Using the Smith Manoeuvre: My Scenario
As promised, I will be discussing my personal scenario regarding using the Smith Manoeuvre. The spreadsheet provided by Cannon_Fodder was a great help and reinforced in my mind the power of smart tax planning.
Anyways onto the good stuff. Spring is here which means my wife and I are on the house hunt. With this comes the opportunity to use The Smith Manoeuvre on our future home, but I would like to discuss some of the numbers that I came up with to make sure that they made sense. From the comments on the article "Anti-Smith Manoeuvre", it appears that some of you are better at analysis that I am. :)
Without further adieu, here are the numbers:
- Current Residential Home Value: $140,000
- Current Mortgage: $80,000
- Equity: $50,000 after Realtor fees.
- Cash Savings used: $20,000
- Non-Registered Portfolio: $40,000 (liquidate)
- Total Down Payment: $110,000
- New House (estimated): $275,000
- New Mortgage: $275k-110k= $165,000 (non tax deductible)
- New HELOC (@ 6%): [ ($275k x 75%) - $165k] = $41,250 (tax deductible)
- Total Debt: $206,250
- New Mortgage Payment (accelerated bi-weekly) @ 5.25%: $584.12 (not including property tax, insurance etc).
- Original Amortization: 16 years
The Criteria:
- All tax returns will be applied to the non-deductible mortgage balance, which then again, increases the HELOC balance.
- All dividends will be used to pay down the non-deductible mortgage.
- HELOC interest payments will be capitalized. That is, the HELOC required payments will be paid by the HELOC itself. This will avoid using any of my own cash flow to support the investment loan. The spreadsheet will account for this.
- Assume that the LOC will be invested in dividend paying stock that provide an income stream of $1400/year (assume 3.5% average dividend yield). This equates to a $54 / bi-weekly period applied to the mortgage. This should be increasing annually but for simplicity sake, I will be keeping this constant.
- Assume that since I'm going to continue to max out my RRSP, I won't have any extra cash to pay down the mortgage.
The Assumptions:
- Marginal Tax Rate: 40%
- Average Investment Growth Rate: 8%
- Diverted Periodic Investments: $54
- HELOC Interest rate: 6%
- Mortgage Interest Rate: 5.25%
The Results:
- Non-deductible mortgage will be paid off in 11.78 years instead of 16
- Investment Portfolio Value after mortgage is retired: $244,833
- Portfolio Value NET of HELOC: $38,583
- Investment Portfolio Value after 25 years: $908,640
- Portfolio Value NET of HELOC: $702,390
Summary:
- This analysis shows the benefits of using the Smith Manoeuvre, not the down side. You need to be comfortable with leverage, especially the downside, before you even consider using this strategy.
- The Smith Manoeuvre will enable me to pay off my mortgage in 12 years instead of the stated 16 years with no extra cash flow out of my pocket.
- At the end of the mortgage term, assuming that I average 8% returns over the term, my portfolio value minus the loan amount will be approximately $38,000.
- It is very likely that we will be putting some of own cash flow/savings to pay down the mortgage. If we were to add an extra $100 to our bi-weekly payments, we would reduce the mortgage term down to 10 years from 12.
39 Comments, Comment or Ping
1. David
FT: Have you tried a 25 year mortgage of $206,250, and flow your current investment portfolio through it? Smith does NOT suggest the homeowner collapse investments for the down payment, but rather suggests that you use the value of the house to carry the greatest possible mortgage for investment purposes. He has further suggested that for those whose mortgage is less than $200,000 that they consider finding the means increase it for the borrowing space.
David
Apr 12th, 2007 @ 12:29 pm
2. Mark
Do you have any rentals properties by chance? This or any other unincorporated business really makes the Smith Manoeuvre interesting. It accelerates the conversion of your bad debt (mortgage) into good debt (interest-deductible investment loan). In fact, my wife and I are currently pursuing either a small business or rental property more aggressively knowing the above benefits. I have used the spreadsheet from the RedFlagDeals thread but have an even better one I got from the financial planner who introduced me to Manulife One and more importantly the Smith Manoeuvre. I will look at cleaning it up and posting a blog entry on it this week actually. Thanks for continuing the discussion. Blessings!
