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Smith Manoeuvre Money Flow and Capitalizing the Interest

I get a lot of emails about leveraged investing and the Smith Manoeuvre.  In particular, how to go about “capitalizing the interest”.  As you may have read, it is possible to fund the investment loan with the loan itself.  This is called capitalizing the interest.  Basically, it’s where you withdraw an amount (equal to the monthly interest payment) from the HELOC, and redeposit it as the monthly interest payment.  CRA accepts that a loan can pay off the interest charges of another loan while keeping the interest on both loans tax deductible.

As a side note, many people have written comments about using the investment loan to buy mutual funds with HIGH distributions.  Typically, high distributions include Return OF Capital which is fine providing that you NEVER withdraw them.  If ROC distributions are withdrawn from the investment account, the tax deductible portion of the loan will be reduced.  Only dividends/interest can be withdrawn without any consequence to the investment loan.  Check out “how to keep your investment loan tax deductible” for more information.

Back to the topic at hand.  If you look at my Smith Manoeuvre money flow setup below, I have a chequing account setup with BMO solely for the purpose of simplifying the intricacies of the Smith Manoeuvre strategy.  Even though it may cost $4/month (unless a $1500 balance is kept), it is worth the few dollars as it will show a proper paper trail if CRA has any questions.

The diagram that I whipped together shows exactly how the money will flow from one account to another while properly utilizing The Smith Manoeuvre strategy.  Hopefully this will clarify any Smith Manoeuvre money flow questions that you may have.  Note that the flow of money may be slightly different with other readvanceable mortgages.

smith manoeuvre
To explain a bit further, BMO’s Readiline does not allow direct lump sum payments from an external bank account even if the regular payments are coming from it.

We decided it was in our best interest to open a BMO chequing account because of three important reasons.

  1. It will provide a means of lump sum payment without visiting the branch.
  2. It will give us online access to view balances.
  3. Perhaps most importantly, it will provide a clean paper trail for CRA should they need it.
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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 48 comments… add one }

  • Ed Rempel June 4, 2008, 2:32 am

    Hi Kris,

    Do you mean you are putting all your investment transactions in your main account, together with all your personal expenses? This is dangerous for tracking, especially for transactions such as monthly regular investments, interest capitalization or withdrawals/redemptions from the investments. This would also mean that your entire chequing account needs to be shown to CRA in an audit of your SM.

    With M1, to do it properly, you should manually transfer every last investment transactions to and from the investment sub account. That makes it far more complex than other banks for the SM.


  • Kris B June 4, 2008, 7:34 am

    If you are familiar with the M1 it is setup so that only the Main account has access for direct payment/withdrawl or ATM access. All transactions come thru this account, then the debt/surplus is moved to the respective subaccount.

    The trail of transactions is fairly straightforward from my perspective. Mutual fund withdraws x amount from my main account, I xfer that debt to the subaccount 1:1. Seems simpler to me than the setup I would have with my RBC account where I would have to leave a balance in a seperate cheq account, then top it up after each withdrawl. This of course defeats the purpose of a M1 as excess/lazy cash is used to pay down the interest on the mortgage.

    I’ve never been audited so I am uncertain, but if audited would the CRA not have access to all your bank accounts anyways, and be able to examine your personal expenses? If the goal is simply to avoid this like you said, I’m not sure if that can happen. If I wished with the M1 I could open a PC financial no fee cheq account then use that to pay the investments, then top it up from M1 but I don’t see the need. The subaccount for investments clearly shows the month the interest was charged and the paper trail for showing the debt xfer is easy to follow. Comments?

  • cannon_fodder June 4, 2008, 12:34 pm

    I do not have an M1 nor any readvanceable mortgage product so I’m only guessing here, but it seems to me that it would be much cleaner to have a separate investment LOC that handles just investments. I know that some readvanceable mortgages have a small list of subaccounts while others have 99.

    Thus, when I implement the SM, I will have my mortgage account and an investment LOC subaccount, under the HELOC, joined with our already existing chequing account. If in the future I need to borrow money to purchase a car, then I will create a new subaccount under the HELOC for that.

    With the M1 as Kris describes it still seems that there is one central account, the main account, from where all transactions originate. It may not be a concern but I like the cleaner (in theory) approach of a traditional readvanceable mortgage.

