Smith Manoeuvre

The Smith Manoeuvre is a financial strategy which slowly converts your mortgage into a tax-deductible loan. Using this strategy can be immensely powerful. You can pay your mortgage off years faster than usual, you will build a productive investment account which generates a steady stream of dividend income, and you will save yourself a substantial amount of money in personal income tax.

The Smith Manoeuvre was popularized by a British Columbian financial planner named Fraser Smith. While he passed on nearly a decade ago, his legacy lives on and his strategy is as popular as ever. Canadians considering this strategy should read his book Is Your Mortgage Tax Deductible? It can be found in many public libraries, or on his website.

What Is The Smith Manoeuvre Exactly?

The Smith Manoeuvre is a relatively advanced financial strategy that slowly converts your mortgage—which is not a tax deductible loan—into a tax deductible investment loan. The Smith Manoeuvre itself is the intricate process that makes this all happen correctly and with full compliance of Canadian tax laws.

The reason the Smith Manoeuvre exists is specifically to comply with Canadian tax law relating to the deduction of carrying charges and interest expenses on your tax return (Line 221). It should be executed by Canadians with reasonable investment experience. The strategy involves moving money carefully between several accounts on a regular basis as you make mortgage payments—often bi-weekly or monthly depending on your payment schedule.

Some people mistakenly believe the Smith Manoeuvre is an investment loan, or maybe even a risky leveraged investment strategy. They would be mistaken. A Smith Manoeuvre does not necessarily increase your leverage. However, used to its fullest potential it can appear like you would never pay off your mortgage. You would have up to 80% of your home value in a tax deductible loan that reduces your income tax by thousands of dollars per year.

A key component to the Smith Manoeuvre strategy is investing in dividend paying stocks in your non-registered investment account. While you might always be carrying some debt, over time the value of your investment account will dwarf the amount you have borrowed in your tax deductible loan. You can pay off the loan at any time by selling your investments, but many people choose to keep the loan for the tax benefits.

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Am I A Candidate For This Strategy?

The Smith Manoeuvre is best suited to Canadian individuals who are disciplined and have a reasonable amount of experience investing on their own. It is moderately complex and requires careful movement of money between accounts (all done online) on a regular basis. There are also year end adjustments to complete.

To begin the Smith Manoeuvre strategy you should have at least 35% equity in your house at its current appraised value. This could be just the difference between your current mortgage loan and your current property value, or the difference between your current property value and your current mortgage loan minus the value of any investments you currently have in your non-registered investment account.

I do not recommend selling investments in your RRSP or TFSA accounts to establish the Smith Manoeuvre. These accounts already carry valuable tax advantages that can be very lucrative when their values are allowed to compound over time.

The Smith Manoeuvre also works best for people who have low debt levels beyond their mortgage. You should be cash flow positive every month. That means you are saving money regularly beyond funding your TFSA and RRSP accounts. It is also best for Canadians who are earning moderate to high levels of individual income ($60,000 or more per year).

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How Do I Set Up The Smith Manoeuvre?

If you are in the right situation to execute the Smith Manoeuvre, you will need to open several different accounts. Most of this can be done online, however, you will need to obtain a very specific kind of mortgage loan. This can involve certain set up costs such as obtaining a current home value appraisal.

Aim to establish accounts with good online platforms that are available at a low cost. This includes free bill payments, no monthly fees, and low commissions for small purchases of individual Canadian stocks.

You may also need to sell some investments and reduce your outstanding mortgage balance as much as possible to maximize your Smith Manoeuvre potential.

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Selling Current Investments

The point of the Smith Manoeuvre is to reduce your outstanding mortgage loan amount as fast as possible so your debt interest will be fully tax deductible.

It is common for people to have some money invested in a non-registered investment account, term deposit, GICs, or a savings account when they start the Smith Manoeuvre.

If you can do so for a low tax cost and without incurring high penalties, consider selling your current non-registered investments and applying the proceeds against your outstanding mortgage. By reducing your mortgage, you will be able to borrow the money back through the HELOC and reinvest the borrowed money without changing your total debt or investments (minus some transaction costs).

However, you will shift some of your debt from standard debt where the interest is paid with after-tax money to tax deductible debt. This simple shift can save you a substantial amount of money in taxes over the years.

Be careful that you do not repurchase any stocks you sold at a loss within 30 days of selling. Although you might be repurchasing the stocks in a new account, it will still trigger the superficial loss rule.

