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Although this is the longest article you will find on this site, the topic of making your mortgage tax deductible, commonly known as ‘The Smith Maneuver’, is one of great popularity. This article simply aims to explain how the Smith Maneuver Works, but entire books can be read on the subject, so it would be a good idea to contact me if you are interested in pursuing such a financial tactic.
A second, but less discussed method of making your mortgage tax deductible will also be discussed. That is to start and operate a small home based business. We will see how this works in the later part of this article.
The Smith Maneuver in a Nutshell
Unlike our neighbors to the south, we are fully taxed on money we use to make our mortgage interest payments. In other words, you make money, it is taxed, then you make your mortgage payment. So hypothetically, a 5.5% mortgage could really feel like an 8% mortgage (because you have less available ‘mortgage payment income’ due to taxes). Our goal then is to make the system work more like this: You make money, you make your mortgage payment, then the remainder of your income is taxed. Here’s how this system works…
1. Sell all existing stocks or mutual funds from non RRSP investment accounts and use it towards a down payment for step 2.
2. Attain what is called a ‘readvanceable mortgage’. This mortgage is both a home equity line of credit and a regular mortgage at the same time. Importantly, as you pay off the mortgage component, your home equity line of credit available grows. I offer some of these types of mortgages at great rates.
3. Use the home equity line of credit to purchase income producing investments, such as dividend paying stocks, mutual funds or possibly a rental property. Since with every mortgage payment your line of credit will increase, you would use this money (out of the now larger line of credit) to invest.
4. When tax season comes around, deduct the amount of interest paid on your home equity line of credit against your income. So for example, if you paid $7000 in interest and you are in a 40% tax bracket, you would get a cheque back from the government for $2800.
5. Apply the tax return and investment dividend income against the mortgage portion of your readvancable mortgage. This in turn will increase the line of credit portion of your mortgage, so now you can use that larger line of credit, again, to purchase more income producing investments.
6. Repeat steps 3-5 until the mortgage is totally paid off. You are now left with a large, tax deductible home equity line of credit and a much larger investment portfolio. (Yes, investments do go down over short term periods, but over the long term will rise).
This is a much faster way to pay down your mortgages and has some other very attractive advantages, but also carries some possible drawbacks. Contact me for more details on this subject.
Starting a Home Based Business to Make your Mortgage Tax Deductible
This method is more straightforward to explain. You would start by looking for a small home based business that you think you would have some fun with, or with a product or service you think that YOU would enjoy. This business could be as small as a Tupperware Salesperson or writing a book, but could also be a small home based franchise. Ultimately any way you could possibly make money out of the home counts!
You would then write off the mortgage interest on a reasonable portion of your home (not the entire home like the Smith Maneuver). For example, a kitchen used as a home office and the dining OR living room as a ‘meeting area’. You could then use the tax credit money, like the Smith Maneuver, to pay off more of your mortgage. Unlike the Smith Maneuver, there is no line of credit attached to the home. But there are some other benefits to owning a small business...
First you can write off other business related expenses, like a portion of your car and fuel, some dining expenses and more… For all business tax write-offs though, it is critical you know what you’re doing, because a government audit has the potential to get you into major trouble. This said, a good accountant or financial planner will help you maximize your tax benefits while keeping you safe. I know a few Kitchener, Waterloo and Guelph tax professionals myself. Contact me for their names.
Second, any profit you make from the business can be used to pay off your mortgage faster. Who knows? You could become very successful and start living much more comfortably. Even if you don’t make any profits though, you can still remain in business for a few years, and procure tax benefits until you will have to close up. These few years could mean thousands in tax savings.
What do you think about making your mortgage tax deductible? Join the conversation and make a post below!