Apr 12th, 2007 @ 12:47 pm
3. FrugalTrader
David: I’m not sure what you mean. Wouldn’t selling off my non-reg port to pay down the house give me a larger HELOC to invest with?
Apr 12th, 2007 @ 12:54 pm
4. Causalien
FT does the Smith manoeuver explains what happens when the valuation of the home actually drops? I am seeing this trend this year across some parts of Montreal.
What happens to the equity value of your loan when the actual equity value of your house drops?
Apr 12th, 2007 @ 2:21 pm
5. FrugalTrader
Mark: Yes, I do have a rental property. How would you maximize the SM using a rental property? Do you mean using the “cash flow damn” to use the HELOC to make the rental mortgage payments?
Causalien:The Smith Manoeuvre is all about long term. In the long term, a small dip in property value will be insignificant. In terms of your investment loan, that amount is based on the appraisal when you applied for it. So no, your credit limit will not decrease.
Apr 12th, 2007 @ 4:15 pm
6. Mark
FT: Yep the whole “cashflow dam” idea mentioned in the book. I know it is a lot easier to setup before you purchase a rental property but you should be able to figure out a way to pay all costs related to the “rental property business” you have with your HELOC and deduct that portion of the interest. From my calculations and spreadsheet scenarios that is where the SM *really* becomes interesting.
Apr 12th, 2007 @ 4:31 pm
7. David
FT asks: David: I’m not sure what you mean. Wouldn’t selling off my non-reg port to pay down the house give me a larger HELOC to invest with?
Yes, It’s just that Smith would launder the portfolio through the mortgage. As long as the banking product you have chosen is based on the $206,250, not the $165,000, the goals should match. The Smith Calculator does not readily allow you to have the LOC on the side as Cannon_Fodder’s does.
Remember, Smith’s numbers are mostly based on the 25 years of amortization being used to build the portfolio.
BTW, care to expand on your statement at the beginning of this entry: “it appears that some of you are better at analysis that I am. :)”
David
Apr 12th, 2007 @ 5:05 pm
8. Q Cash
FT
I wish you every success. Although I am too conservative to leverage my investments these days (I was more aggressive in my youth :-) I have been examining the following strategy to see if it has any benefit (using round numbers here):
1) I have a rental property, no mortgage, worth $180 K
2) I have an RRSP portfolio worth $130K
I would like to take a mortgage on the rental property and invest in an income/dividend/roi fund providing 7% return (combination of interest/dividends/return of capital). The revenue would be about $9100. Not all taxable (only about 75% as the roc portion is not taxable)
I would borrow the money from my RRSP with a self-directed mortgage (B2B Trust or TDW) at 5.5% (market rates). The payments would be about $9000 a year (6600 Interest and 2400 Principal). The $6600 would be deductible as a carrying cost for the investments, but (and here is the good part)…
…I would be receiving the interest in my RRSP tax free, so my RRSP would be increasing by $9000 per year.
Over time, the mortgage is paid out (no hurry as I am earning the interest) and I am left with another $130,000 of securities.
The only downside I can see so far is that the Return of Capital will eventually reduce the ACB for the securities to zero.
Thoughts, critics, am I missing anything?
Q
Apr 12th, 2007 @ 6:31 pm
9. Ed Rempel
Hi Q,
Here is what you are missing:
1. You are investing your RRSP at only 5.5% – easy to beat with almost any equity investment held long term.
2. Since you are taking a distribution that is likely mainly ROC, your mortgage used for investments becomes non-deductible. If you take a $10,000 distribution (7%), then only $120,000 of your mortgage is deductible. After 13 years, it is completely NON-deductible. (We call having a ROC distribution from a fund the Reverse-Smith Manoeuvre, since it is a process of converting a tax-deductible loan into a non-deductible loan.)
3. You are choosing an income fund because of the distribution, but it will have a lower return and cost you more tax than an equity fund – or any fund chosen for it’s risk/return, as opposed to whether or not it pays a distribution.
