Smith Manoeuvre - Questions

[cardhu]

If you don't have non-registered investments other than your house, it's irrelevant.

Wrong ... initiating the Smith Maneouver does not require any existing non-registered investments.

[pitz]

Simple explanation: The interest on money borrowed to invest is tax-deductible.

The devil is in the details, and Fraser Smith, in his book, outlines some of the mechanics of borrowing to invest while paying down a residential mortgage.

[pitz]

You can accelerate this by putting any dividends and tax returns onto your mortgage and by paying interest only on your investment loan.

One can also pay the interest on borrowed money using the HELOC, and this will accelerate the process.

Interest on interest paid to borrow to invest is also tax deductible.

[adrian2]

You can accelerate this by putting any dividends and tax returns onto your mortgage and by paying interest only on your investment loan.

One can also pay the interest on borrowed money using the HELOC, and this will accelerate the process.

Interest on interest paid to borrow to invest is also tax deductible.

I don't think you're right. I know that, for the purpose of attribution rules, interest on interest is not attributable. Why would it be tax deductible?

[patriot1]

If you don't have non-registered investments other than your house, it's irrelevant.

Wrong ... initiating the Smith Maneouver does not require any existing non-registered investments.

So where does the money come from to pay down the existing non-deductible mortgage, so you can remortgage to buy investments?

[cardhu]

So where does the money come from to pay down the existing non-deductible mortgage, so you can remortgage to buy investments?

From wherever you get the money to make the regular mortgage payments ... whenever a mortgage payment is made, a portion of it is repayment of principal ... that's what you reborrow ... then when the investments start producing dividends (or distributions in the case of mutual funds), you direct that money against the mortgage and reborrow it again ... then when you get a tax break for deductible interest, you direct that amount against the mortgage, and do the same ... if you have extra cash for voluntary prepayments, you can do the same with that cash flow ... it starts slowly and builds momentum ... that, in a nutshell, is the essence of the Smith Maneouver.

Of course, if you happened to have an existing portfolio, you could do as you suggest ... sell it, direct the proceeds into the mortgage, reborrow the amount and reassemble the portfolio … but its not a prerequisite.

[patriot1]

That's just leveraged investing using new borrowing. The fact that it's secured against your house is incidental. It could just as well be a margin loan.

The plain fact is the the interest on the money you borrowed to buy your house is not deductible, and cannot be made deductible. The "Smith manouvre" is just smoke and mirrors to make you think you're getting around this.

What I don't like about this whole pitch is that it gives people the impression they are getting a free pass into leveraged investing, which I think is a bad idea in itself (unless used to buy an asset with favourable cash flow). I also get the sneaky feeling it's being promoted by sellers of high-MER mutual funds, which I don't approve of either.

[Shifty]

That's just leveraged investing using new borrowing. The fact that it's secured against your house is incidental. It could just as well be a margin loan.

The plain fact is the the interest on the money you borrowed to buy your house is not deductible, and cannot be made deductible. The "Smith manouvre" is just smoke and mirrors to make you think you're getting around this.

What I don't like about this whole pitch is that it gives people the impression they are getting a free pass into leveraged investing, which I think is a bad idea in itself (unless used to buy an asset with favourable cash flow). I also get the sneaky feeling it's being promoted by sellers of high-MER mutual funds, which I don't approve of either.

It's not new borrowing, it's just borrowing back the principle paid off of your mortgage. With the SM, your total debt level will never go up, hence no new borrowing.

The risk factor is that your total debt level will never go down, either, as it would without the SM.

[cardhu]

That's just leveraged investing using new borrowing.

Nevertheless, that’s what a Smith Maneouver is.

The fact that it's secured against your house is incidental. It could just as well be a margin loan.

Not really … where would the money come from to secure a margin loan? … in a margin account, the security for the loan must be in the account, alongside the debit balance … with a HELOC, the security for the loan is the home, and doesn’t need to be deposited into the brokerage account. They are different animals.

