume that the highest possible ROC proportion is 10%. I’ll reinvest $25 (technically withdraw, pay down HELOC, then reinvest) and withdraw $225. Let’s say that when I eventually receive my T3, the ROC was actually 1% of the total distribution. I’ll document that the $2.50 ROC I received was used to pay down the HELOC, and that I also made a separate $22.50 payment on the HELOC.
It’s not perfect, but I think it’s the best solution to using ETFs in the Smith Manoeuvre.
I have nothing against the Smith Manoeuvre but saying “your mortgage will be paid off sooner and you’ll have a much bigger portfolio than if you waited until the mortgage was paid off to invest”. There are a lot of unscrupulous advisors who use this line on clients all the time. It is a risky technique and is not for everyone. There were a lot of people who were sold this a few years ago who I’m sure regret it.
It all depends a the investment choice you make and the pattern of returns it produces.
Life Insurance Ottawa,
That’s a fair point about the risk and yes, someone who leveraged all the equity in their house even one year ago would not likely have high praise for the Smith Manoeuvre at this point. I did mention that readers should talk to a financial planner and too make sure they are comfortable with the risk.
I do agree that people should really know what they’re getting into. To point this out in detail, I will do a post soon about the increased risk of leveraged investing.
First of all, thanks a lot for all the information provided in your website!
In about a month I will start implementing the Smith Manoeuvre but I’d like to understand as much as I can before starting.
I don’t understand how 100% tax-efficient funds will meet “…the purpose of earning income test…” described in CRA’s document IT-533.
That’s why I’m considering implementing an indexed portfolio (30% TD Canadian Index-e, 40% TD US Index-e, 30% TD International Index-e)
I understand the dividend distributed by these US and International index funds are tax at 100% (as if they were interest income), is this correct?
Can you please comment on how bad the fact that these fund are not tax efficient can impact the future value of the indexed portfolio?
Thanks a lot in advance,
After studying smith maneuver and analyzing it, I came up with conclusion that it would not work in most of cases due to market fluctuations and human factor. To implement smith maneuver you must be very dedicated, live at the same home for many years and you cannot utilize your equity in the most efficient ways. What will happen when interest rates will increase and your HELOC in not 3% anymore but 7%, and your investments were not performing that great. Also there are many more ways of utilizing your equity to make more money. Using 100k for Downpayment on 3 properties will result in higher net worth and cash flow over long term then any maneuver. My clients came to me looking for advice, because they were going into it as well. I showed them the advantage of real estate investment and non-constant HELOC option. Now they are receiving 400 dollars a month positive cash flow which they can put towards their first mortgage. In 20 years they are going to have both properties paid off with values three times exceeding current values. Plus they have possibility to utilize both homes eventually to draw more equity to create more wealth. So Smith maneuver is not that great after all.
Dimitri, your solution in my opinion is too narrow and places your clients solely in one market – real estate. Good investment advisors would never recommend a strategy that lacks diversification of some sort. Even during this last correction, investors with foresight have retained the value of their assets by prudent diversification. An acute real estate correction (not experienced in Canada this time around) would devastate clients should the choose your strategy alone.
“HELOC in not 3% anymore but 7%, and your investments were not performing that great.” An increase in interest rates coupled with poor performance investment across the board seldom occurs because probably diversified assets would gain traction from the instruments driving the interest rates ( money markets, bond markets etc). In the scenario you are warning against real estate would most certainly be as vulnerable as any other investment.
What about lending guidelines for the average person? For someone to qualify for 3 new mortgages in your example they would have to have an existing income far above the average vs a client who is merely qualifying for a single mortgage on their existing property as is required with the Smith Manoeuvre.
Few people calculate the time factor involved in managing multiple properties vs a mutual find portfolio and residential tenancy laws do not always favour swift resolution to conflict which can leave clients with serious cash flow challenges.
I do not believe this is an either or argument, it depends on the clients situation entirely.
I have a different strategy.
1. First I used the equity to buy a property and then convert it to a rental property
2. Then I convert that unit into smith manuver by paying of the mortgage and just have the HELOC instead. That frees up a monthly cash and have an equity
3. I use the equity to get a leverage loan 3 for 1. i.e. ($30,000 x 3 = $60,000)total $90,000 invested in Mutual funds that pays a distribution.