4. The RRSP mortgage idea only sounds good. See my entry at the Red Flags blog – http://www.redflagdeals.com/forums/showthread.php?t=427699&highlight=smith+manoeuvre – on the topic. If you invest your RRSP in a 30-year bond and get a good rate on your mortgage, you will always beat the RRSP mortgage strategy.
Your fear of leverage may go away when you study the markets, Q. You are leveraging with both your house and your rental – and you are not diversified. Depending on how you measure risk, real estate is at least 2/3 as risky as the stock market.
If you measure it by the largest possible decline top to bottom, in Toronto it is TSX -43% and Toronto real estate -28%: real estate has 2/3 the downside risk of stocks.
If it is by longest possible time with no growth, the answer is TSX 6 years, Toronto real estate 13 years: real estate can have bear markets more than twice the length of stocks.
Meanwhile, while real estate has seen above average returns for the last few years, the returns are very low long term. Since 1977, Toronto real estate has averaged 6.0%, which is 2% over inflation. This compares to 12.3% for the TSX and 7.7% for GIC’s.
Suprisingly, the last 30 years, which include the largest real estate boom of the 1980’s and the recent real estate strength, real estate has had 1/2 the return of GIC’s and less than 1/6 the return of stocks!
So, 2/3 the risk and 1/6 the return.
My point is that leveraging equities (if invested well) is hardly any more risky than buying your home with a mortgage and many times more lucrative.
Ed
Apr 13th, 2007 @ 10:57 pm
10. Q Cash
Thanks Ed,
Just looking for some clarification for some of your points:
1) 5.5% is the guaranteed return for the life of the mortgage, nothing stops me from reinvesting the proceeds as they come in to the RRSP in equity investments as well (example the first year will have a 9,000 cash flow into the RRSP that could then be invested in any equity or other vehicle, thus compounding over and above the original investment)
2) If I borrowed $20,000 to invest in an income trust that had an ROC component to its distribution, are you saying that the interest on the $20,000 is not tax deductible. I question that interpretation.
3) Keep in mind that in my early retirement plan, I am concerned about cash flow more than growth. If I can average 6-8% on my investment portfolio, I provide myself with the cash flow I want to live my lifestyle (ala Derek Foster), so locking in guaranteed rates benefits my lifestyle choice and protects my principal.
4)If I am going to leverage, why not pay the interest to myself. It allows me to not be in hoc to anyone (i.e. debt free) which is critical to my lifestyle choice (sleeping easy at night :-)
Finally, keep in mind that my properties will continue to appreciate in accordance to real estate trends. I can refinance as my RRSP grows and the values of the properties increase.
I will not actually have altered my NetWorth initially.
Also, since I am setting up the mortgage within my RRSP, I can vary my rate of return to do what I want it to do. I can set it up for 1 year term and continually set the amortization to 25 years each year.
As well, see point 1 of mine above, you can reinvest the proceeds from the mortgage (super-compounding) to further increase the rate of return. I do not foresee using the money in my RRSP within the next 25 years or so.
There is a reason why banks like offering mortgages :-)
Regards,
Q
Apr 14th, 2007 @ 11:56 am
11. FrugalTrader
Q: If you receive ROC on a distribution, you will reduce a portion of your investment loan that is tax deductible.
Apr 14th, 2007 @ 12:58 pm
12. Sam
hi ed,
“Since 1977, Toronto real estate has averaged 6.0%, which is 2% over inflation. This compares to 12.3% for the TSX and 7.7% for GIC’s.”
i believe the TSX growth includes dividends..
by the same measure should not the net rent(rent- prop tax – maintenance fee) be includedd in real estate growth…
does the 6 % growth includes rental income too or is it just pure growth…
thanks a lot…
Apr 14th, 2007 @ 1:10 pm
13. cihanlee
Well after thinking it over, I came across this idea, since the SM allows you to take your HELOC out and invest it, is it not smarter to pay down your mortgage say in 15yrs, and than take the full HELOC value from your house and invest this equity? Am I missing something here, since the latter seems as the smarter choice.
