When you own a home, the expenses can seem endless – electric upgrades, utility bills, property tax, plumbing issues, lawn maintenance, you name it. And then there’s the mortgage, with an interest rate that has you spending an extra couple of hundred dollars a month without even touching the principal payment, as well as the tax.
The worst part is that you can’t even deduct any of these expenses if the home is your primary residence – that’s only allowed if it’s a rental property. Normally, Canadians aren’t able to deduct their mortgage interest tax from their income during tax time.
However, there is a way to achieve this using the Smith Maneuver.
Key Points
- The Smith Maneuver is a tax strategy that makes interest on a mortgage tax-deductible.
- This strategy involves converting the interest on your home loan into tax-deductible investment loan interest.
- To use the Smith Maneuver, you’ll need a re-advanceable mortgage, which includes a mortgage and HELOC portion.
What Is The Smith Maneuver?
Developed by financial planner and strategist Fraser Smith, the Smith Maneuver is a legal strategy that helps Canadian homeowners turn their mortgage interest into a tax-deductible investment loan.
Smith noticed that wealthier Canadians were finding more deductions in their taxes because they had the means to spend more money on expensive accountants. He shared his strategy to level the playing field, and to help- low to middle-class Canadians find the same tax breaks.
How Does The Smith Maneuver Work?
For the Smith Maneuver to work, you need a re-advanceable mortgage. Similar to a line of credit, a re-advanceable mortgage includes both a mortgage and a line of credit that you can borrow from. These are commonly known as Home Equity Lines of Credit (HELOC).
Each mortgage payment you make pays down your mortgage while also increasing the amount you can borrow from your line of credit.
The Smith Maneuver converts your mortgage loan or line of credit into an “investment” loan that qualifies for interest deduction during tax season. If you borrow funds from your HELOC and invest them into something that produces income, you can deduct the interest on the borrowed funds from your income.
Keep in mind that in order to get a re-advanceable mortgage, you’ll need at least 20% equity in your home. If you’re planning to buy a home, you’ll need at least a 20% down payment to be eligible for a re-advanceable mortgage.
The Smith Maneuver In Action
To give you an idea of how the Smith Maneuver works, let’s illustrate using an example:
- Your home’s current value: $750,000
- Outstanding mortgage: $300,000
- Monthly mortgage payments: $2,400
- Principal portion: $1,600
- Interest portion: $800
Now let’s say you set up a re-advanceable mortgage with a HELOC limit of 65%. With most lenders, you can borrow up to 65% to 80% of your home’s value. However, the HELOC in addition to your outstanding mortgage cannot exceed 80% of your property value.
The calculations to determine your credit limit are as follows:
- $750,000 (property value) x 65% = $487,500
- $487,500 – $300,000 (remaining mortgage balance) = $187,500
In this scenario, you would have $187,500 access through a HELOC combined with your mortgage.
In addition to this amount, you also have access to another $1,600 per month that you put toward your principal with each mortgage payment you make.
If you want to borrow $200,000 from your HELOC for investment purposes for one year and you’re paying a rate of 4.25% on your HELOC, you would pay $8,500 in interest in the year. When you file your income taxes, you can claim this $8,500 as a tax deduction.
Steps To Set Up The Smith Maneuver
Follow these steps to set up the Smith Maneuver and start deducting your mortgage interest:
Step 1: Obtain a re-advanceable mortgage loan (HELOC) from a lender.
When you buy your first home, make sure the mortgage is re-advanceable. You can also obtain a re-advanceable mortgage when you renew or break your existing mortgage.
Step 2: Make mortgage payments.
As you pay your mortgage, you’ll increase your credit limit on your HELOC. This will open up more money for you to use for investments.
Step 3: Invest using funds from your HELOC.
Make sure your investments are likely to give more of a return than the cost of interest in borrowing from the HELOC. If you’re looking for a simple way to invest your money from a HELOC, consider using a robo-advisor app, such as Wealthsimple, Nest Wealth, or QuestWealth.
Step 4: Make a claim for deduction on the interest incurred on the HELOC.
