Smith Manoeuvre and tax deductible mortgages

An interesting article by Bob Aaron; Toronto Real Estate Lawyer, was published on “Smith Manoeuvre” today in Toronto Star. The article was published after REM (Real Estate Magazine), a monthly publication for real estate industry stakeholders, carried an article by tax specialist Dan White. Dan sounded an alarm about using the Smith Manoeuvre strategy. In his article the “Dark side of the Smith Manoeuvre,” he cautions anyone contemplating using the technique to “think again and think carefully.”

According to Smith Manoeuvre Financial Corporation, “Smith Manoeuvre is a financial strategy that simultaneously converts mortgage interest to tax deductions, shortens the amortization of your mortgage and builds a free and clear pension portfolio for your retirement, funded through monthly mortgage payments and without requiring any additional monthly cash investment!”

Here’s how the program works according to the Smith Manoeuvre strategy: The homeowner obtains what the Smith people call a re-advanceable mortgage -which is basically a mortgage combined with a line of credit, where the balance can fluctuate from time to time.

As the homeowner pays down the principal with monthly payments, he or she then immediately have that amount re-advanced in order to invest in stocks, bonds or other real estate. In theory, that portion of the loan used for investments – and that portion only – is tax deductible.

In other words, the interest paid on the “re-advanced” portion of the loan can be used to reduce investment income.

Where White finds a “significant flaw” in the above Strategy, Certified Financial Planner and an accountant, Ed Rempel begs to differ.

As per Ed Rempel, “Any accountant or tax professional would be able to correct all the errors in tax knowledge in Dan White’s article. The Smith Manoeuvre is a fancy name for borrowing to invest. The article seems to imply that Canada Revenue Agency (CRA) has a problem with borrowing to invest in the stock market investments. For example, article taken literally would mean that the Teachers Pension Plan would not be able to claim as a business expense any interest involved in buying Bell Canada. This is ridiculous. While it is technically correct that the Tax Act does say that there needs to be an expectation of profit excluding capital gains, taking this literally would exclude all borrowing to invest in any stock, since stocks rarely have very high dividends.

In practice, however, CRA has never contested any interest expense in a simple borrowing to invest into a mutual fund or stock. Using your home as collateral for a loan can in no way make the home at risk of being considered a business asset. If you run a business from your home and claim more than 50% as a business asset, it may be an issue, by just using it as collateral for an investment cannot possibly have such an effect. CRA is not money-hungry. In fact, there are many incentives built into the Tax Act available for knowledgeable people that know how to effectively apply it.”

“The Smith Manoeuvre done properly easily meets all CRA rules”, say Ed Rempel. “It is just borrowing to invest, which is done by every company and every business owner in Canada every day. However, the related strategy being marketed by SMFC called the ‘Smith/Snyder’ does not”.