Apr 14th, 2007 @ 2:52 pm
14. FrugalTrader
Cihanlee: If you look @ my scenario, starting the Smith Manoeuvre early gives you an advantage of around $40k over waiting to invest. This is because you have an extra 15 years to compound your returns, makes a big difference. On top of that, the Smith Manoeuvre will enable you to pay down your mortgage EVEN faster than conventional methods because of the tax return applied to the mortgage.
Apr 14th, 2007 @ 3:04 pm
15. Ed Rempel
Sam,
Good question. These figures are from the Toronto Real Estate Board and are growth only.
We didn’t want to unfairly prejudice the figures. Since the cash flow is now a negative number, this could reduce the return of real estate quite a bit.
Markets vary betwen favouring landlords & favouring tenants. Right now in Toronto, it strongly favours tenants. If you compare renting or buying the same condo, for example, a condo can cost $1,700/month to carry after putting 10% down, when you could rent the same condo for $1,300. And that is if you assume repair costs are zero.
I’m not a real estate expert, but normally, these costs roughly balance or are slightly negative. Rental real estate generally only has positive cash flow when you get significant equity built up. Of course, there are many specific exceptions to this, but I’m quite sure that is the long term average.
If you count the rent and expenses, you would have to compare that to what you could have otherwise made by investing the downpayment and the negative cash flow. In the vast majority of cases, if you rent your home and invest the down payment and saved cash flow in equities, you will be ahead of owning. This will always be true if you leverage the equities to the same level as real estate.
Here is the interesting part. Even though stock markets have had more than 6 times the growth of real estate in the last 30 years, most of our clients know more people that have made money in real estate than stocks. Isn’t that wierd?
I thought about this a lot and figured out why. Real estate investing has 3 benefits – but not what you might think. Here is why people make money in real estate:
1. Leverage – We leverage to buy our homes, but not for faster-growing investments. All examples of real estate being profitable include high leverage. There is a perverse logic here. You put $100,000 down on your $400,000 home which rises by 4%, you have made 16% on your $100,000 down. Then most people want to pay down the mortgage. As they do, the return gets lower and lower – and once the mortgage gets paid off, your return will be lucky to keep up with GIC’s. Real estate is only a good investment if you maintain a large mortgage.
If you compare any scenario with equities leveraged to the same level as real estate, the equities always win by wide margins.
2. Forced savings – While investing the down payment and cash flow saved by renting will usually give you a larger nest egg than owning, few people have the discipline to invest it all.
3. Terrible equity investing – When it comes to equities, studies consistently show that the average investor makes only 1/3 the return of of the investments they own. This is because our human brain is designed to continually make us buy and sell at the worst times.
This is the beauty of the Smith Maneouvre. It keeps you highly leveraged, puts most of the money in high-growth investments eventually, and involves investing automatically every 2 weeks (which means you are less likely to try to market time).
Ed
Apr 14th, 2007 @ 3:09 pm
16. Ed Rempel
Hi Q,
In response to your comments:
1. I see 5.5% as a low RRSP return and a high mortgage rate. We’re getting 5.15% variable now, which will allow us to take advantage as rates decline over the next year. Equity returns should earn 8-10% or more over time. And the RRSP mortgage strategy has high setup and maintenance fees.
2. You are putting $9,000 into your RRSP without getting a tax deduction, but will then have to pay tax on it in the future when you withdraw it. You get tax-deferred growth, but that applies to any RRSP investment and largely to equity investments outside the RRSP.
3. A ROC distribution is just getting some of your own money back. Many people confuse this with the investment return, but ROC funds or income trusts pay out even when they lose moeny. CRA’s view is that it is the “current use” of money that matters. In you case, if you borrow $130,000 and invest in a ROC fund and have $10,000 paid to you in distributions, then $10,000 of the $130,000 is no longer invested and the interest on only $120,000 is deductible. After 13 years, none of it is deductible.
4. You are concerned with cash flow, but you are paying $9,000. If you look at examples with leverage doing RRSP or Smith Manoeuvre with the same cash flow, you will find there will be many better options. The best strategy depends on your complete financial picture.
