The rule that is in use is the rule that if you borrow money to invest in an income producing investment (eg. a investment property, an anuity, or a dividend paying stock), then you can deduct the annual interest that you paid on the investment through your annual income taxes.
Basically, if you borrow money to invest, then you can claim the interest paid on your taxes. Using this rule allows for you to take advantage of the Smith Manoeuvre.
How does this rule make a Mortgage Tax Deductible?
Mr. Fraser Smith has written a book on the topic, and with all the details to do this in all potential situations; however, it basically means that if you borrow money against the available equity in your home, invest it in income producing investments, and then use the tax return to pay down your mortgage. Repeat this process multiple times until you have a large investment portfolio, a house that is paid in full, and an investment loan. If you have invested successfully, then you should have a portfolio that is several times larger than your outstanding loan. This sounds complicated, but it is really quite simple.
The Smith Manoeuvre Process
- Sell all existing stocks from your non-registered investment accounts. Use these funds to pay down your outstanding mortgage balance, or as a down payment on a new purchase.
- Get a readvanceable mortgage. This means that as you pay down your mortgage loan, you will have a secured line of balance limit that will increase. The more you pay down your mortgage, the higher your balance on the secured line of credit. You need to have at least 20% of your home paid off to be able to get a secured line of credit. Many banks offer this form of product. Make sure that you ask your bank if they offer this product before signing up for a mortgage.
- Take all the money you have available on your secured line of credit and invest it in income producing investments. With every mortgage payment, your secured line of credit will increase, so continuously increase the amount of money you are investing in your income producing investments. Make sure that you are investing in non-registered accounts, and not RRSPs or a TFSA. This is because only the non-registered accounts will allow you to write off the interest.
- When it comes time to file your taxes, deduct the total amount of interest that you paid on your secured line of credit throughout the year. Depending on your tax bracket, you may get up to 40% of the interest paid back on the money invested.
- Use your tax return and investment income to pay down your mortgage balance, then use the increasede credit limit in your secured line of credit to invest more.
6. Repeat this process until your mortgage is paid in full.
The Disadvantages of the Smith Manoeuvre
- This is leveraged investing, so it is not for people who are not good with risk.
- Your mortgage will never be paid off as long as you keep the tax deductible loan. You will be able to continuously deduct the interest of this loan as long as you keep the investments.
- Make sure you have a second savings account in case property values depreciate.
The Advantages of the Smith Manoeuvre
- The secured line of credit is completely tax deductible.
- You get to pay off your non-deductible mortgage quickly.
- You get to create a large investment account while paying down your mortgage, not waiting until after.
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