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HELOC Mortgage Loan

Having the correct mortgage loan on your house is the most important element of the Smith Manoeuvre strategy.

You will need to obtain a readvanceable HELOC mortgage loan where you can access up to 65% of your home equity in the revolving loan portion. In addition, if you want to be able to access up to 80% of your home equity, you should have a HELOC structure where you can hold more than one term style mortgage within the HELOC.

Your HELOC will allow you to access up to 65% of your home equity. It is paired together with a standard mortgage. This is sometimes called loan splitting by your bank. As you pay down the principal of your standard mortgage with each mortgage payment, the amount of money you can borrow in your HELOC should automatically increase up to that 65% level.

Your HELOC loan is an open line of credit loan that normally carries an annual interest rate of Prime + 0.5% for borrowers with good credit. Interest is charged monthly on the outstanding HELOC loan balance. You should make sure your HELOC loan has a unique account number that is separate from the term mortgage.

Your standard mortgage will be a term mortgage that is either a fixed rate mortgage or a variable rate mortgage. When you set up the Smith Manoeuvre, you will want this mortgage amount to be as low as possible while still being the complete amount of your "normal" home mortgage. In your term mortgage you will make regular payments consisting of interest and the loan principal. You should seek terms where you can double up your regular mortgage payment and make an annual lump-sum payment against your mortgage balance penalty-free.

(If you want to access up to 80% of your home equity, you can obtain an additional one year fixed mortgage equal to 15% of your home equity. However, paying down the principal of this mortgage will not increase the money you can borrow with your HELOC loan.)

Consider using an experienced mortgage broker to help you with your correct HELOC set up. They usually do not charge you a direct fee and some brokers are very knowledgeable with the Smith Manoeuvre process. However, do not be tempted into using high fee products such as Manulife and don't use them for the investing process. Just hire them to set up the loan for you—that's it.

Some banks that offer the correct structure include:

  • TD HELOC FlexLine Mortgage
  • RBC Homeline Mortgage
  • BMO ReadiLine Mortgage
  • National Bank All-in-One
  • Vancity Creditline Mortgage

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Chequing Account

You will also need to set up a chequing account that is solely dedicated to facilitating money movement for the Smith Manoeuvre strategy. This account is the hub of the Smith Manoeuvre. For easy accounting it is important to keep this account separate from your daily chequing account.

The best account to use is a free online chequing account that does not require you to maintain a balance in the account. You should also look for an account that has no fees for bill payments and a great online platform. If you are married or in a common-law relationship, consider opening a joint account for estate purposes. This does not mean you need to split ownership of the Smith Manoeuvre for tax reasons. As long as the money trail is clearly established, you can demonstrate attribution and only one spouse (one of the account holders) can claim ownership of the interest expenses and investment income from the account. Just make sure you are consistent in how you claim this.

Some banks to consider include:

  • Tangerine Bank's No Fee Daily Chequing Account
  • Simplii Bank's No Fee Chequing Account

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Non-registered Investment Account

The final account you need for the Smith Manoeuvre strategy is a non-registered investment account. This is an online self-directed brokerage account that you will use to manage the investments you purchase as part of your Smith Manoeuvre strategy.

You may already have a non-registered account where you sold all of the investments in that account and applied the proceeds against your outstanding mortgage loan. If the account has been completely divested, you can use this account for the Smith Manoeuvre strategy.

However, if you have some other investments in the account, for easy accounting it is best to open a separate non-registered account that is only used for your Smith Manoeuvre. This way you can ensure you are only purchasing appropriate investments stocks with the money from your HELOC loan while controlling your dividend yield. You will also be able to account for any tax adjustments, such as return of capital distributions.

If you are married or in a common-law relationship, consider opening a joint account for estate purposes. This does not mean you need to split ownership of the investments this account holds for tax reasons. As long as the money trail is clearly established you can demonstrate attribution and only one spouse (one of the account holders) can claim ownership of the investments and investment income from the account. Just make sure you are consistent in how you claim this.

You might also choose to open a new non-registered investment account now if your current brokerage is not the best option for your situation. With the Smith Manoeuvre it is generally best to invest directly in common stocks rather than using ETFs. This way you can control the dividend yield in a way that is best for your current situation and avoid having return of capital distributions.

Some brokerages to consider include:

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Accessing 80% Of Your Home Value

The readvanceable, revolving HELOC loan where you are only required to make interest payments is limited to 65% of your home value. While 65% is a good level of risk for most people and provides an adequate margin of safety, some experienced investors who are comfortable taking on more risk might choose to increase their loan structure to access up to 80% of their home value.

