Make Your Canadian Mortgage Tax Deductible

Have you guys heard of the Smith Manoeuvre (SM)? For those who don’t know what it is, it’s a Canadian wealth strategy to structure your mortgage so that it’s tax deductible. Our US neighbors already get the luxury of claiming their mortgage interest and now there is a way for us Canadians to do the same.

There’s a tax rule in Canada where if you borrow money to invest in an interest producing investment (like a dividend paying stock or investment property), you can deduct the annual interest paid on the investment loan from your income tax. Kinda wordy I know, in layman’s terms, if you get a loan with x amount of interest / year, you can claim that x interest during income tax season if you use the loan towards stocks or rental properties. If you’re still confused, please read on below where I will eventually explain everything step by step.

So, who came up with this idea and how does this apply to making a mortgage tax deductible? Mr. Fraser Smith has all the answers and he has written a book on the topic which explains how to do this properly. To summarize the Smith Maneouvre in a nutshell, it’s where you borrow against the equity in your home, invest it in income producing entities, and use the tax return to further pay down the mortgage. Repeat until your mortgage is completely paid off leaving you with a large portfolio and an investment loan. Voila! Your mortgage is now an investment loan which is tax deductible and hopefully, your portfolio is larger than your loan.

Below is my understanding of how someone would implement the Smith Manoeuvre (SM). Note that I have not read the book, but this is information I have acquired from around the net and from speaking with various people that have implemented the technique.

1. Sell all your existing stock in non-registered investment accounts and use it towards a down payment for step 2.

2. Obtain a re-advancable mortgage. This is a mortgage that has 2 entities, the home equity line of credit (HELOC) part and the regular mortgage part. Nothing unique about this setup EXCEPT that as you pay down the mortgage, the credit limit on the HELOC increases. This is a key feature that is needed when implementing the SM. Note that you usually require at least 25% equity before you can obtain a re-advancable mortgage. Some financial institutions that offer these mortgages are:

RBC - The Homeline Mortgage
Firstline - The Matrix Mortgage
Manulife - ManulifeONE Mortgage

3. Use the HELOC portion of your mortgage to invest in income producing entities like dividend paying stocks or rental property. With every mortgage payment, your HELOC limit will increase. So with every payment, you will invest the new money in your HELOC. Note that you SHOULD NOT the HELOC money to invest in your RRSP as you will lose the tax deduction on the invested money.

4. When tax season hits, deduct the annual amount of interest that you paid on your HELOC against your income. So, if you paid $6000 in interest payments for the year and you have marginal tax rate of 40%, you will get back ~$2400 of it.

5. Apply the tax return against your non-deductible mortgage and invest the new money that’s now in your HELOC.

6. Repeat steps 3-5 until your non-deductible mortgage is paid off.

As you can see, this process will pay down your regular mortgage in a hurry.

The Advantages:

* You get to build a large investment portfolio without waiting to pay off your mortgage first.
* You get to pay down your non-deductible mortgage in a hurry.
* Your new investment loan is tax deductible.

The Downside:

* You need to be comfortable with LEVERAGE and investing in general.
* You need a plan ‘B’ in the case that you need to move and home values have gone down. If you invested properly, your portfolio should at LEAST cover your loan.
* Your mortgage is NEVER paid off where you keep the tax-deductible loan (this is also a good thing).

In part 2 of this series, I will talk more about general questions regarding the Smith Manoeuvre. Like, the extra HELOC interest payment IN ADDITION TO the regular mortgage, different investment options, ways to optimize the SM and when i’m going to implement this technique.