1. I am confused by this, it seems like a technicality but does this mean to avoid any chance of CRA coming after you, you should invest in some dividend producing stocks, that return you greater than interest costs of the loan? I thought that as long as their is a reasonable expectation that the stocks you have invested will produce some kind of income in the future, you can invest in them for the purposes of SM. In my sitation, i have not invested in dividend paying stocks and only have capital gains, how would this impact my tax deductibility?

2. Is it fair to say that you cannot use any of the capital gains for anything else but to pay off your deductible loan if you want to keep it tax deductible? In another thread, i was reading that any taxable gains (such as Capital Gains) can be used for anything…is this not correct – maybe i just misintereted this? Technically does this not mean that i can’t use my investment portfolio for anything else but to pay off my loans if i want to avoid nightmare reconciling accounting….

Answers to the above would be greatly appreciated. I apologize if this has been answered before.

Your strategy sounds correct, but is not optimal. You are combining a good strategy with a bad one. If your home is paid off, you can just borrow against it to invest in BMO or whatever you want, and it should be tax deductible.

We would not recommend investing all in one stock, since that would be very risky. You should be able to invest more effectively, but it should be tax deductible.

Then you are combining that with an RRSP mortgage, which is a dreadful strategy. I don’t know why anyone would consider it. It is a combination of a horribly expensive mortgage and a very low RRSP investment return.

In your strategy, you borrow from your RRSP at 6%. That would be a low RRSP return, especially since there are large up front and annual costs.

Then you are borrowing at 6% to invest, when you can invest at prime +.5% today. What do you gain for paying an extra 3% on your mortgage? Absolutely nothing. You have probably the most expensive mortgage in Canada.

Normally, you can invest your RRSP and make an equity return at say 10%/year long term. Then you can get a mortgage at 1.99% today. So you make an 8%/year profit. With an RRSP mortgage, you give up the entire 8% profit, plus you pay high fees to do it.

An RRSP mortgage is a bad mortgage plus a bad RRSP.

My advice – forget the RRSP mortgage. It is a dreadful concept! Borrow from the bank at 1.99% and invest it properly. You will be way ahead.

Ed

With the house paid off and $100,000.00 in self directed RRSP as cash, could I take a mortgage for the investment purposes (say $100,000.00 worth of BMO stock outside the RRSP), and hold it within my RRSP?

I believe the answer is YES!

It looks to me that with a bank posted rate of 6%, It will generate $6,000.00 of tax deduction, which will offset about 40% of the $6,000.00 dollars paid into my RRSP – net out of my pocket: $3,600.00. + mortgage fees (lets say $1,400.00) for the total of $5,000.00
Now lets cash that BMO dividend of 5% – this generates also $5,000.00 (less 15% for the tax)

Overall – it cost me $750.00 (15% of $5,000.00) to get:
- guaranteed RRSP growth of 6%
- exposure to capital gains of the $100,000 worth BMO stock

After one year, the same above applies, but this time there are no fixed up-front legal and insurance mortgage fees – rendering all the above profits at no cost. … and that $12,000 accumulated in the RRSP could be held in anything, subject to compounding, until the amount is big enough to justify redoing everything with much higher RRSP number.

Where is the flaw?

It is a good idea to pay the extra 10% the company gives you onto your investment loan in order to make sure it is all tax deductible.

Ed

It’s actually two separate benefits…first you get to buy the shares at 90% of the average market price and on top of that the company will give you an extra 10% of your initial contribution amount. So I believe it’s a pretty good deal but I believe both benefits give rise to a taxable benefit.

I definitely agree with you as far as not over exposing myself to just the one company. I’ve seen the documentary on Enron!

Thanks for your help,

Rod

As long as you can track that the money from the investment loan went to buy the shares and you keep the loan separate, it should be tax deductible.

The $500 from the company would be taxable to you and is probably the same 10% that gives you the shares at 90% of the average price (is that right?), but that still sounds like a good offer.

Whether it is a good investment is a different question. Just because you work there, you should still consider whether you would buy these shares if you did not work there. If you wouldn’t, then you probably shouldn’t buy them now.