If you want to do this, the last 15% of your home value must be borrowed through a term mortgage. You will need to make mortgage payments that consist of principal and interest, reducing your borrowed amount over time. For clean accounting, keep this term mortgage separate from your main mortgage. The proceeds from this term mortgage will be solely used to purchase investments in your Smith Manoeuvre non-registered investment account.

To maximize your borrowing potential, choose short term mortgages. With 1-year fixed term mortgages for this portion, you will be able to re-borrow the principal amount you repaid over the course of the year. For accounting ease, choose monthly payments instead of bi-weekly payments to reduce the necessary money movements for this smaller mortgage amount.

This strategy will add some accounting complexity and takes more time to manage as you will need to renew a mortgage every year. However, you will be able to borrow and invest another 15% of your home value while deducting the interest expenses from this mortgage from your income. This can increase your overall wealth, maximizing your Smith Manoeuvre strategy's potential.

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How The Money Flow Works

As stated earlier, the Smith Manoeuvre is reasonably complex and requires careful management of the money flow. Every time you make a mortgage payment, you have to make several other transactions to keep the strategy functioning well. By completing the entire process with each payment you will ensure your HELOC revolving loan interest remains fully tax deductible.

This is a step-by-step guide to how you will move money with each mortgage payments using your Smith Manoeuvre accounts.

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Move Money For Mortgage Payments

The first step is to make sure you pay your regular mortgage payments. Usually these payments will be bi-weekly or monthly, depending on your mortgage terms.

Instead of making the payment from your regular household chequing account, transfer the value of your mortgage payment to your Smith Manoeuvre chequing account several days before your mortgage payment is due.

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Apply Dividends To Mortgage Payment

Your Smith Manoeuvre non-registered investment account will be invested in Canadian common stocks that pay some dividends. Instead of using these dividends to purchase more shares, have the dividends deposited directly into your Smith Manoeuvre chequing account. If this can't be done automatically with your brokerage, make the transfer manually as you receive dividends into your non-registered account.

As soon as you can, you will use these dividends to increase your mortgage payment, taking advantage of mortgage payment top up privileges. The extra money you contribute to your mortgage payment will go directly to paying down the principal—the outstanding term mortgage loan balance.

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Move Additional Savings To Pay Down Mortgage

You may have extra money each month that you would normally save in your non-registered investment account. Instead, move this money into your Smith Manoeuvre chequing account as soon as it becomes available.

You will then use these extra savings to increase your mortgage payment, again taking advantage of mortgage payment top up privileges. As you top up your next mortgage payment, the extra money will be directly applied against the outstanding mortgage principal.

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Make Your Mortgage Payment

Once you've moved the regular mortgage payment amount, any dividends you've earned in your non-registered investment account, and any extra savings you have in your Smith Manoeuvre chequing account you are finally ready to actually make your mortgage payment.

With good mortgage terms, you should be able to double up your standard payments without incurring any penalties. As money comes available from the above mentioned sources, make as large a mortgage payment as you can.

If your dividend income or other extra savings were particularly large in a given month, spread the extra payment amount over more than one period. It is generally not worth over-contributing beyond the allowed amount and incurring the bank penalty.

With good mortgage terms you should also be able to make a penalty-free annual lump-sum payment of 15% to 20% of the outstanding mortgage balance.

If you find you are regularly doubling your payment amounts and still have extra money available, consider changing your mortgage terms if you can do this for a low fee. You might want to reduce the amortization period which would increase your standard payment amount.

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Borrow Back Available HELOC Money

As you make each mortgage payment—hopefully with a sizeable top up portion—your outstanding mortgage principal will be reduced. With a readvanceable HELOC, you should automatically see a corresponding increase in the funds you can borrow from your HELOC revolving loan.

For example, if you made a mortgage payment of $1,000 and $500 of that payment was the principal repayment portion, you should be able to borrow an additional $500 from your HELOC loan.

After the mortgage payment is booked and your available HELOC loan amount has increased, you will immediately borrow this money back from your HELOC account by making a transfer from your HELOC account to your Smith Manoeuvre investment account.

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Purchase Dividend Paying Stocks

After the transfer from your HELOC account to your Smith Manoeuvre non-registered investment account settles, you will promptly use that money to buy more stocks that pay dividends. To keep your fees as low as possible, just make one stock purchase transaction. You may choose to purchase stocks every second mortgage payment to control commission costs.

