If you reinvest the dividends, it increases the ACB by that amount and you can usually withdraw that amount later with affecting the deductibility of your loan.

The issue whether your ACB is up or down. If the investments go down and you do any transactions, your ACB falls below the original amount borrowed. If the ACB is down, then any withdrawal is proportional.

However, if you reinvest dividends or do transactions when your investments are up, so that the ACB rises, you can withdraw the amount of the increased ACB without affecting the deductibility of your loan.

Over time, your investments and ACB should go up, so normally, withdrawing some money later is not a problem.

Does that answer your question, Brendan?

Ed

You do not generally need to withdraw all your dividends (although it might help) and you don’t need to track additional contributions or dividends.

For example, if you receive a $1,000 dividend and immediately withdraw it, your investment loan is fully deductible. If you reinvest that dividend and the investments remain flat or go up, you can later take out $1,000 and deem that to be the $1,000 from the dividend, so that your loan remains fully deductible.

You track this with the ACB of your investments.

The problem comes in if the investments are down. If the $100,000 investments are down to $90,000 market value and then you take that $1,000 out, then it must be proportional – $990 is considered to be the borrowed money and $10 is considered to be from your dividend.

This is called the “flexible approach” and is explained in IT-533.

Ed

In general I agree with your article, but you can choose to keep the investment loan completely deductible under the “flexible approach”.

If you add $10,000 of your own money to a leverage account and the investments grow $31,700, if you then withdraw the $10,000 under the flexible approach you can choose to consider that the $10,000 withdrawal is entirely related to the $10,000 contribution of your own money. Therefore, the entire $200,000 investment loan remains deductible.

This would not apply if the investments are down. In that case, you would have to consider the withdrawal to be proportional.

The critical issue is the ACB. Generally, if the ACB remains at or above the loan amount, then you can choose to have the entire loan remain deductible by choosing to consider the withdrawal amount to relate to the portion of the ACB that is above the loan.

The ACB of investments generally only goes up if you add other money or have a taxable transaction (sell at a profit and reinvest or reinvest a dividend). A withdrawal after that can be deemed to relate to the extra cash you invested or to the reinvested income.

There are some examples of this in IT-533. Do you agree that this flexible approach can be used in your second example?

Ed

Your comment

“Any reinvested dividends are basically the same as new purchases. If you leave them in the same account then you will have to track them if you want to do any partial withdrawals later on.

I always withdraw all my dividends from my leveraged account.”

Just looking for a bit of clarifcation here from you and others.

This basically means that all dividends should always be taken out of a leveraged account to ensure that all money in the account remains 100% from the HELOC? What about the case where the dividend given was actual shares? What should be done then?

I know that any ROC will screw up the deductibility , but I also understand that if you are taxed on it, you can take it out, be it interest, dividends, or capital gains. Your own capital is not taxable therefore you cannot take it out.

Mutual funds also distribute capital gains and you are taxed on them. Surely you can take gains out of the leveraged account.

I am still curious as to the draw down phase of a Smith manouevre. Seems complicated. Certain withdrawals must be paid down on the heloc, or used to service the interest.

Is there anyone here actually retired, drawing from a leveraged portfolio?
Ed happened to mention a couple of new strategies(in regards to a SM draw down?) in another post. I hope he will post soon.

The loan was used to purchase investments that earn income. You could withdraw the interest and dividends from the account without affecting the deductibility status of the HELOC. There would be no proportional decrease in interest deductibility.

Sampson – we have just paid off the nondeductible part of our mortgage and are planning to keep our investment loan (an open variable mortgage with 40 years amortization – not quite a HELOC but close) going, just putting additional cash into investments as well. We are comfortable with our overall risk profile, therefore see no reason to change.

Any reinvested dividends are basically the same as new purchases. If you leave them in the same account then you will have to track them if you want to do any partial withdrawals later on.

I always withdraw all my dividends from my leveraged account.

While we have your attention, please confirm that this does not affect any interest deductability:

A non-registered portfolio completely funded by a HELOC which doesn’t fund anything else;
A non-registered portfolio that consists of some dividend paying companies;
You withdraw amounts no more than (and certainly could be less) than the dividend payouts;
You funnel that to either: the mortgage portion of an SM product (perhaps then withdrawing the principal paydown from the HELOC to then go back into the non-reg portfolio); OR, you fund some other banking account for other purposes (pay down non-deductible debt, RRSP contributions, etc.).

In all of the above, are there any red flags other than the typical ensuring that there are clear lines of money movement?

For me, the reason to eliminate leveraged investing by the time I retire is partly because it would be too stressful for my wife, and by association, myself. The second reason is that I reduce certain flexibility and control over my own affairs. In retirement I would need more stability (leveraged investing amplifies moves) and would not be in a favourable position to respond (e.g. go back to work).

If I was starting this out when I was 25 and eliminated my mortgage at 40 then I would not be leaning towards eliminating the HELOC immediately.

I certainly understand how it would be nice to be completely debt free (even if you have underlying investments of equivalent worth) – but now that you have greater assets (house paid off), why are you more likely to not want to leverage?

Seems like most with HELOCs probably simply set them up to write off some of the interest, and not actually to produce greater returns.

There are two related issues: One with tainting the account and the other is tainting the loan.

If you use a portion of the HELOC for anything other than investments, you “may” taint the deductibility of interest. For example, if you paid down a portion of the HELOC and bought a car, you would lose a portion of the interest expense as a deduction.

You need to be able to trace the source of funds to the use of the funds. Often with a HELOC, people will use it for both deductible and non-deductible expenses. This should be avoided.

When you contribute cash to an investment account, you do not taint the deductibility of interest on the HELOC. The full interest is still deductible.

However, if you withdraw funds from the account, you can affect the deductibility of interest. For example, if you borrow to invest and then add personal cash to the account and then withdraw a portion in the future, the withdrawal will affect the amount of interest that can be deducted.

The point I was trying to make in my response to FT was that keeping separate accounts is always easier than trying to track contributions and withdrawals from the account and principal payments and purchases wit the HELOC.

For example, if our term is 4 years and we retire our mortgage in only 3 years, will the bank allow us to keep the HELOC intact with all of the same terms? Could they say we need to restructure the entire deal again with new adminstration fees and perhaps even a Prime + X% interest rate structure on the HELOC?

Our plan is once our payments eliminate the mortgage portion, then those same payments will be steered towards the HELOC amount. For the ultimate in flexibility, we are trying to position our retirement to begin with no debt so that it makes it easier for us to leave the country if that is something we’d like to do. For my wife, she does not want any debt when she retires – it doesn’t matter to her that it may be financially better to have a deductible loan funding a retirement portfolio. She would sleep better at night and that is something you always need to take into account.

I could see there could be issues if I later turn around and withdraw 1/2 the total account value – in that case, what proportion of the loan interest stays deductible? However, as long as I don’t do that, why would the CRA claim I should only be deducting 3/4 of the interest? The paper trail of the borrowed money into the investments is untouched by other money having followed a different path later.