It is nice to own a bit of the company you work for because they send you shareholder information and you can feel like an owner, but I would recommend to keep the shares to less than 5%, or definitely 10%, of your investments.

It is very risky to be over-exposed to one company. You already have your job there, if you also have your investments in the company and it gets into trouble, you can lose your job and investment all at once.

Ed

The plan works by selling employees shares of the company at 90% of the 5 day average stock price before the purchase is made. Also, they top up your purchase by 10% so if I buy $5,000 worth they would put in an additional $500 towards my share purchase. So I believe it’s a pretty good plan.

If I wanted to borrow say, $5,000, to purchase some shares would the interest on my investment loan still be deductible? (the company regularly pays dividends).

Thanks!

Rod

Your age is not really the issue. You probably have 10 years or more until retirement and then probably 30 years after that.

The issue is whether you have the risk tolerance and will be able to maintain the strategy through the bear markets that will happen.

You are trying to pay your mortgage off quite fast. It looks like you believe that the SM will pay it of f very quickly. The real Smith Manoeuvre only pays it off a bit faster from paying the tax refunds onto your mortgage, although you can accelerate this with more aggressive versions. The Smith/Snyder version pays it off faster, but replaces it with a NON-deductible investment loan, so you are no further ahead.

The reason for doing a strategy like the Smith Manoeuvre is that it creates a large nest egg for your retirement without using your cash flow (and pays off your mortgage a bit faster). It needs to be a long term strategy, because the risks decline significantly over time.

Do you think you and your husband will be able to stick with this strategy for the long term, Brenda?

Ed

It sounds like you have been to a Smith/Snyder presentation with the “funnel”. You are withdrawing ROC distributions to pay onto your mortgage, so that definitely reduces the deductibility of your investment loan. If you had paid the distribution directly onto the credit line, you would be fine.

Even better is to reinvest the distributions. There is no advantage at all of paying out distributions. Paying them out leads to the “4 Meaningless Transactions”. You pay out the distribution, pay them onto your mortgage, reborrow from the credit line to invest and then you have to do the Snyder Tax Calculation to see how much of the loan interest is still deductible.

At the end with all that effort, you are in exactly the same place that your started! The only difference is that your mortgage is a bit smaller and is replaced by an extra amount from the investment loan that is NON-deductible.

It looks cool, because it looks like you are paying off your mortgage quickly. But you are replacing it with a NON-deductible investment loan of the same amount. Once the mortgage is gone, you have to start over again paying off your NON-deductible investment loan.

In addition, the NON-deductible investment loan is at a higher rate than your mortgage.

My advice – do the real Smith Manoeuvre and reinvest all distributions. We have run many simulations and it always comes out ahead of any strategy involving paying out ROC distributions.

Ed

I said pay down the mortgage because my set up for the investment LOC is via a re-advanceable mortgage (the mortgage principal paid is then lent back via a line of credit which is then directly used for investments). Everything is set up to be very clear and traceable so I wanted to see if using the ROC payouts to make the mortgage payment, used as a funnel for reinvesting in the funds would be acceptable or whether there would be an issue.

K

It sounds like you have answered your own question – I think.

What do you mean “pay it down on the readvanceable mortgage”? Are you referring to the mortgage or the investment credit line?

There is not a separate rule for ROC, since it is ROC is just your principal. If your investment is not up or down, there is absolutely no difference between taking a ROC distribution of $1,000 and selling $1,000 of your investment.

Therefore, the rules that apply to the principal when you sell also apply to ROC.

So, if you take a $1,000 ROC distribution, $1,000 of your investment credit line is no longer deductible. However, if you paid that $1,000 onto the credit line, then your credit line is also $1,000 smaller, so it is still all deductible.

If you do anything other than pay 100% of the distribution onto the loan or buy new investments with it, then your investment credit line becomes non-deductible by the amount of the distribution that you did not use for those 2 purposes.

If you apply the ROC to your mortgage, that is not an acceptable use.

Does that answer your question, Kate?

As for the cool strategy, I have been writing a couple of other articles, but will write it soon. Stay tuned.