4. Then I take RSP loan to max my contribution. The Income from the mutual fund pays the rsp loan
5. The income from property pays the leverage loans
6. The interest from the HELOC, Leverage Loans, and RSP loan are all tax deductable.
7. The tax return will pay the HELOC, Leverage and RSP loan.
Once I developed enough equity on this Unit, I will repeat this process.
Interest on RRSP loan is NOT tax deductible in Canada!
This is bang on. Start with a rental property, then you can draw on the HELOC and invest in non-taxable accounts like TFSA and RRSP, while at the same time deducting the interest against the rental property. Well done Jess.
Something to be aware of as I found out the hard way when I went to lease a vehicle with an R1 credit rating and was declined. Most banks, including mine (RBC), report the balance of the Line of Credit portion of your mortgage to Equifax and Transunion, which hammers your credit score and limits your access to credit outside your mortgage. Even with an R1 credit rating, lenders will get very nervous when they see that you have a large line of credit on your credit bureau report. This is based on my own personal experience. Make sure you don’t need access to other forms of credit if you have a large balance on the LOC portion of your mortgage. It will be very hard to obtain other credit.
I am a client of Robinson Smith (son of Fraser Smith) and I started the Smith Manoeuvre over a year ago. It is working tremendously well for us. The problem is that other well-meaning financial advisors will try to recreate how they believe it works using their own investment preferences.
Robinson Smith is working to put a patent on the name “Smith Manoeuvre” so that only certified and trained people can set up the Smith Manoeuvre rather than try their hand at what they think it is and give the Smith Manoeuvre a bad name when it does not turn out the way they had hoped.
Ed, I’m confused by your statement: “This is because the extra payments from the investments are considered “return of capital” (ROC for short), which means you are getting some of your principal back.”
If your smith manoeuvre portfolio is entirely Canadian dividend-paying stock (i.e. big banks), are there distributions paid that are considered RoC? This is the first I’ve heard that a portfolio made up of these types of assets will destroy the ability of deducting interest over time. It was my understanding that a properly selected portfolio would allow your LoC interest to (hypothetically) remain tax-deductable “forever”.
I’m new to these concepts, and simply trying to tie down all the details.
mr.smith has shown us how to save money and shorten our mortgagaes and claim a tax deduction from an investment portfolio which is created from his strategy? he deserves the order of canada and our thanks as well…
I’m not sure how old this is, but I just noticed your post. If you read IT-533, it is clear that essentially any stock market investment is acceptable, unless it’s prospectus expressly forbids it from ever paying income.
If you invest in a 100% tax-efficient mutual fund, you are not getting any taxable distributions, but you COULD get them. If the fund has enough taxable transactions, it would distribute them.
IT-533 goes through some examples. So you understand the intent, it is common, for example, for small fast-growing companies to reinvest all their profits because they are growing so fast. Once they get large and growth slows down, then they start paying a dividend, since they are no longer using all their cash to grow. Borrowing to invest in this company would be tax-deductible at any point. When it is small, it is not paying a dividend, but it COULD pay a dividend and probably eventually will when it’s growth slows down.
That is why CRA allows investing in stock market investments that are not currently paying any income.
My own leveraged investments are all in tax-efficient mutual funds for 17 years. I’ve had hardly any tax on investment income in that time, yet I can claim the tax deduction every year. I’ve been audited by CRA and there were no issues.
We back this up for our clients. I am a registered e-filer and we prepare tax returns for no charge for our clients that are working 100% with us. If CRA questions their interest deductions, we are the ones that answer them. We have had no issues with this.
That’s an interesting combination of strategies.
I always enjoy reading different versions of strategies that people come up with. I came up with one and named it after me. Now I have some clients constantly trying to work out something we have not thought of so we can name it after them. 🙂
There are a couple of tax issues with your idea, though.
1. The RRSP loan is not tax deductible.
2. The investment loan deductibility declines with the distributions. If you have an 8% distribution, then you take $7,200/year in distributions, which means that $7,200 of the investment credit line is no longer deductible. It is up to you to make that calculation accurately.
When you restrict your investments to mutual funds that pay a distribution, you also miss most of the best fund managers.