While having the cash sitting in your account for a few weeks shouldn't be an issue, it is important that you do not leave a large cash balance in your non-registered account. To keep the HELOC loan tax deductible, you need to use this money to invest.

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Capitalize The HELOC Interest Amount

Finally, once per month you will need to make an interest-only payment on your HELOC revolving loan. To make this payment, you will use a strategy called guerilla capitalization.

Always leave a small amount of available money in your HELOC account that is enough to cover the anticipated interest costs. Several days before your interest payment is due, transfer the amount to your Smith Manoeuvre chequing account. Then, make a payment from your Smith Manoeuvre chequing account back to your HELOC for the interest owing.

With this strategy you will not need to use any extra money from your personal cash flow to make the HELOC interest payments. As an added bonus, you will know exactly how much money you can deduct at the end of the year from your taxes is it should be equal to the total payments you make from your Smith Manoeuvre chequing account to your HELOC loan account.

If you are maximizing your Smith Manoeuvre strategy, you can also capitalize the interest on the smaller 15% mortgage. To execute this, make sure you leave a little more available funds in your HELOC account. In addition to moving the HELOC interest amount to your chequing account, you will need to move over the prescribed payment amount for this mortgage.

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Ensuring The Loan Is Tax Deductible

With the Smith Manoeuvre, it is important to ensure the money borrowed from your HELOC revolving loan is completely tax deductible. This is not difficult to do, but here are a few things to be mindful of as you execute the Smith Manoeuvre strategy.

To have a tax deductible loan, you must ensure the loaned money is entirely used to purchase investments that currently generate income, or have a reasonable likelihood of generating income in the future. For this purpose, income only includes dividend income or interest income. It does not include capital gains, even if they are distributed.

Since the borrowed money must be invested, you should avoid borrowing money from your HELOC and having that money sitting in cash in your non-registered account for a long time. If you have a large cash balance, use the money to purchase a bond ETF.

Be careful when purchasing investments which may distribute return of capital, even if it is just part of a larger distribution. Return of capital is not considered income for this purpose. Also, you must adjust your outstanding loan balance for any return of capital you receive. This reduces the interest you can deduct and makes for more complex year-end accounting.

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Claiming the Smith Manoeuvre Taxes

The Smith Manoeuvre is designed as way for Canadians to save money on taxes, build a sizeable investment portfolio, and reduce their debt levels relative to their assets. You will want to ensure you maximize the tax deductions on your HELOC loan while keeping income from the strategy as low and tax efficient as possible.

Interest expenses and investment income must be claimed together by the same person, or be split evenly between two spouses. You may not have the higher income spouse deduct the interest expenses from their income while the lower income spouse claims the investment income on their tax return.

The higher your income level is, the more opportunity you have to benefit from implementing the Smith Manoeuvre. You will be able to deduct HELOC interest costs at a high marginal tax rate and earn a minimal amount of dividend income at a much lower tax rate.

This means it is generally best for the higher income spouse to claim the interest expenses and investment income on their tax return. Particularly if one spouse earns a much higher income than the other. However, if both spouses are in the same tax bracket, you may split the strategy evenly between each spouse.

It is important to be consistent with how you report the Smith Manoeuvre. Once you elect one spouse to claim the strategy, they must continue claiming the entire strategy. The same principle applies if the spouses split the strategy evenly. You cannot make changes simply because your income mix changed.

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Investments To Consider

The main benefit of the Smith Manoeuvre is reducing your annual tax bill by deducting interest expenses from your regular income at your marginal tax rate. These tax savings are invested and compound over time adding to your overall wealth. It is important to ensure your Smith Manoeuvre investments are tax efficient.

In Canada there are tax incentives for certain types of investment income in your non-registered investment account. As an investment loan requires income for it to be tax deductible, we will discuss the two main forms of income from investments you would normally make in a brokerage account.

Dividends

Dividends are a form of profit sharing where companies distribute a portion of their after-tax profits to their shareholders. It is standard for dividends to be taxed at the regular tax rate; however, when Canadians receive dividends from Canadian publicly traded corporations these dividends are eligible for the dividend tax credit. To reduce double taxation—corporate tax paid by the company and personal tax by the shareholder—on the dividend payment, the government credits money back to the shareholder at a rate which changes based on the personal income level. This makes dividends from Canadian stocks very tax efficient, particularly at lower income levels.

Dividends from foreign corporations are not eligible for the tax credit. These dividends are taxed at your marginal tax rate.