The plain fact is that the interest on the money you borrowed to buy your house is not deductible, and cannot be made deductible. The "Smith manouvre" is just smoke and mirrors to make you think you're getting around this.

Correct … some of the more rhetoric-prone SM fanatics create the impression (and may, in fact, believe) that the maneouver somehow “transforms” non-deductible debt into deductible debt … but its not a transformation, its merely a replacement … and that’s not the only myth / misconception circulating on the subject … there’s certainly a smoke-and-mirrors aspect to the promotion of it, but when you strip all of that away, there is still something of value in the general principal … it does allow one to eliminate debt faster, though not without added risk, and not anywhere near as fast as some would suggest.

I agree that there seem to be promoters who present a misleading story, and there seem to be no shortage of rabid SM fanatics, eager to swallow it hook line and sinker … some are so gung-ho that they seem almost to declare “jihad” on anyone who dares to dangle a few facts into the discussion ... one particularly logic-deficient nut claimed he had “… encountered all sorts of people with objections to SMITH, and in 100% of cases it is because they either don't understand it or don't want to understand it because it would be too upsetting to them to admit whatever they are doing might not be the way.” … so yeah, I agree that the way some people pitch SM may give people the impression that its some kind of minimal-risk sure-thing, which it obviously isn’t.

It's not new borrowing, it's just borrowing back the principle paid off of your mortgage. With the SM, your total debt level will never go up,

That’s the common spin, but of course its new borrowing … in the ordinary course of a run-of-the-mill conventional mortgage, the principal balance progressively gets lower and lower … five years into a $250k mortgage, with amortization of 25 yrs & interest rate of 5.2%, the balance outstanding should have fallen to about $222k … if the combined debt, under a Smith Maneouver, is anything higher than $222k at that point, then it is because debt has been added.

And yes the total debt level can go up … SM promoters brag that the maneouver can be done without requiring any additional cash flow, above and beyond what you would have been paying in mortgage payments anyway … this can happen ONLY if the interest charges on the deductible debt are accrued (ie. added to the debt) rather than paid out of pocket … which means the overall debt level will climb, and keep on climbing until some cash flow is freed up to pay the deductible interest cost directly.

[adrian2]

One can also pay the interest on borrowed money using the HELOC, and this will accelerate the process.

Interest on interest paid to borrow to invest is also tax deductible.

I don't think you're right. I know that, for the purpose of attribution rules, interest on interest is not attributable. Why would it be tax deductible?

Any comments on the validity of the above? Our resident accountants?

[Jo Anne]

One can also pay the interest on borrowed money using the HELOC, and this will accelerate the process.

Interest on interest paid to borrow to invest is also tax deductible.

I don't think you're right. I know that, for the purpose of attribution rules, interest on interest is not attributable. Why would it be tax deductible?

Any comments on the validity of the above? Our resident accountants?

I've just re-read this, and I can't figure out what you are talking about, so I can't comment.

If anyone can explain in simpler terms, I'd be happy to look at it again.

[adrian2]

I've just re-read this, and I can't figure out what you are talking about, so I can't comment.

If anyone can explain in simpler terms, I'd be happy to look at it again.

Say you borrow to invest in stocks, $100k.
The interest charged in the first year is $6k. Instead of paying it separately, you add it to the principal. In year two, you owe $106k.
The interest charged in year two is $6,360 = $6,000 interest on the money you borrowed to purchase stocks + $360 interest on the interest.
In year two, is the full $6,360 tax deductible?
My non-accountant mind says no; only $6,000 is tax deductible.
What say you?

[andrew]

Against my gut, I'm feeling optimistic today.

So, what the hell.....

In a straightforward scenario, interest on interest, is interest. It is more generally referred to as 'compound interest'. It retains the nature of the original interest - that is, if the interest was deductible, so should the compound interest, just as interest on taxable interest revenue, compound interest revenue, is also taxable.

Attribution determines who pays the tax, not whether it is taxable.