  • Kris B June 5, 2008, 12:01 pm

    Here’s my attempt at using google docs as well to share a ppt slide, let me know if it doesn’t work.

    Shows an example how someone could use the M1 to manage investing using the SM.


  • Cannon_fodder September 2, 2008, 11:27 am

    Thanks again, FT, for the diagram and explanation. My first HELOC payment is due in just over a week. We went to BMO for their Readiline product (thanks again Ed Rempel) and IB for discount brokerage (due to the low margin rates).

    One interesting thing to note – the statement from BMO for the interest due portion on the HELOC was not extremely clear that it was already set up for pre-authorized debit. I’m so used to seeing bill payments that put it in bold letters near where the amount due is placed. For BMO’s statement, they have it at the bottom of the transaction details. I wasn’t totally convinced that I didn’t have to make a manual payment but one call proved that it was set up for automatic payment.

    Now, it’s off to the banking website to set up a scheduled withdrawal from the HELOC to pay itself the interest due!

  • Fadi Habib September 16, 2008, 11:06 pm

    Hi everyone

    I have a Scotia STEP and i haven’t yet withdrawn any funds from it. When I do, will the minimum payment be the interest only or the usual 3%. if it is 3%, can i still do the Smith Manoeuvre?

  • FrugalTrader FrugalTrader September 17, 2008, 5:53 am

    Fadi, typically HELOC’s will allow for interest only payments, however, you’ll have to double check with your banker to make sure.

  • KevinL September 17, 2008, 11:31 am

    My wife and I own our house together. My marginal tax rate is much higher than hers.

    Regarding SM, is there a way to save my tax only?


  • cannon_fodder November 4, 2008, 7:35 pm


    I’ve set up an SM with BMO and Interactive Brokers (IB). The problem is that the dividends produced from my investments at IB can only go back to the funding account or else I have to wait 60 business days. The funding account is the HELOC attached to the BMO Readiline product.

    What I want to do is apply the dividends against the mortgage portion, reborrow from the HELOC and then send them back to the IB for reinvestment.

    One option is for me to do the following steps – will CRA be okay with this trail and allow me to claim the interest deductibility?

    1. I send the dividend payments to the HELOC (right down to the dollar) from IB
    2. I then borrow immediately from the HELOC and send to my personal banking account
    3. I then pay down my mortgage with that portion from my banking account
    4. I then reborrow that same amount from the new room created at my HELOC and send that to IB.
    5. I invest that amount at IB so that it is now deductible.

    I hate that this is convoluted but there is no way that I can send a payment from IB directly to the mortgage since BMO won’t allow it. I can’t send it to my bank account directly unless I’m willing to wait 60 days.

    As it turns out, because it took me awhile to find opportunities to invest and generate significant dividends, I can wait another week and the 60 day threshold will be met. At that point, I can send it to my bank account directly. What I don’t think will work is sending it to the mortgage directly. Why? Because in order to ensure that there is an EFT link between the two accounts, IB sends some money (less than $1) to the account AND withdraws money from the account. With my BMO mortgage you can’t apparently send money to it except from the BMO linked savings/chequing account and you certainly can’t remove money.

    I hope this helps anyone else in this particular situation trying to achieve the same results.

  • Universal.Trader February 28, 2009, 2:38 am

    Hi, FrugalTrader,

    This is a very good site with lots of good and useful information.

    I am very close to setting SM based on the money flow diagram shown here and have a simple question. You have shown in your diagram that the investment funds should be funded from BMO HELOC to brokerage account. If fund from BMO HELOC to BMO Checking account and from BMO Checking account to Brokerage Account, would that be still okay from revenue canada tracking point of view.

    The reason I want to do it this way is my Checking account (for using in SM) is ready and I have that already linked with my brokerage account. However my HELOC is just getting approved and will be set-up sometimes next week. What they said is that once it is setup next week, then I can order the checks which will arrive in 2 to 4 weeks and then I can use that to link it with my brokerage account. However based on the current situation in stock market and 10%+ dividends, I want to get in to market sooner rather than waiting for about 4 weeks.

    Would appreciate your response.


  • FrugalTrader FrugalTrader February 28, 2009, 8:50 am

    Universal Trader: Thanks for the kind feedback. Ideally, you would fund your trading account directly with your investment loan. However, if you have a separate chequing account with very little personal activity, that would be ok as well. If the chequing account is a personal account with a lot of activity, then make sure you have a clear paper trail showing how the money is flowing. You should double check this with an accountant however.