Interest

Interest income is typically distributed by bonds, GICs, and other loan style investments. Interest income is taxed at your marginal tax rate, so it is not very efficient to hold a lot of investments which pay interest as their primary form of returns.

Good Investment Options

For the best tax efficiency, investors using the Smith Manoeuvre should try to invest in Canadian stocks which pay at least some dividends in their Smith Manoeuvre non-registered investment account. The dividend yield you should pursue may depend on your income level.

Canadians earning moderate to higher levels of income should try reduce the amount of dividend income they receive as this income is taxed and those taxes reduce your overall returns. You can purchase stocks which do not currently pay a dividend, as long as there is a possibility they may pay a dividend in the future. In being selective about the stocks you purchase, you should be able to keep your overall dividend yield under 1% while still being reasonably well diversified.

Canadians earning lower levels of income may try to pursue higher dividend income as they may receive these dividends tax free or close to tax free. You should be able to construct a diversified portfolio of Canadian stocks with an overall dividend yield of 4% per year.

Remember to build a reasonably diversified portfolio across major Canadian industries. In Canada you can achieve this by investing in the big banks, life insurance companies, utilities, pipeline companies, oil majors, technology companies, mining companies, telecoms, railways, and major retail stores. Many of these sectors are oligopolies and have very high barriers to entry thanks to government protections.

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Do I Pay Additional Interest Expenses?

Sort of. At first, if you have sold some investments at the start of the Smith Manoeuvre and repurchased them borrowing from your HELOC, you are simply doing a debt swap. You have the same amount of total debt and the same amount of money invested, but a portion of your debt interest is now tax deductible.

If you have a standard mortgage and make regular payments on that mortgage following your amortization schedule, you will slowly be reducing your debt. This means you pay less and less interest as time goes on. More of each mortgage payment goes toward repaying the principal balance.

Then, if you have some extra money to save in a non-registered account each month, you will slowly build an investment account as well. Eventually you will be debt free and have a moderate investment account.

The Smith Manoeuvre doesn't work the same way. Instead, you choose a level of debt you are comfortable with (usually 65% of your home value, but sometimes 80%) and maintain this level of debt. As long as you are doing the Smith Manoeuvre, you will not be paying this debt off. You will be converting that debt from a mortgage loan to a HELOC investment loan. You will build your investment account much faster and save a lot of money on income taxes over the life of the strategy. Typically you can pay off your mortgage loan at least 25% faster than normal.

Since you are always maintaining at static level of debt with the Smith Manoeuvre, you will be paying higher interest costs than with a traditional mortgage pay down. However, it is important to remember a good portion of this interest is tax deductible. Also, you are likely to have a substantial investment account of dividend paying stocks. With dividend growth stocks your dividends alone will eventually cover your interest expenses.

Although you will have ongoing interest expenses, you do not pay these expenses out of pocket. Instead, we use a strategy called interest capitalization. This is a fancy term for borrowing money to pay the interest on borrowed money in a repeated cycle.

If being debt free is important to you, you can still do this with the Smith Manoeuvre and receive a lot of tax benefits in the process. You will simply wind down or pay off the HELOC loan.

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Annual Smith Manoeuvre Taxes

The Smith Manoeuvre is a tax strategy, so you will need to examine your strategy and make some calculations and adjustments at the end of each calendar year.

Return of Capital Adjustments

First, depending on your investments, you may need to make annual adjustments at the end of the calendar year to realign your Smith Manoeuvre loan and keep the accounting in balance. This is only if you received Return of Capital in your dividends. Return of Capital is most commonly distributed by real estate investment trusts (REITs), exchange traded funds (ETFs), and certain mutual funds that tend to brand themselves as being tax efficient funds (T Series funds).

The easiest thing is to avoid investments which pay return of capital. However, if you have some returns, you must adjust your outstanding HELOC loan amount by the amount of return of capital you received. To do this, find out the exact amount of return of capital you received. Make a payment for that amount from your Smith Manoeuvre chequing account to your HELOC loan account. Then, borrow that money back by transferring from your HELOC account to your Smith Manoeuvre non-registered investment account. Finally invest that money in stocks.

Next, you need to adjust the interest expense on your tax return. Simply dividend the adjusted loan amount (outstanding HELOC loan after the return of capital payment) by the original loan amount. Then multiply this number by your total interest expenses.