[andrew]

(off topic) Thanks My Dream (end off topic)

[Jo Anne]

I guess I was confused because I was reading too much into this. Perhaps it was the comment...

I know that, for the purpose of attribution rules, interest on interest is not attributable

which has absolutely nothing to do with interest deductibility in this discussion.

Yes, it's deductible.

You borrow money to buy stock. The interest is deductible. If you don't make quite a big enough payment on your loan to cover all the interest, there will be interest on interest. It's deductible. Lather, rinse, repeat.

[andrew]

Our resident accountants?

It's deductible.

In case I wasn't 'resident' enough?

Is it worth pointing out that not all interest incurred to buy stocks is deductible?

Ahh, what do I know anyways?

[adrian2]

I guess I was confused because I was reading too much into this. Perhaps it was the comment...

I know that, for the purpose of attribution rules, interest on interest is not attributable

which has absolutely nothing to do with interest deductibility in this discussion.

To me, it's a quite similar case. What's the use of the money that you're paying interest for? Is it used to earn income? No, the interest paid in year 1 is not directly used to earn income. There is no increase in the potential return of your investments (e.g. stocks) due to the interest paid in year 1. So you should pay the interest from a different account, to make it easier. Similar to the attribution rules, IMO.

Yes, it's deductible.

You borrow money to buy stock. The interest is deductible. If you don't make quite a big enough payment on your loan to cover all the interest, there will be interest on interest. It's deductible. Lather, rinse, repeat.

Different example, with a twist of personal tax returns vs. corporate ones. You don't pay in full the taxes due. Is interest on your taxes tax deductible? The answer is no. Again, to me it's like the interest on interest, or if you wish tax on tax. OTOH, for a corporate return AFAIK the interest is deductible.

[andrew]

Is interest on your taxes tax deductible? The answer is no.

Actually, that's not always true. Interest deductibility on taxes follows deductibility of taxes.

For example, look up whether interest is deductible on Ontario capital taxes. It is. Why? Because Ontario capital taxes themselves are deductible.

The original question has a simple and somewhat obvious answer. I was in the process of quoting the definitive guidance when the obvious light when on in Jo Anne's head and I decided that it wasn't necessary.

This provides some overview and supports deductibility although IMO it overstates the distinction between 'paid' and 'payable'. If the interest is not contingent, that is that it is legally payable, the amount is reasonable, then the distinction is often a matter of simple wording and structure. NB - Any expense that is never paid or payable will always have problems.

http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.html

But I can see that, even though my intentions were good, they are unwelcome. I have been asked why I don't post here anymore and try to provide help in areas that I am qualified to. Maybe this helps show why. It's not because it's not blindly accepted, but because it's not even acknowledged. Instead, I can expect reprimands for every mild transgression based on someone's personal judgements.

Enjoy.

EDITED - to add links and descriptions

[adrian2]

Actually, that's not always true. Interest deductibility on taxes follows deductibility of taxes.

For example, look up whether interest is deductible on Ontario capital taxes. It is. Why? Because Ontario capital taxes themselves are deductible.

Actually I've mentioned the distinction between personal and corporate taxes in my post.

But I can see that, even though my intentions were good, they are unwelcome. I have been asked why I don't post here anymore and try to provide help in areas that I am qualified to. Maybe this helps show why. It's not because it's not blindly accepted, but because it's not even acknowledged. Instead, I can expect reprimands for every mild transgression based on someone's personal judgements.

I'm sorry, but I think you're overly sensitive. Nobody personally attacked you, and initially you only came up with opinions, no links. I don't see why I should blindly accept yours when you don't accept mine.

As for the links in the last message, the first one clearly refers to corporate, not personal taxes. The second one does not, IMO, clearly state your case. There is again a section which draws distinction between personal and corporate, for credit card debts (personal = non-deductible, corporate = deductible).

So everything, to me, is clear as mud. I may ask the question on Tim Cestnick's forum.

[andrew]

Section 5 of the second link addresses the issue.