I would suggest to not have any distribution paid. We have modeled many versions of the Smith Manoeuvre and having mutual funds pay distributions never has a benefit. The only exception is if it allows you to leverage a higher amount than you could without it.
If you do have a distribution paid from the mutual fund, you can avoid the tax problem if you pay the entire distribution onto the investment credit line.
You are correct. The issues is that if you receive taxable income from your investment, then generally the investment credit line interest is still tax deductible.
It is tax-free income that creates a problem.
Dividend income is taxable, so that should not affect the deductibility. Distributions that are Return of Capital (ROC) are tax-free because you are receiving back your principal. That is why it reduces the deductibility of the credit line.
Most financial advisors or mortgage brokers that talk about the Smith Manoeuvre are actually talking about the Smith/Snyder, which has a tax problem. The Smith/Snyder involves having the mutual funds pay out tax-free ROC distributions. With the actual Smith Manoeuvre, there are no distributions.
You can also get ROC from income trusts and ETFs. You have to be careful with ETFs and look for any ROC in their distributions.
If your investment income is all dividends from big banks, your deductibility is fine, but you have no diversification in your investments. Dividend-paying stocks are also the current popular sector, so you generally have to overpay for dividend-paying stocks.
When we modeled the Smith Manoeuvre, we looked at taking dividends and paying them onto the mortgage to pay it off more quickly. We have a mutual fund that pays a 10% eligible Canadian dividend (believe it or not). However, we found that having no dividend produced a higher projected benefit.
In other words, a mutual fund with 10% growth and zero distributions made more money than the same mutual fund if it also pays out a 10% dividend. The reason is that there is a “tax bleed” each year, since you have to pay tax on the dividends.
Dividends are taxed at a lower rate, but there still is tax every year. Capital gains are taxed at a similar rate and you can defer them decades into the future. Would you rather pay reduced tax on a dividend this year or reduced tax on a capital gain 20 years from now?
My advice from this is that you should never determine your investment choice primarily based on tax reasons.
Choose your investments based on the best risk/return potential and the quality of the investment. Once you have selected your investment, look for tax-efficient ways to own that investment.
Hi, I have a mortgage for $135K @ 2.25% variable ad remaining term is 1 year 3 months and another one for 48K @ 2.49% fixed and remaining term is 1 year 6 months and I have a $95K line of credit @ 3.5% available for me. The maximum extra prepayment allowed without penalty for 2012 that I have on the $135K is $37K and for the $47K the maximum allowed is $7K.
I set my goal to pay off this in 4 years and I’m paying $861/week for the $135K and $300/week for the $47K and I’m wondering if it does make sense what I’m doing right now with this plan and whether it would make sense and if it would be a better strategy and will be paying less interest if I pay the maximum allowed for my 2 mortgages from the available line of credit?
The other thing I’m wondering about is real estate investment in an income property and thinking about using $50K of the $97K line of credit available for me for the down payment, also I have a proposal for partnership in a business requiring $20K investment and I’m wondering if it is a good idea to use that form the line of credit as this is the only money available for me.
After reading this article, I’m wondering if the Smith Maneoeuvre is better or if a combination of these strategies? Would the Smith Maneouvre work and the amount used for investment will be tax deductible if I’m using other amounts of the line of credit for real estate property investment and business investment or does it have to be that the line of credit is used only for the smith manaeuvre investment to eligible for tax deduction?
I would appreciate you thoughts about this and what would be the best strategy to follow in order to get ahead financially, sae on interest and enter the real estate investment market? If you have better suggestions on how to manage this situation, it is very welcome!
Do you have to use a HELOC for it to be tax deductible? I was hoping to refinance my mortgage and get 100k out of my rental properties. The reason being the HELOC are all roughly 4% and my mortgage is 2.5% Then I guess it would take 10 months for the mortgage to be completely tax deductible if my property expenses were 10k/month.
Please advise. I don’t think the tax benefits on a 100k @4% mortgage is worth it when I could just pay 2.5% on a non-tax deductible mortgage.
No, it does not necessarily have to be a HELOC to be tax deductible. The deciding factor in determining whether a debt of any type tax deductible is the purpose for which the money was used.