  • Alan March 13, 2009, 9:39 pm

    Is Cash Flow Damming officially dead? I have a couple of rental properties and was going to implement it, but the more I read, the more I’m unsure if CRA is allowing it.

  • Ed Rempel March 14, 2009, 2:33 pm

    HiI Alan,

    What are you reading? The Cash Dam is specifically mentioned and allowed by CRA in IT-533.

    I have seen quite a few advisors use the Cash Dam as somehow an explanation that allows an investment loan to stay deductible if you take ROC distributions out of a fund. That doesn’t fly, but that isn’t Cash Dam.

    Using Cash Dam with rental properties works well to make your home mortgage deductible.


  • Alan March 14, 2009, 10:13 pm


    Thanks for the quick reply. I read one article in specific where Smith said he wasn’t going to be recommending it after the Lipson decision….and then all the naysayers started blogging! At any rate, I read IT-533 and, trying not to be daft here, but the mechanics for me would be – pay eligible expenses from HELOC, draw on property revenue for lump sum on personal mortgage portion of HELOC…right?

    Thanks again.

  • Ed Rempel March 15, 2009, 12:30 am

    Hi Alan,

    I read that quote from Fraser and have not talked with him since then. I’m not sure exactly what he means, but he was advocating mutual funds with ROC distributions. I took his quote about Cash Dam as referring to this, since I believe he had been using Cash Dam as an explanation for the ROC process.

    Anyway, it works perfectly for rental properties and nonincorporated businesses. It is purely a tax strategy – not an investment strategy. Your mechanics sound exactly right, Alan.


  • universal.trader March 19, 2009, 11:19 pm


    Based on the SM Money flow diagram shown here, if I make a capital gain in my discount brokerage account, but do not withdraw that gain and simply re-invest it, then will I still be able to claim all of the interest paid on the originally borrowed money?


  • FrugalTrader FrugalTrader March 20, 2009, 8:24 am

    Universal trader, as far as I know, providing that you keep the capital gains within your account, you can still claim the interest from the investment loan.

  • Tron March 24, 2009, 3:37 pm


    How do you keep track of how much the interest payment will be for the current month. It will always increase, and I can see myself making errors on the amount if I calculate it myself.

    Do the LOC’s have automatic interest payments where the bank will automatically pull the funds out of an account?

  • FrugalTrader FrugalTrader March 24, 2009, 6:44 pm

    Tron, yes the payments due for the HELOC are automatically withdrawn from a pre-assigned chequing/savings account.

  • Tyler September 23, 2009, 7:37 pm

    I have my HELOC setup and now I am trying to open Etrade account, but they told me that they could not withdraw money from my HELOC account, only fromsaving/chequing account.

    Is it true? if so, i have to xfer money from my HELOC account to my saving account very month so Etrade can withdraw it? I am so confused

    Thanks for any helps

    • FrugalTrader FrugalTrader September 23, 2009, 7:46 pm

      Tyler, if your bank can support a bill payment to Etrade using your HELOC as the funding account, then it should work.

  • JimC October 15, 2009, 5:04 pm

    Hello. I’m not a finance guy, so I want to make sure I have this nailed.

    Using our example, we have a 120k HELOC setup at 2.5%/a. Mortgage is locked at 5.79%.
    We’ve pulled 100k of that into investment bonds returning 15%/a, paying out quarterly. Our first quarter payment came in and it was only 2 months worth, so we held that in the tracking account to pay the HELOC interest costs. I’m debating whether or not I should “capitalize” that interest by pulling that money back out of the HELOC, and getting back up to the original $2500, or just leave it at the eroded amount.

    Now, our second interest payment has arrived, and I’m ready to get this into full swing and make a mortgage payment. So, assuming I capitalize that interest, I’ll have $6250 in the tracking account. So, I’m thinking I withold the 40% for tax, make a mortgage payement of $3750, pull 10k out of the heloc and reinvest it, and go on my merry way till next quarter. Rinse, repeat.

    All the while, we’re still making our accelerated payments of $700 into the mortgage.

    So, am I on track or have I botched this?

