What’s the Smith Maneuver? It’s a
wealth-building strategy to create a tax-deductible mortgage. You may have heard,
and envied, that mortgage holders in the US can claim their mortgage interest
as a tax deduction. Well, you may be able to use that strategy in Canada with the
Smith Maneuver. Here’s how it works.
In Canada, if you borrow money to
invest in a product that produces an income such as an investment property or a
dividend paying stock, the interest on the borrowed money may become tax deductible.
If you borrow against the equity in
your home, invest it in income-producing products, then you can use the tax
refund to further pay down the mortgage. By repeating that a number of times,
you can pay off your mortgage.
The man behind it
all was Fraser Smith, a financial strategist based in Victoria, British Columbia.
He pioneered The Smith Maneuver, a ground-breaking, legal strategy that lets
ordinary Canadian homeowners make their mortgages tax deductible. In his work, he saw that too many Canadians were waiting until their
mortgages were paid off before they started to build an investment portfolio,
missing out on years of compounding interest, and putting themselves in the
position of being house rich and cash poor in retirement, unlike his wealthier
investors who used tax strategies to grow wealth. So, he learned the rules of
tax deductibility and penned the book The Smith Maneuver for all Canadians.
In a simplified way -- here’s how it works: It
starts with a re-advanceable mortgage, which is a mortgage linked with a line
of credit. The credit limit for
your mortgage plus the credit line is normally 80% of the appraised
value of your home, but new rules have changed that to 65% of the value
of your home. With each mortgage payment, you pay down some principal, which
immediately becomes available credit in the credit line. You can now borrow
this amount to invest directly from the credit line. Your investment credit line interest is
normally tax deductible and you should receive a refund, which will be small in
the beginning.
Use the line of
credit portion to invest in incoming-producing products but never in an RRSP –
you’ll lose the tax deduction.
At tax season,
you can deduct the annual amount of interest you paid on your line of credit
against your income. Then apply the tax
return and investment income against your non-deductible mortgage and invest
the new money that’s now in your line of credit. Repeat this until your
nondeductible mortgage is paid off.
By doing this
you get to build a large investment portfolio without waiting to pay off your
mortgage first; you get to quickly pay down your non-deductible mortgage in a
hurry; and your new investment loan is tax deductible.
To learn more
about this strategy and to see if it can work in your situation, contact a
mortgage broker.