If you borrow to invest, it is tax deductible whether the debt is a mortgage or a credit line. If you borrow to spend, it is not deductible, even if it is a HELOC.
CRA is concerned about the “current use” of the money and being able to trace it. In other words, if you borrowed to invest, is that money still invested, or have you withdrawn part or all of it. And can you show how the money moved from borrowing it to the investment.
I’m sorry, I don’t understand the rest of your question. You seem to have a strategy in mind, but I don’t understand your strategy.
It sounds like you might be trying to do the Cash Dam, instead of the Smith Manoeuvre. Is that what you are doing, Courtney?
Ed, if I have a rental property with say 50% equity in it, can I re-lever the property by way of a HELOC and invest it my TFSA and still deduct the HELOC interest? Can’t I claim that the interest on the drawings from the HELOC are simply deductible against my rental property income?
No. Interest is tax deductible if you can trace the flow of cash from the loan to qualifying investments – and the current use of that cash is still in that investment.
The fact that you use your rental property as security for the credit line is not relevant. It does not make a TFSA loan deductible.
This is a commmon misperception. I have seen quite a few people that think anything they borrow against their rental property is tax deductible. They use it to pay off their credit cards or buy a car or some other non-qualifying expense.
They will fail a CRA audit. CRA will ask them to trace the flow of cash to a proper investment.
Can I buy a share of BRK.A through my Smith tax strategy. My concern is that BRK does not pay any dividends and thus no income. Would I still be eligible for tax deduction by CRA.
I think I have somewhat followed the Smith Manoeuvre. Let me know what you think.
I paid off my principal mortgage at 37 and then set up a home line. I borrowed against it for down payments on rental properties. I am now 43 and have 5 rental properties in Burlington/Oakville Ontario. I breakeven each month which includes my downpayment interest. My goal is to get to 10 units by the age of 48.
thanks for reading,
No problem. Berkshire Hathaway might pay a dividend at some point in the future and is not forbidden in its prospectus from paying dividends. Warren Buffett just thinks dividends are the lowest priority. There should be no problem claiming interest deductions for investments in Berkshire.
You are not doing the Smith Manoeuvre at all. You just borrowed to buy rental properties. The Smith Manoeuvre involves borrowing back the equity portion of each mortgage payment to invest. It also usually involves capitalizing the interest.
The income you get from it is not relevant, since the Smith Manoeuvre is self-funding from a cash flow perspective (by capitalizing).
You have the right name for the Smith Manoeuvre, though!
I don’t think I could stomach the up and down of the market with this type of setup. I don’t like mutual fund MER so this would not work for me
Can this technique be used when buying an investmentment rental properties?
I plan to change from my conventional mortgage to a readvanceable mortgage and this is a great idea if it can be used towards investment properties as well.
You can use your home equity to buy rental properties. Just save up equity until you have enough down payment to buy a property.
This is not the Smith Manoeuvre, though. The Smith Manoeuvre involves investing regularly and efficiently, generally bi-weekly or monthly with each mortgage payment.
If you like real estate, that may make sense. However, there is a tendency of investors to always buy whatever has done well the last few years. Real estate returns have been consistent, well above average and similar to equity returns the last 10 years. Investors can remember the last 2 equity bear markets, but not the last real estate crash (in the 1990s).
The Smith Manoeuvre is a risky strategy, since you are borrowing to invest. I would suggest to avoid focusing on whatever has done well recently.
I sold my house.
I purchased another house to live in.
I will be giving to a bank a 1st conventional principal and interest mortgage of $86,000.
I will also be giving a 2nd collateral line of credit and will make one (1) draw of $86,000 in funds from this line of credit for investments in order to conduct the Smith maneuver.
Can I do the Smith maneuvre with 2 separate products as noted above or do I have to have 1 readvanceable mortgage?
Also to conduct the Smith maneuvre do I have to purchase the house for cash first and then mortgage it for $86,000 and then draw from a secured line of credit $86,000 to make investments with and ultimately conduct the Smith maneuvre.
Also can I draw from my line and make a one time investment equal to my mortgage or do I have to invest an amount equal to my mortgage payment each time I make a mortgage payment?
I have read so much different conflicting information.