5. You are not debt free. If you don’t make your mortgage payments, your RRSP mortgage administrator will foreclose on your house. There is really no difference between the RRSP mortgage strategy and getting 5.5% mortgage at the bank and then investing your RRSP in your neighbour’s mortgage or a mortgage-backed security earning 5.5% (except $2,000 in fees). Thinking that you are mortgage free is only a matter of “mental accounting”. You and your RRSP are not the same, so think of your personal mortgage and your RRSP investment separately. So, if you can get EITHER a personal mortgage below 5.5% or an RRSP investment over 5.5%, you beat the RRSP mortgage strategy.
Work out options with the Smith Manoeuvre & RRSP strategies and you will be way ahead, Q.
Ed
Apr 14th, 2007 @ 3:42 pm
17. Sam
hi ed,
thanks for your replies….i value your expertise.
how would there be a negative flow on real estate. (rental income- prop tax – condo fees).
i have left the motgage payments/interest out…in comparison with stock returns. for even if we buy stocks on leverage we have to pay the interest isn’t…
1) for stocks while we use growth & dividends(not interst on our borrowed money to invest)
for real estate shouldnt we use growth & income(rent – prop tax – condo fees)
this way we take out the interest component on both investments..that would have a level playing field for comparisons….
hi ed one personal question..
i plan to buy a condo..my assumptions are as under..
price- $200,000
interst payment for a year .assuming 6%- $12,000
rental saving – $7,200(that’s the rent i save by buying a condo – prop tax – condo fees)
rental saving work out to 3.6% on my investment & it’s a 100 % guaranteed investment.since the fictionary tenant would only be me…
in a nut shell i pay interest 6%..my savings are 3.6%..so i lose 2.4% for a year… which would be more than offset by the capital growth of the condo…if even i asssumed a moderate capital growth of 5% that would leave with a gain of 2.6%..would’nt it..
Apr 14th, 2007 @ 4:16 pm
18. Q Cash
Hi Ed,
Valid points, but since I don’t have any mortgages currently, the Smith Manouvre doesn’t apply to me. I am simply borrowing to invest. What I am doing is using realestate as collateral on the investment loan.
Thanks for the other points, it gives me lots to think about.
Regards,
Q
Apr 14th, 2007 @ 6:59 pm
19. Ed Rempel
Hi Q,
I am always leery of any strategy that uses either an RRSP mortgage or a ROC mutual fund. These strategies can also be presented to sound good, however, they are almost always inferior to other strategies.
For example, in your scenario you detailed, instead of doing the RRSP mortgage and then using the mortgage proceeds to buy a ROC fund, you will get a better gain by just buying the fund in your RRSP and forgettig about the RRSP mortgage strategy. I did a quick spreadsheet projection to verify this. And this is before all the fees involved.
Is this your idea or did someone try to sell you on it, Q? I can’t actually see any benefits of it, and you are doing it instead of all kinds of strategies that would have benefits.
Are you planning to pay all the distributions on the mortgage, or are you planning to spend the difference? Are you looking to just forget all the long term growth and just try to get more spending money now?
Also, you seem to be hesitant to invest in equities or leverage your home or rental property to invest in equities. Since you don’t have a mortgage, you can still do leverage (essentially jump to the finish line of the SM).
Your “income fund” is mainly in equities – why not buy a real equity fund and try to be tax-efficient with your investment? Income funds are really just balanced funds. They are often sold as though they are some sort of income product, but most are about 1/3 dividend paying equities, 1/3 income trusts (which are only equities with a different legal structure) and 1/3 bonds.
They tend to be very tax-inefficient, so you will lose most of the interest deduction benefit because of tax on the investment.
However, if you bought an equity fund that is tax-efficient, you could still just sell a bit each month (systematic withdrawal plan, or SWP) to get whatever cash flow you want.
A SWP on a tax-efficient equity fund will easily beat buying an income fund paying a ROC dividend – and it avoids the tax problems.
Ed
Apr 15th, 2007 @ 10:57 pm
20. Ed Rempel
Hi Sam,
My comparison was with fully-leveraged real estate compared to un-leveraged equities. If you compare them with both full-leveraged, then of course the equity benefit is much higher.