For example, lets say you had a HELOC loan balance of $100,000 at the end of December and paid $4,000 in interest expenses for the year. If you received $200 in return of capital, your adjusted HELOC loan for the year will be $99,800. The interest adjustment will be (99800/100000)*4000. That means your tax deductible interest expense for the year will be $3,992 instead of $4,000.

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Claiming Investment Income

On your tax return you will need to claim any income you earned from your Smith Manoeuvre non-registered investment account and any interest you received in your Smith Manoeuvre chequing account.

Every year you will receive tax statements from your brokerage. If you employ a buy and hold strategy of Canadian dividend paying stocks, you will generally receive a T5 Statement of Investment Income. This will spell out the dividend income and any interest income you received in your account.

If you hold ETFs or REITs in your investment account, you will also receive a T3 Statement of Trust Income. This statement will provide the dividends, interest, return of capital, and distributed capital gains you received from your ETFs or REITs.

Finally, if you sold some investments during the year, you will receive a T5008 Statement of Securities Transactions. This form will detail the securities you sold, what their total book value was, and what the sale proceeds were. You are responsible to make sure the information is correct and that the book value is adjusted for return of capital distributions.

Remember that the person who is claiming the investment income must also claim the interest expense. If the Smith Manoeuvre strategy is split between two spouses, each spouse must claim the income and expenses in the same proportions. You cannot change this split from year to year.

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Claiming Interest Expenses

On Line 221 of your tax return you will claim the interest and carrying costs from your Smith Manoeuvre HELOC loan account.

Most banks will offer a monthly and annual statement of the interest expenses of your HELOC loan. Just make sure you adjust the interest expenses for Return of Capital distributions if you had those during the year from your investments. Aside from interest costs, carrying costs can include administrative type charges (monthly fees and transfer fees) related to your Smith Manoeuvre HELOC account, chequing account, and brokerage account. You cannot deduct trading commissions.

You cannot claim the interest paid on the standard mortgage loan you have on your house. This is a personal loan, not an investment loan.

Since the interest expenses reduce your top level income, you are receiving a tax refund at your marginal tax rate. Make sure you use this tax refund to contribute to your Smith Manoeuvre chequing account, pay down the standard mortgage loan, borrow the money back through your HELOC, and purchase investments in your Smith Manoeuvre investment account.

Remember that the person who is claiming the interest expenses must also claim the investment income. If the Smith Manoeuvre strategy is split between two spouses, each spouse must claim the income and expenses in the same proportions. You cannot change this split from year to year.

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When The Smith Manoeuvre Is Complete

Your Smith Manoeuvre is completed once you have paid off the entire mortgage loan. When your mortgage loan is paid off, you will no longer need to make the series of transactions each month: paying your mortgage payment, borrowing back the principal through your HELOC loan, and investing that money in your Smith Manoeuvre non-registered investment account.

All you have now is a HELOC loan that used for investing so the interest is completely tax deductible. You will still need to make monthly interest payments on that loan. I no longer consider this a Smith Manoeuvre. It is simply an investment loan and a corresponding investment account.

At this stage, you can safely store at least seven years of monthly statements from your Smith Manoeuvre chequing account and close this account. You need to store the paperwork going back seven years in case you are audited.

You also have several options to explore moving forward.

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Keep The Tax Deductible Investment Loan

The first option is to keep the investment loan intact and continue claiming the lucrative interest expenses each year on your tax return. You will save a lot of money each year on taxes and you are free to do what you wish with the tax savings.

However, I would recommend investing the tax savings and continuing to build your financial independence. You can contribute to your RRSP, TFSA, or open a new non-registered investment account.

As long as you have your Smith Manoeuvre HELOC loan, do not mix new money into your non-registered investment account. Keep the account separate with a clean paper trail to ensure your loan remains tax deductible and all of the investments you purchased with borrowed money are generating some income.

The Smith Manoeuvre is typically claimed by the higher income spouse who would pay somewhat more tax on investment income. This could be a good time to shift new savings into an investment account for the lower income spouse. They may choose higher yield dividend stocks, you can invest in real estate investment trusts, and more tax efficient ETFs that you normally wouldn't choose in the Smith Manoeuvre strategy for tax complications.

If you are still building your wealth and are comfortable with a moderate amount of tax deductible debt, this could be the best option for you from a strict financial viewpoint.

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Wind Down The Loan

You can also wind down your HELOC investment loan in a strategic, tax efficient manner. To do this, start by using all of the dividend income from your Smith Manoeuvre investment account to pay down the loan. It is likely that the dividend income will cover a good portion of the interest expenses and may even contribute towards reducing the principal balance.