Also if there is no first mortgage on a principal residence property, but simply a secured 1st position line of credit, can one invest using such line of credit and all interest is deductible since the money’s were borrowed to invest.
The mortgage and credit line do not have to be the same amounts. Just buy the house as you normally would with the mortgage amount you need to be able to buy it. Then you can use whatever credit you have available in the credit line to invest.
It is definitely better to have a readvanceable mortgage. You can get essentially the same rates as with a conventional mortgage, plus you can often avoid all legal, appraisal or setup fees.
If you have 2 separate products, then you cannot readvance the principal portion of your mortgage payments or capitalize your interest – unless you leave a bunch of credit available for this. With a conventional mortgage, you will need new legal and appraisal fees when the mortgage comes due to be able to access your additional credit.
If you plan to do the Smith Manoeuvre, you should definitely get a readvanceable mortgage. I have a free Smith Manoeuvre mortgage referral service on my site, if you need help getting the best rates on a good SM mortgage.
Yes, if you have no mortgage and just borrow the equity to invest, it should be tax deductible.
Marlene, it sounds like you are new to this and really not sure what to do. The Smith Manoeuvre can be an excellent strategy for building wealth long term, but is also a risky strategy of borrowing to invest. It may not be suitable for you. If you plan to do it, make sure you know what you are doing, have an effective investment strategy, and will be able to do it long term.
Hi, I have a question about the SM strategy. I am aware of what this is and how it works. My question is do I need a to fund the leveraged investment using the revolving portion of the HELOC or can I fund this with an amortizable loan. The following two cases illustrates what I am trying to ask.
Case 1: I borrow $100k from the bank and invest this amount into securities. Is the interest on this $100k is tax deductible?
Case 2: Let’s say I have a HELOC with total borrowing capacity of $500k of which $80k is allocated to my mortgage. This leaves the remaining $420k available for borrowing. Instead of borrowing using the HELOC rate which is usually prime + some spread. I can create another tranche of amortizable loan under the $420k available and use it for investing. So, in other words, of the $500k of HELOC, I have 3 tranches, tranche 1 is my $80k mortgage – fixed rate amortizing loan. Tranche 2 is my $100k investment loan – fixed rate amortizing loan. Tranche 3 is the remaining $320k revolving portion on my HELOC unused.
My question is for case 2, can I deduct the interest expense from tranche 2 which I use for investment?
Both options are tax deductible.
To be deductible, you need to be able to trace that the money went into investments and is still in investments.
With option 2, your payment is higher but your interest rate is lower. You are paying down your tax deductible loan. However, you can capitalize the full payment for both options.
The main threat to this strategy is loss of income. If you can’t make the interest payments it all falls apart.
Good luck trying to sell a home that is tied up with this option. You’d be better off gettinga line of credit need on your home equity then taking a course on investing then opening an investor account with someone like Scotia or BMO. Transfer some funds in from your line of credit and look at the various ETF’s and energy sector stocks available. Join the various stock exchanges world wide and read, research and watch. It’s like a hobby. Treat like one and you’ll get the hang of it rather quickly. Timing and good information make people rich.
How to address Estate planning when using a HELOC? If the borrower passed away, would the bank freeze the HELOC or force the spouse to pay off the HELOC?
Would a small business be considered an eligible investment for the SM? My cash flow can maintain the business in its early days, but startup capital is proving hard to find.
Is there a necessary condition for it to work? Something like [ annual rate of return > (1- tax rate) * interest rate on loan ]
I am reading about SM on various blogs and podcasts. My questions :
1. As we need pay income tax (high tax bracket) on dividend income which could be higher than the interest of HELOC portion to claim tax refund, how this will be effective? what are tax-efficient MFs that can be used for investment to avoid more tax?
2. who should invest (high tax bracket or low tax bracket) with dividend income?
Hi, wondering if I can get some validation on this strategy:
1. Borrow from HELOC to make down payment on rental property.
2. Take the rent earned to pay principal (non-deductible) mortgage payments
3. Borrow back from the HELOC to make mortgage payments on the rental property.
4. Make interest only payments to HELOC from personal cash flow or capitalize the interest.
5. Claim tax deduction for interest payed on HELOC and Rental property mortgage interest.