Smith Manoeuvre-Converting Bad Debt to Good

In Canada you are allowed to deduct the interest on a loan used for investment. The Smith Manoeuvre, coined by Fraser Smith, is a proven way of converting your non-deductible mortgage interest on your primary residence to a fully deducible loan. Here is how it works. Say you have a $250,000 mortgage on your home and $250,000 of non-registered (not in an RRSP or TSFA for example) investments such as mutual funds. This has no immediate tax advantages as you cannot deduct the mortgage interest payments.

Following the Smith Manoeuvre would have you sell your mutual funds and pay off your mortgage with those funds. Then re-borrow the $250,000 using the house as collateral to purchase $250,000 in mutual funds. The end result is the same in that you have $250,000 of debt against your home and a $250,000 investment except, with the latter, you have now created a tax deduction on the interest of the loan to be used for years to come.  A word of caution though, you should consult a tax professional that is knowledgeable in the exact process of doing this as the timing  and paper trail is critical.

The Smith Manoeuvre can be used in small increments too, especially if you have a mortgage that allows you to make prepayments and re-borrow the equity that you have paid down. (The Scotiabank Step-Mortgage, RBC Homeline, or Manulife One are great products for this). Say you get an annual bonus and wish to invest it. Why not pay down your mortgage by the amount of your bonus and re-borrow that same amount to purchase your investment. Your non-deductible mortgage will have decreased by the amount of your bonus and conversely your deductible loan will have increased by that same amount essentially keeping your debt the same put increasing your tax deduction.

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