What is “The Smith Maneuver ”
Over the last couple of months, we have had some savvy investors call us inquiring about “The Smith Maneuver”, and how we could help them benefit from this strategy. Yes, there is an upside, but this strategy is not for everyone, and could leave you worse off if you are not careful.
The Smith Maneuver is a legal tax strategy that effectively makes interest on a residential mortgage tax-deductible in Canada. Smith Maneuver is used to convert the interest you pay on your mortgage into a tax-deductible investment loan. The concept takes its name from a financial planner named Fraser Smith, who developed it.
As many of you know, in the US, homeowners are able to deduct their mortgage interest when filing their taxes. In Canada, interest paid on mortgage loans for your personal residence is unfortunately not tax-deductible… but using the Smith Maneuver it could be.
So how exactly does the Smith Maneuver work?
When you sign for a mortgage, you must provide a down payment for the purchase of the residence. The minimum a home buyer needs to put down in Canada is 5% of the purchase price of the house.
As you begin to pay down your mortgage, a portion goes to paying the interest on the loan, and the other portion pays down the principal, and slowly and surely, you begin to build equity in your home. When the equity goes over 20% of the value of your home, you can then take out a home equity line of credit better known as a HELOC.
Generally, you can borrow up to 65% of your home’s value in the form of a HELOC. When you combine your HELOC and your mortgage balance, the two cannot exceed 80% of the value of your home.
A HELOC is like a credit card or a line of credit using your house as collateral. You can use these funds as you wish, including college tuition for your kids, a vacation, home renovations, a down payment on another property, and or investments.
For the Smith Maneuver to work, you need a re-advanceable mortgage, and HELOC combined. Defined: a re-advanceable mortgage is a mortgage comprised of a home equity line of credit (HELOC) that are packaged together.
As you pay down your mortgage, your HELOC limit increases, and gives you direct access to your mortgage equity.
What the Smith Maneuver does is convert your mortgage loan into an “investment loan” that qualifies for interest deduction at tax time. When one borrows to invest with the reasonable expectation of generating income. You, the taxpayer can deduct the related interest from income.
To make this happen, these are the steps you need to take:
· Sign for re-advanceable mortgage. As mentioned, this mortgage is made up of a regular mortgage and a HELOC.
· You then use these funds to invest in income-producing investments. Such as dividend-paying Canadian stocks or you can also invest in a rental property.
· Deduct the interest paid on your home equity line of credit HELOC when filing your taxes. The result is a tax refund that is based on your marginal tax rate – your marginal tax rate is income based; the more you make, the higher percentage you pay.
· Then re-invest your interest tax refund and other proceeds from your investment portfolio (dividends, rent) to pay down your mortgage. This automatically increases your available HELOC limit and funds available for you to make more investments.
· If your objective is to pay off your mortgage, keep repeating the steps mentioned above.
If this is the right strategy for you or would like more information on how to make the Smith Maneuver work in your favor. Contact one of our mortgage brokers, and they will happily take you through the steps. Also point out the traps that you need to be aware of.
Martin Spalding
Mortgage Broker