The historical return of equities is over 12%, while real estate is only 6% (although both will likely be lower going forward in this lower infation environment.)
If we use the historical returns, $200,000 in equities would grow $25,000 in the first year while real estate would grow $12,000. If you collect $1,200/month rent (about $15,000) and pay 2/3 of this for property taxes, condo fees, repairs & maintenance and whatever, you gain about $5,000, but are still about $8,000/year behind.
Compound this for many years with the “magic of compounding” and you have a monstrous benefit to equities.
This is still extremely favourable to the rental property, since it excludes all the other costs – legal fees to buy, CMHC fees, commissions and legal fees to sell – and of course all the PITA of collecting rent, finding tentants, having vacant months, having to fix it up between tenants, etc., etc.
Even in your situation, you say the interest will cost you $12,000 and you save $7,200 in rent less condo fees & property taxes, that means it is costing you $4,800 more to own than to keep renting.
Keep renting and put this $4,800 into an equity fund and you are ahead of buying. This is 2.4%, which is about the same as your benefit of buying.
I notice you omitted utilities, CMHC fees (if there is no down payment), costs of buying and selling, and the PITA factor. And you won’t be tempted to waste all kinds of money on renovations.
What’s more, we should go back to comparing both leveraged. This $4,800 could make the payments for you on an investment loan of $120,000. Assuming you are in a moderate 33% tax bracket, you should pay $7,200 in interest and get a refund of $2,400.
Now if this $120,000 equity fund grows by 10%, that’s a gain of $12,000 – quite a bit better than owning.
Bottom line – rental real estate is a PITA and has a low return. Owning your own home, however, gives you the pride of ownership, which might make up for the additional cost over renting.
Now if you do the Smith Manoeuvre on your home or rental, this might make up the difference (depending on how you do it).
Ed
Apr 15th, 2007 @ 11:33 pm
21. Sam
hi ed,
thanks again for your reply..
“Keep renting and put this $4,800 into an equity fund and you are ahead of buying. This is 2.4%, which is about the same as your benefit of buying.”
let me recap…
choice1- i buy a condo for $200,000 fully leveraged at 6% int..
interest cost – $12,000
rental saving- $ 7,2000
so my negative outflow is $4,8000
if instead i rent i save the $4,8000 agreed..
but in choice 1 would not i benefit by appreciation of around $10,000..around 5%
…how would the $4,800 saved be better than $10,000 appreciation…thanks in advance..
and hi ed from your website i know you are knowledgebale about insyrance too…if you have a spare moment can you educate us about universal life..it might be useful for most of us here..i read a little about them..but the Management fees scared me of…
Apr 16th, 2007 @ 2:41 pm
22. David
cihanlee said: “Well after thinking it over, I came across this idea, since the SM allows you to take your HELOC out and invest it, is it not smarter to pay down your mortgage say in 15yrs, and than take the full HELOC value from your house and invest this equity?”
I postulated this in the original Anti-Smith Maneuvre and on Canadian Capitalist’s site. Ed indicated how the SM could improve my suggestion. I also believe that your proposal matches that of Garth Turner, as discussed inteh Smith Manoeuvre book.
Have a look at the earlier posts.
Apr 16th, 2007 @ 9:06 pm
23. David
Sam,
In msg. 21 you have not added the additional costs of acquiring your $200,000 condo, which would be more than an equities purchase, so, at least in the first year your negative outflow would be far greater than the $4800 you describe. You would also have all the expenses of moving into a new place as you add those “finishing touches”.
If as Ed said, you purchased a loan with your $4800, you could have a portfolio of $120,000, which might appreciate at a compounded 10%. In the first year you would see a $12,000 return. Here’s where it really makes the difference — if you are in a changing job situation, where you might move to another location in a few years — people today are VERY mobile, the rental makes a lot of sense, as the ease of departure remains. Your portfolio moves easily with you where ever you go.
If, like many of us, you are more comfortable with leveraging to purchase your home than other instruments, then you’ll likely follow that route. If on the other hand, you’re willing to take the jump into leveraged equities, then a whole new set of options appear.