  • Ed Rempel December 14, 2009, 1:41 am

    Hi Jim,

    2 questions:

    Mortgage at 5.79%??? That is ridiculously high. Most likely, you will benefit by paying the penalty and getting a new mortgage. We are getting between 1.99% to 2.3% for 1-year fixed today.

    What kind of investment bond are you referring to that pays 15%? That must be a high risk investment and is likely unsuitable for the Smith Manoeuvre. It is a leverage strategy, which already magnifies your gains and your losses. Using it to invest in high risk investments is extremely risky.


  • Jim C December 14, 2009, 3:43 pm


    You’re right on the first part. I called Firstline today and we’re going to be renewing at a much lower rate. We were initially locked in at 5.79 when we activated the matrix part of the mortgage, but they’ve changed the product now so we’ll be a Prime-1. As for the second part, it is risky, but I’m comfortable with the investment, and the manager so I’m willing to accept it for now.

  • Nicki January 9, 2010, 5:32 pm

    Does anyone know of a chartered accountant in Montreal (pref. West Island) that knows how to set up proper accounting for cash damming for a self-employed work, i.e. real estate agent.

  • Ed Rempel January 23, 2010, 12:48 am

    Hi Jim,

    Prime -1%? That interest rate is not available now. Do you mean prime +1%?

    I would recommend to avoid variable rates for now. We believe that mortgages with big discounts from prime will be available again in a year or 2, so stay short. You will probably regret locking in to a mortgage for 5 years that does not have a big discount from prime when those become available again.

    I would suggest to stick with 1-year fixed for now and enjoy the amazingly low 1.99% rates available now.


  • Brenda January 28, 2010, 10:12 pm

    If I want to capitalize the interest but the interest payment for the HELOC is withdrawn automatically from my chequing account then how does it work?

  • FrugalTrader FrugalTrader January 28, 2010, 10:52 pm

    Brenda, at that point, simply withdraw the same amount from your HELOC back to your chequing account.

  • Brenda January 28, 2010, 11:17 pm

    Thanks! You are GREAT!

  • James November 11, 2010, 6:44 pm


    I read on a previous post that you were implementing the RM formula. From what I understand this uses your principle paydowns to pay for interest on a seperate LOC.

    How would you include the RM LOC payments into the diagram? Is it necessary to create 2 seperate brokerage accounts?


  • James November 11, 2010, 7:12 pm

    Have a look at my uploaded flow diagram and see if it jives with the RM SM.


  • FrugalTrader FrugalTrader November 12, 2010, 12:11 pm

    @James, you’ll have to refer to Ed Rempel for that question as I didn’t implement the RM after.

  • Ed Rempel February 8, 2011, 1:22 am

    Hi James,

    I just noticed your post. Your drawing is fine, except that you don’t really need a separate credit line for the Rempel Maximum. The Rempel Maximum is the maximum benefit you can get from the Smith Manoeuvre without using your cash flow.

    You start by borrowing the maximum amount to invest that the principal portion of your mortgage payment will cover. For example, if your mortgage payment pays $500/month of principal, that would cover approximately $150,000, depending on your interest rate. You should allow a bit for interest rates to rise.

    You can borrow from one credit line or from a credit line and investment loan, depending on your situation.


  • TC July 27, 2011, 11:37 am

    Kris B.,

    I’d be interested in see your ppt slides if you still have them. Are you still using the M1 account for SM?


  • SK September 30, 2012, 1:43 pm

    Question about capitalizing the interest from HELOC..so if I withdraw from HELOC to fund the interest payment every month (though still tax deductible) say $100 for the outstanding balance, say $40,000.00, the outstanding balance of my HELOC will increase by $100 the following month on top of the original borrowing amount, so it will become like $40,100.00? Please comment. Thanks.

    • FrugalTrader FrugalTrader September 30, 2012, 1:48 pm

      @SK, yes, your HELOC balance will increase by the amount of your required payment.

  • JC October 19, 2012, 9:59 am

    What happens if you max out your heloc? how can you capitalize interest then?

    • FrugalTrader FrugalTrader October 19, 2012, 10:39 am

      If the HELOC is maxed out, you have three options. Pay with your existing cash flow, use another line of credit to service the debt, request that the bank increases your HELOC credit limit (fees may apply). Personally, I would leave a buffer in the HELOC to service the debt.