Ed

Your concern based on the article is on the definition of “compound interest”. You are thinking of compound interest as I do – interest on the interest. In the article and in IT-533, they refer to compound interest as interest that is accrued but not paid.

For example, your mortgage statement will show the interest paid and may also show the accrued interest up to the end of the month that is part of next month’s payment.

The article is referring to this accrued interest that is not paid, not to compound interest as you and I define it.

IT-533 has a similar reference, but clearly states that compound interest (interest on interest) is deductible, as long as it is paid. If you capitalize (compound) the interest on your credit line, your statement will show that you were charged interest and paid it.

If you read IT-533, you will see that it is clear.

You seem surprised that compound interest is deductible, Brendan. Companies do this all the time. They increase their credit lines or loans with money used to pay expenses, including other interest. There is never any doubt that compound interest in a company is deductible. The same principle applies to individuals compounding interest.

Your concern about tax is why we do tax returns for no charge for our clients that are working 100% with us and following their plan. If they are audited, we handle it with CRA. As long as we can track all transactions properly, it is not an issue.

Ed

Thanks for the digging. I am aware of the tax bulletin and find that it is quite clear on loan interest being deductible for investments – I have no issue there, it was more around the ROC distribution that then reduces the portion of the loan which qualifies for deductible interest.

In the preceding discussions there are different views offered. On one hand, it is stated that returns of capital would reduce the portion of the loan that is eligible for deduction, but on the other hand, it is also noted that it would not have a negative impact if the amounts were directly reinvested or used to pay off the loan.

I would just like to know, although it is not advised here due to complicated accounting, if (as long as you have everything carefully tracked in separate accounts) reinvesting the ROC via down payments on the re-advanceable mortgage (which is then used directly for investment) still allows interest on the full loan amount to be eligible for tax deduction.

I am assuming yes, but wanted to see if there was anything in writing from CRA – but having thought about it, I don’t suppose there would be because we are just simply saying that ROC reduces the capital portion of the investment, therefore you no longer have matched the loan figure you borrowed with the investment figure dollar for dollar (equivalent of a withdrawal form the investments).

Assuming what I have said above is correct, what then after TSM? The only way to maintain the 100% deductible portion of the loan would be to either use the ROC to pay down the loan, or reinvest directly back into the funds (or a combination of both). Maybe I’ve answered myself here. If not, someone set me right!

Thanks

I cannot find this information. Trying to navigate the actual tax act is difficult.

I did however come across this:
http://www.ctf.ca/articles/news.asp?article_ID=1907

The way I read it is that you CANNOT deduct compound interest. If you borrow to pay loan interest then you are not borrowing to earn income you are borrowing to service interest.
In the provided link company x repays the interest and then immediately re borrows it again to earn income. This is simple interest.

As much as I would like the SM to work i am starting to smell a bad fish. Too good to be true. Borrow money, never pay out of pocket to service your loan, and reap the rewards. Does this sound like something CRA will let you do?

I am awaiting confirmation from CRA (I sent in a letter for a tax opinion on this) before I commit. I also have an accountant who specializes in tax law to give me an opinion on this as well.
Mr Fraser should have asked for and paid for an advanced ruling on the SM if he believes this really works.

Personally as it stands now i believe deducting compound interest on an investment loan is a grey area, that people are getting away with at this point because:
1. there are not many people doing this, and the amounts are so small it is not worth “going after”.

2. CRA simply has not gone after this strategy at this point yet. CRA will initiate different “projects” i.e people in the service industry who receive cash tips, contractors the next few years, and buy low/donate high schemes.

I still think leverage can be usefull but if I initiate a leverage strategy i will simply deduct the simple interest and pay it out of pocket.

I know I can contribute to an RSP and I will never worry about it being scrutinized.
I am not as confident with deducting compound interest.

In theory it all sounds good, but I would hate to do this for 5 years and then be reassesed by CRA..

Does not pass the smell test.

By the way if anyone can post the actual tax law, specifically 20(1)(c), and 20(1)(d) this would be helpful. IT 533 alone does not give the whole story.

Would like to hear about both, cheers.