You can also use your annual tax refund to pay down the HELOC loan balance instead of using that money for investing. To pay the loan down even faster, direct some extra savings towards the HELOC loan and begin paying down the loan balance.

As the loan balance begins to shrink, your interest expenses will shrink as well. Your dividends will continue to grow as your interest costs go down, meaning your dividends reduce the outstanding loan amount faster and faster.

This could be a good strategy if you are nearing retirement but still have a few years to work with. It is also a very tax efficient strategy for people who are debt averse but don't want to trigger unnecessary tax costs.

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Become Debt Free Now

Finally it is likely that you can pay off your HELOC loan at any time after you finish the Smith Manoeuvre strategy. Over the 15 to 20 year period that you were using the Smith Manoeuvre, your Smith Manoeuvre investment account—with a decent investment strategy—will have grown quite large. The value of the investment account should easily exceed the value of the HELOC loan. After all, the money you borrowed from your HELOC went straight into your investment account and your investment returns over a 15 year period with regular contributions are very likely to be positive.

If you are looking to become debt free right away, you can sell all of your investments in your Smith Manoeuvre investment account and use the proceeds to pay off the HELOC loan in one payment.

Just be aware that selling your investments will trigger tax consequences for any capital gains. To try remain as tax efficient as you can in this process, sell the investments with the smallest gains or those with losses. Use can use capital losses to offset capital gains, reducing your tax bill.

Instead of paying off the entire loan, you may choose to sell some investments to pay off a portion of the HELOC loan to a level that you are more comfortable with.

This could be a good strategy if you are at the retirement stage and you can sell your investments and pay down the loan with very low tax consequences.

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Selling Your House With The Smith Manoeuvre

People are often concerned that the Smith Manoeuvre strategy might prevent them from selling their home, or make the selling process much more difficult. This isn't true. But there are a few things to keep in mind.

If you sell your house and are moving into a new home that you are purchasing, you can simply roll your Smith Manoeuvre over into the new home. You will need to make sure you have at least 20% equity in your new home.

In some situations, there may be a delay between the sale of your home and the new purchase. This means your mortgage may not transfer seamlessly. You could use a short-term investment loan if needed. Try avoid selling your investments, unless you can book a capital loss and not trigger the superficial loss rules (repurchase the same investment within 30 days). This will reduce tax costs.

Be careful about using your Smith Manoeuvre investment account to finance a new home purchase. If you do this, make sure you first adjust your HELOC loan balance with the investment sale proceeds. Then remortgage the newer home with a larger standard mortgage.  Keeping this clean trail of how the HELOC loan funds were used will ensure your HELOC loan interest remains tax deductible because the entire remaining loan amount was still used for purchasing investments.

You might sell your home and rent a new house instead. This would mean that you no longer will have access to the HELOC loan to borrow for investing. You also wouldn't have a mortgage, so that would effectively end your Smith Manoeuvre. Since you are borrowing between 65% and 80% of your home value, normally you would use your home sale proceeds to pay off the mortgage loan and outstanding HELOC loan amount.

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Stopping The Smith Manoeuvre

Before starting the Smith Manoeuvre, you should understand the implications of stopping the Smith Manoeuvre process in the middle of the strategy. Remember, you are actively in the middle of the strategy if you still have the mortgage loan that you are paying off and you are making the series of transactions to borrow back the principal to invest. Once the mortgage loan is paid off and you only have the tax deductible HELOC loan, you are no longer performing the Smith Manoeuvre and you need to follow one of the options of dealing with your HELOC loan when the strategy is complete.

Even if you are stopping the Smith Manoeuvre strategy, it is important to ensure your accounting for the strategy stays clean. Do not use your HELOC for personal purposes or sell investments in your Smith Manoeuvre investment account without adjusting the HELOC debt. If you don't monitor this carefully, you can run afoul of the disappearing source rules. This reduces or completely eliminates the tax benefits of the strategy and can cause unnecessary tax reporting headaches.

The Smith Manoeuvre is a very lucrative strategy for the right person in the right situation, but that doesn't mean it is without its risks. It is a long term strategy that gets better with time. You must be disciplined with your investment approach and follow a sound investment strategy with a good positive expectancy of returns over long time periods.

In some cases, a combination of poor money management and a poor investment strategy can be very damaging to people who use the Smith Manoeuvre. You can find yourself in a very bad negative equity situation. This means you could be forced to sell what remains of your investments and sell your home, being much worse off than when you started.