My rental experience was the best financial decision I ever made. When I was reduced to one salary, the house became a financial millstone, in a flat market. The apartment was half my mortgage payment, and included heat, hot water, laundry and taxes. I had to pay hydro, phone & internet. It was within walking distance of my workplace, and near all other daily necessities such as groceries, post office & liquor store! In addition to clearing all my debts, the 18 months I stayed there enabled me to add some $25,000 to my RSP. Were a similar opportunity to present itself, I’d jump at the rental in a heartbeat.
David
Apr 16th, 2007 @ 10:49 pm
24. Sam
hi david,
thanks for your reply…agreed the $4,800 could service a portfolio of $120,000
1)do you not think the stock market is overheated right now..agreed the home market is heated too…but the home market does not scare one as easily as a stock market..
2)with respect to purchase of a condo it’s relatively easy to even get 100% finance..
would you or anyone here know of means to relatively get large leverage on equities(all i could get right now is 50% margin)..would there be any financial planners helping clients get large leverage on equities…
i understand that unlike in SM manoeuvre i don’t have a house/property to back my loans..
Apr 17th, 2007 @ 1:41 pm
25. David
Sam,
Have a look at some fundamental equities on the net, and see how most of the blue chips have performed. While some of the market (housing too) may be heated, quality stocks are there to be found. Have a look at Canadian Capitalist’s blog for my comment on this:
http://www.canadiancapitalist.com/2007/03/12/smoke-and-mirrors-myths-part-3#comment-23933
Play around with the Rent vs Own calculators — there are numerous ones on the ‘net, and see what might work for you. Just remember, for most folks, a house is just somewhere to live, not an investment, unless you can move to a cheaper place in the future.
A house can be a money pit, so be aware of the potential for regular, extra costs of ownership that will eat into your $4800!
David
Apr 17th, 2007 @ 5:58 pm
26. falconaire@sympatico.ca: Sandor
Dear Frugal,
It seems silly, but although I do contribute the odd letter to the SM debate, I just discovered this page.
So, like a newborn baby, for whom all jokes sound funny, I would like to address your original article about your own prospects.
The only caveat I am making is that instead of disputing your cenario, I just ask about an alternative.
Namely, the first alternative is paying the HELOC interest instead of capitalizing it. It does sound distastful, but unless you pay it, you cannot deduct it from your taxes. Only the actually paid interest is deductible.
The other alternative would be the RRSP contributions. I think your house would be paid off even sooner if you redirected your RRSP contributions to the SM. Also, your portfolio would benefit from it too. Since you would give up the tax benefir of the RRSP what would be the benefit, you may ask. Well, it is up to you to calculate the alternatives, but you would get an other tax benefit instead and the money invested in the portfolio wouldn’t be burdened by the limitations of RRSP.
Sandor
Jun 8th, 2007 @ 7:28 pm
27. FrugalTrader
Falconaire, I believe the way to make the “capitalized interest” tax deductible is by paying the interested owed through your chequing/savings account, then withdrawing the same amount back into your chequing/savings account.
Jun 8th, 2007 @ 8:17 pm
28. Ed Rempel
Hi Sandor,
FT is correct. Capitalizing interest still means you are paying it. And it is not true that you have to pay it – accrued interest can also be deductible.
Capitalizing interest is part of the Smith Manoeuvre, which fully fits the tax rules if implemented properly.
I might add that the Smith/Snyder may not meet tax rules. Most of the presentations I’ve seen promoting the Smith/Snyder will likely result in you losing your next tax audit. This is because a distribution is paid out from the fund and not applied fully to the investment loan.
You don’t have to worry about tax with any steps that are part of the original Smith Manoeuvre, though, if they are properly implemented.
Ed
Jun 9th, 2007 @ 1:01 am
29. falconaire@sympatico.ca: Sandor
My sympathy gentleman,
Hi Ed!
I am afraid you and FT are both mistaken.
If I may recommend CRA’s lovely bulletin IT533 for a closer look, there you will find the following:
“Contingent interest
¶ 6. Where an amount computed as interest expense is not payable in respect of a year because of an unsatisfied contingency, the provisions of paragraph 20(1)(c) are not met as the interest is not paid or payable since there is no legal obligation to pay (as was the case in Barbican), and accordingly, the interest is not deductible in that year.”