Claim your deductions when you file your taxes.
Step 5: Reinvest your tax refund.
The funds you get back from your tax refund can be reinvested to continue to make your money work for you.
Benefits Of The Smith Maneuver
Here are some reasons to consider the Smith Maneuver:
- Pay off your mortgage faster – By deducting interest from your income, you’re able to receive a larger tax refund. While you can use the fund to invest, you can also use it to make a lump sum payment on your mortgage each year to pay it off faster.
- Pay less in taxes – Deducting the interest allows you to reduce your tax liability, thereby reducing the amount you have to pay in income taxes. This is particularly advantageous to those who are in a higher income tax bracket.
- Invest without using your own money – If you have limited cash flow because of debt, low income, or family obligations, the Smith Maneuver gives you an opportunity to invest and earn passive income without using your own money. This allows you to save more for retirement, even if your cash flow is low.
What Are The Risks Of The Smith Maneuver?
Like any investment, the Smith Maneuver isn’t free of risk. Make sure you consider the following before using it:
- You’re leveraging your home – If you invest into something that doesn’t make you any money – or worse if it causes you to lose money – you could be in trouble. Leveraging your home equity is always risky because the lender can take your house if you’re unable to pay back the debt.
- You’ll need an accountant – Filing taxes is manageable as an individual, but you need to know the rules. If you file without covering all your bases, you could face an audit from the CRA. An accountant can help you navigate your taxes, but they also come at an expense.
What Happens When You Pay Off Your Mortgage?
With a mortgage that isn’t re-advanceable (non-HELOC mortgage), you’re free and clear once you pay it off. However, this isn’t the case if you have used the Smith Maneuver. Even if you’ve paid all of your mortgage interest, you are still on the hook for paying the interest on your HELOC loan.
You can address this issue in two ways:
- Option A: Keep your HELOC forever. This works if you’d like to continue to benefit from the Smith Maneuver and use the loan credit to invest.
- Option B: Pay off the HELOC. This works for people who aren’t comfortable carrying a large loan into retirement. To pay off your HELOC, redirect the cash that would have gone toward your mortgage to the HELOC loan.
Other Ways To Access Your Home Equity To Invest
In addition to a HELOC, there are other ways to tap into your home’s equity if you’re looking for extra cash to invest:
Home Equity Loan
A home equity loan is similar to a HELOC in that you can use it to borrow from your home’s equity. Like a HELOC, a home equity loan is backed by your house.
With a home equity loan, you can borrow up to 80% of your home’s appraised value, less your original mortgage. You’ll receive one lump sum payment, instead of having access to a line of credit like a HELOC.
Rather than making interest-only payments (which is the case with a HELOC), you’ll make regular installment payments toward repaying your home equity loan. These payments will consist of both a principal and interest portion. Interest is usually fixed on home equity loans, unlike HELOCs which typically come with variable rates.
Is The Interest Charged On A Home Equity Loan Tax Deductible?
Interest charged on a home equity loan may be tax-deductible only if the funds from the loan are invested for eligible purposes. The CRA will consider various factors, such as the intention to earn a profit and the investment risk. Even if you use a home equity loan for an eligible investment purpose, there may be limitations on how much of the interest may be tax-deductible.
Cash-Out Refinance
Another way to access your home’s equity to use for investment purposes is with a cash-out refinance. This financing option allows you to refinance your mortgage for more than what your outstanding mortgage balance is, and then take the difference in cash. You’ll need at least 20% equity in your home to qualify.
Is The Interest Charged On A Cash-Out Refinance Tax Deductible?
Mortgage interest on a cash-out refinance is not tax deductible. The interest can only be deducted if the loan is used for investment purposes. So, you may be able to deduct the interest on money you borrow to make improvements to a rental property, for instance. But if these improvements are made on your primary residence, you would not be able to deduct the mortgage interest.
Smith Maneuver FAQs
When does it make sense to use the Smith Maneuver?
Can I use the Smith Maneuver on tax-free accounts?
Is the Smith Maneuver a good choice for a risk-averse person like me?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