I don't see why I should blindly accept yours when you don't accept mine.

My last post says that I don't expect anyone to blindly accept a position. I don't. IMO to not acknowledge a poster trying to be helpful is rude and worse than some of the things that I have been warned and threatened about from the management here.

But I can see that, even though my intentions were good, they are unwelcome. I have been asked why I don't post here anymore and try to provide help in areas that I am qualified to. Maybe this helps show why. It's not because it's not blindly accepted, but because it's not even acknowledged. Instead, I can expect reprimands for every mild transgression based on someone's personal judgements.

A lot of the distinction between interest and compound interest is just semantics. A basic definition of compound interest is that it is added to and becomes principal. This oversimplifies but in that sense, the new interest (interest on interest) is really interest on new principal. These are semantics and more generally, tghe deductibility of interest is a large and complicated issue, but nmot much because of any issue raised here.

Actually I've mentioned the distinction between personal and corporate taxes in my post.

IMO, it's not the right distinction to make. It's the deductibility of the taxes that is more relevant. Certain business taxes are deductible to a persoanl taxpayer. The interest on that would be also.

I tried to help. You don't want it and make it clear, IMO that it is personal about me. No one else posted supporting links. Now I am the only one that has.

Although I had intended to give it another sincere try, because someone suggested that I should, I end up only being able to use your ignoring (and therefore rude IMO) response it to answer questions posed about why I don't do this here anymore. My response has been that it is because I am unwelcome here. You've helped to show that. A non-sarcastic thank you for that. I address this to you but not as a personal attack. I could write the same about many here. It is not jusy you. I hold no personal animosity towards you.

The irony is that many people pay me.

[andrew]

I see many typos above. Ahh well, I can't be bothered. You don't want my position and while I tried, I don't have to support it or you.

My position is supportable. It was offered freely and sincerely to try to help. IMO overtly ignoring it is kind of rude and explains to me and others what I have been telling them to explain my own change in behaviour.

Enjoy. Happy investing. I'm gone to other places for a bit. Say hi to Tim for me until the next time I see him. I'm sorry to heat that his merger didn't work out.

[steves]

Could someone set up a scenario which would demonstrate where the SM could be applicable?....

"George is xx years old, earns xxx in salary, has a home worth xxxxx with a xxxx mortage. He has xxxx in his rrsp and xxxx in nonreg?

Indicate what kind of investment growth rates and mortgage rates should be considered. I will try to model the SM if possible.

[adrian2]

Section 5 of the second link addresses the issue.

Indeed. Thank you.

I tried to help. You don't want it and make it clear, IMO that it is personal about me. No one else posted supporting links. Now I am the only one that has.

There was nothing personal about you in my posts. I'm sorry if you felt that way. Even in my first remarks about this subject, I've mentioned that "I think" it works the way I was describing. That should have made it clear that I wasn't sure and I was looking for comments and/or definitive links. Thank you again for finding the relevant passage in the often arcane tax documents.

[andrew]

And to show that I'm not ignoring you, thank you as well.

I will be taking it offline for a bit though, so I may not see any further responses.

[SW20 MR2]

I am a newbie investor and will start to dabble in the stock market. I currently have money in a PCF savings account earning interest. I am going to be taking that money and using it for stock purchases via the Smith Manoeuvre. To do so, if I understand the concept correctly, I need to setup a LOC and borrow via the LOC to invest in stocks and then take my existing funds and then pay them into my mortgage.

I don't have the LOC and am waiting for the paperwork to come through. If I simply take my funds out of the savings account, use them to buy equity, and then afterwards transfer funds from the LOC directly to my mortgage, does this still legally qualify as tax-deductible interest or will the CCRA view the money as not being for investment.

Hope what I typed made sense. In essence, I'm funding the stock directly from savings->stocks and LOC-> mortgage as opposed to savings->mortage and LOC->stocks. This is all so that I don't have to wait another week or two for my LOC to be finalized.