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Pausing The Smith Manoeuvre

It is extremely easy to simply pause the Smith Manoeuvre process. In this case, you would continue paying your mortgage loan as required, but you no longer borrow more money back via the HELOC and contribute new money to your Smith Manoeuvre investment account. This is an easy way to reduce your risk and exposure to the Smith Manoeuvre. Your overall debt will slowly drop as you continue paying down principal on the mortgage loan. You may still capitalize the HELOC interest to keep your cash flow impact low.

It will also be easy for continued accounting as you would not borrow new money from your HELOC for new purposes and you will keep your investment account intact. This means you can continue taking the interest expense deduction on your HELOC loan interest costs. Over time your investment account should grow and will eventually be far larger than your HELOC loan amount.

In this situation, you will keep all of your Smith Manoeuvre accounts active and in place. This will help keep the accounting clear and facilitate the interest capitalization process. Once your mortgage loan is paid off, you can follow the standard options to deal with your outstanding HELOC loan balance. It is much better to have tax deductible debt than standard debt, so only pay off the HELOC loan after paying off the mortgage.

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Exiting The Smith Manoeuvre With Positive Equity

If you want to completely exit the Smith Manoeuvre, meaning you want to close your HELOC investment loan and revert back to a standard home mortgage, you can do this with a little more work. You should only take this step if it is absolutely necessary and you have considered all of your options. In most cases it is a much better choice financially to pause the Smith Manoeuvre than to exit the Smith Manoeuvre.

If you have been following the Smith Manoeuvre for some time and you used a good investment approach, your investment account should be larger than your HELOC loan. This situation makes it psychologically easier to exit the Smith Manoeuvre.

You can sell as much of your investment account holdings as you need and use the proceeds to completely pay off the HELOC loan. Don't forget you will likely owe some capital gains taxes on the sale of the investments. Make sure you use the investment account proceeds to pay off the HELOC loan first. If you use the proceeds for other purposes, some or all of your HELOC loan interest will no longer be tax deductible.

After paying off the HELOC loan you will simply have the standard mortgage loan and an unused HELOC account. You can keep this structure in place with no negative consequences, even allowing you to restart the Smith Manoeuvre at some point in the future. If you wish, you can close your HELOC and obtain a standard mortgage alone when your current term on your standard mortgage loan comes due for renewal. There should be no need to keep the chequing account open, but save your records for the prior seven years before closing the account.

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Exiting The Smith Manoeuvre With Negative Equity

If you want to completely exit the Smith Manoeuvre when the value of your Smith Manoeuvre investment account is lower than the outstanding HELOC loan balance, it is going to take a little more record keeping and will be psychologically more difficult.

Most people in this situation are choosing the leave the Smith Manoeuvre because their investment performance has been very poor, or because their personal situation has drastically changed through divorce, a death, or other large impact event. If you are thinking about exiting the Smith Manoeuvre because poor investment performance, you could be much better off pausing the Smith Manoeuvre and rebuilding your investment approach. Focus on building long term wealth with appropriate diversification.

If you need to exit the Smith Manoeuvre, start by selling all of your investments and booking the capital loss. You can carry this capital loss forward indefinitely to be used against future capital gains, or you can apply them to capital gains realized in the past three years.

Use all of the proceeds to pay off as much of your HELOC loan as you can. If you used the entire proceeds to repay the loan, you can still deduct all of the interest expenses on the remaining HELOC loan balance going forward indefinitely until the HELOC loan is paid off. To reduce demands on your monthly cash flow, you may still capitalize the interest on the HELOC loan. Make sure you keep the accounting straightforward by not using the investment sale proceeds or the HELOC loan money for personal purposes.

In order to reduce interest rates and begin a debt reduction process, you can refinance the outstanding HELOC loan amount into a separate term mortgage. As long as you only refinanced the HELOC loan amount that was originally used for investing, the interest on this mortgage would be tax deductible. To keep the accounting simple, keep two separate mortgage terms—one for the original mortgage on the house, the other for the refinanced HELOC loan.

In some cases you might need to exit the Smith Manoeuvre in a very poor financial situation. You might have substantial negative equity and be forced to sell your house, or be part of a foreclosure and bankruptcy process. Speak with an accountant on the best way to structure your Smith Manoeuvre exit and house sale. You should be able to keep tax deductible status on debt interest related to your investment loan even if you sell your house and proceed with foreclosure or personal bankruptcy.

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