  • AlexOntario March 24, 2013, 4:51 pm

    I am planning on implementing SM in the next couple of months, while I will consult with a tax accountant I have a question about brokerage fees.

    Let’s say I borrowed from my LOC 10K this year and invested in stocks (with Questrade).
    I paid $50 in brokerage fees.

    From what I understand the amount I can deduct interest is 10,000 – 50 = $9,950
    Is that right?
    What do I do with the $50 when bought the stocks?

    I know from reading CRA’s website that when I sell the stocks and have (let’s say) capital gains, I can use the brokerage fees when calculating the ACB value of the stocks.
    So, if I sell the stocks $15,000 and paid brokerage fees $120, then:

    9,950 + 120 = $10,070
    Capital gain: 15,000 – 10,700 = $4,930

    But what happened to the $50 I paid when I bought the stocks?

    Thank you!

  • AlexOntario April 18, 2013, 10:11 am

    To answer my own question, the brokerage fees (buying and selling) go into calculating the ACB of the stocks.
    And I can’t deduct the amount I paid for the fees, but I can deduct the interest on them.
    In case anybody’s interested in that.

  • Sid January 8, 2015, 7:50 pm

    Hello, this is an amazing post with equally useful comments and questions – many thanks for posting and answering all the questions so far.
    I’m not a finance guy so please bear with my question which has been answered multiple times in the comments but I’m still struggling with it:
    This is about capitalizing the interest, if I look at post #85 from Brenda and your answer (#86), how is it capitalizing if your HELOC is going up by the amount your are withdrawing, what part of that 100$ actually get capitalized and how/when/where etc…?
    Sorry again if this is very obvious to everyone here, just don’t understand :).
    Thanks in advance.


  • FrugalTrader FrugalTrader January 9, 2015, 3:56 pm

    @Sid, your HELOC will charge your interest only. Assuming that your HELOC was only used for investments, the interest that you are charged is taxed deductible. For me, the interest is taken out of a specific checking account every month, say $100/month. So, in turn, I login to bank account online, and transfer $100 from my HELOC to “pay back” my chequing account.

  • Sid January 10, 2015, 5:14 am

    Thanks FT for the quick response.
    So if I understand right, assuming that you started of the year with a balance of 10000 on your HELOC, you would end up with a balance of 11200 at the end of the year and what you’re saying is that the 1200 is tax deductible?
    Assuming the above, do you get the whole 1200 back after filing your taxes or just part of it?


  • Ed Rempel January 10, 2015, 7:38 pm

    Hi Sid,

    “Capitalizing”, in this context, means to add it to the loan. If you start with $10,000, the interest is probably closer to $30/month. You can have the HELOC pay its own interest, but you have to do it manually. The bank will take the interest from your chequing, but you can repay your chequing by transferring manually from the HELOC.

    You should transfer the exact amount back – to the penny. The reason is that, in case of a CRA audit, you would need to show that all the amounts from the HELOC were invested (and remain invested) or where used to pay the interest.

    The tax rule here is essentially that if interest on a loan is tax deductible, then interest on the interest is also tax deductible.

    Being deductible does not mean you get it back as a tax refund. You can claim it as a deduction on your tax return and then your refund would be based on your tax bracket.

    Does that make it clear, Sid?


  • PENNY WORKS January 11, 2015, 12:41 am


    Thanks for the answer, which makes me clearer on “capital the interest”

    I use an example to show If I understand right. If not, ED please correct me:

    * Borrowing 100k from HELOC at interest rate of 3.6% to invest on fixed monthly return mutual funds
    * 1st month interest is $300. If I capital the $300 as instructed, then the bal. of HELOC for $100,300 for the 2nd month. and the interest of 2nd month will be $300.90……
    * So on until the 12th month, the bal. of HELCO will accumulate to $103,660.00, and monthly interest will be $310.98.

    So the balance of HELCO and monthly interest is growing every month. The loan will grow although the original investment is only $100k.

    my HELCO is from RBC, does RBC allow me to capital interest this way and will RBC bother to calculate different interest every month? if yes, the annual interest paid $3670.98 should be all deductible, right?


  • PENNY WORKS January 11, 2015, 12:55 am

    Happy New Year FT,

    Just curious, did you hit your goal of 1M net worth by Dec 31, 2014? ;-)

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