Bad news. Pay the interest and be done with it.
Sandor
Jun 9th, 2007 @ 9:49 am
30. falconaire@sympatico.ca: Sandor
OOps!
I reconsidered it.
You should pay the interest if it gets you more tax refund then it would make in the investment. If however, you could earn more by investing it, then it is worth forgoing the tax refund. Each individual case has to have its own calculations.
Sandor
Jun 9th, 2007 @ 9:59 am
31. falconaire@sympatico.ca: Sandor
OK, one more.
In the early years of the SM you may forgo the tax refund, since it is small, but in later years you better take advantage of it by paying the interest, since that doesn’t grow unlike the tax refunds.
Sandor
Jun 9th, 2007 @ 10:02 am
32. Ed Rempel
Sandor,
You are referring to contingent interest, not accrued interest. IT-533 about deducting carrying charges consistently refers to interest that is “paid or payable”.
Often interest is paid the month after it is billed by your bank. It is acceptable to use the accrual method (based on date billed) or the cash method, as long as you use it consistently.
Capitalizing interest IS paying it. Capitalizing only refers to where it is paid from. So capitalizing interest is definitely deductible.
With the Smith Manoeuvre (not the Smith/Snyder), all the interest is fully deductible, even though you capitalize it all.
Ed
Jun 9th, 2007 @ 12:21 pm
33. falconaire@sympatico.ca: Sandor
Ed,
They are so strict about interest deductibility that in the case of interests on policy loans, borrowed from life insurance policies, they only allow the deduction if the insurer issues a certificate about the payment of interest. What’s more, there is a specific form that the insurer must certify.
I don’t think the unpaid interest to be dedutible.
In fact, the paragraph below the one I sent before also tightens the screw even further, saying, that if the interest is paid in the following year it is still not deductible retroctively.
Sandor
Jun 9th, 2007 @ 12:48 pm
34. Ed Rempel
Sandor,
Oh, that’s your issue. All kinds of games can be played with insurance policies, so I can see why policy loans would have to meet higher standards. There are investments inside the policy you borrow from, so there is a different standard to make sure it is actually interest borrowed for investments.
This is not an issue if you borrow from a bank and buy normal mutual funds.
There is no doubt that accrued interest and capitalized interest are deductible. Just read IT-533 about interest “paid and payable” being deductible, allowing the “accrual method of accounting” and “compound interest” being allowed.
The quote you used is about “contingent interest”, in which the interest is not actually payable for some reason. That is not relevant to the Smith Manoeuvre (unless you borrow against insurance policies).
Forget about investing and borrowing with insurance policies and you won’t have all of these problems, Sandor.
Ed
Jun 9th, 2007 @ 1:05 pm
37. cannon_fodder
FT,
Does your Readiline mortgage balance grow daily (i.e. when you log in, do you see the accrued interest added to the balance)? What I have seen for the first month and a half was that interest was only evident when the mortgage payment was applied and the principal went down by less than the mortgage payment.
Now, for the month of September, every time the mortgage payment was applied, the mortgage balance went down by the entire amount! No interest!
I don’t know what is going on. It isn’t being added to the HELOC as far as I can tell.
Oct 1st, 2008 @ 12:34 am
38. FrugalTrader
Cannon, AFAIK, the mortgage balance does not grow daily. They simply send me a statement once a month telling me what I owe and it is withdrawn automatically from my bmo chequing account. From there, I pay back my chequing account with the heloc.
Oct 1st, 2008 @ 9:27 am
39. cannon_fodder
FT,
Where does the mortgage interest go? Is your mortgage going down by exactly your payments or is the interest showing up once the payment is made? The easiest way to tell is to log on the day before the payment and note the balance and then log in after the payment has been made.
From my way of thinking, the interest MUST be added on to the mortgage portion of the Readiline or else you end up having the interest being piled onto the LOC which is at a higher rate.
Oct 1st, 2008 @ 6:44 pm
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