I remember reading about the Smith Manouver on Ozzie Jurocks' website and I remembered reading about it in the bookstores. Specifically I recalled it under "ask an expert" on financing who was Harvey McCallum the mortgage broker. Anyways, it never meant much to me because I never really had a home before. I mean, we had a small condo, but we never bothered to implement this 100% tax-deductible & 100% LEGAL tactic because, frankly, we knew we would be moving out... just weren't sure exactly when. So we didn't bother. We just sucked it up, paid the interest to the bank and never claimed the interest as tax-deductible. We took our lumps for a couple of years. Well, that was then and this is now.
Now we have a huge mortgage and a gorgeous home. And we want it to be tax-deductible!
So here's how we've accomplished this:
- 1) We're taking out a 2nd mortgage on Property SIX. There's plenty of equity as the house is valued at $185,000 and the mortgage currently is $126,000. With the help of a private lender through our amazing mortgage broker, we can go all the way up to 85% of the value of the home. We only took $25,000.00. That should do it for now. I'll get back to this $25,000 in a sec.....
- 2) Just to recall, remember how we got Property SIX? We pulled out $60,000 in the form of an inter-alia mortgage that was done by another WestCoast private lender who took equity from both Property One and Property Two. This was our down-payment for This sixth property, Property SIX. This duplex has been zoned as a duplex and has had a long-term tenant in the upstairs unit who pays all cash each month, and now the downstairs tenants pay $1150 a month. Total $1685 monthly. There is no question whatsoever that this is an investment property, right? And the $60,000 was used as a down payment on that INVESTMENT (property) right? Thus, all the interest on this $60,000 private mortgage is 100% tax deductible as it fits the legal parameters for CRA (Revenue Canada). So that one is fine....
- 3) This is where I need to keep organized notes and this post is part of that. Ok, here we go... Harvey McCallum says, "You own a $300,000 home with an existing mortgage of $150,000. You own a rental with a mortgage that pays you $900 a month rent. Each month you receive the $900 rent - pay it on your home mortgage. The $900 will go to reduce the principal - increase your equity - and decrease your mortgage payout. But now how are you going to pay your rental mortgage? Well . . . lets take out a floating 2nd mortgage against your home so you can dip into it when you need money. Which will be every month. By the way the floating 2nd is tax deductible because the money is borrowed for the purpose of paying your rental mortgage not your home mortgage." So how does this relate to our situation? Firstly we are setting this $25,000.00 new money aside that we pulled from Property SIX. We are setting it aside so we can use it, just as Harvey says, to pay our rental mortgage on Property FIVE. Then, we are using the rental income from Property FIVE to service our home mortgage, Property EIGHT. And to correct Harvey's numbers and relate it specifically to ours, our $485,000 home is our Primary Residence (our home) with a mortgage damn near $400,000. Our rental property is $185,000 with a first mortgage $126,000 and now a second of $25,000....
- 4) Once we have enough equity built up in our HOME, then we will do a 2nd MTG (MTG is short for mortgage) there... and payout the original 2nd MTG on Property SIX. We want this 2nd MTG against our HOME (that hasn't been set-up...yet....as there needs to be enough equity) to get bigger and bigger and eventually replace our original 1st postition MTG of currently approx $400,000. Then, at the time when the 2nd MTG fully absorbes the 1st MTG and there only remains a 2nd high interest tax deductible MTG on our home, we will convert it back to a first for the lowest rate & payments possible.... And yes, this would be STILL BE tax-deductible too :)
- 5) More from Harvey, "I can hear the wheels turning . . . why would you want to use a higher interest rate, probably higher but not always, 2nd to pay your rental mortgage. One reason . . . it is better, all most always, to have a higher deductible mortgage then a lower non-deductible mortgage.
Over time you will have paid off your home 1st mortgage and be left with a floating 2nd that can now be rewritten as a lower first mortgage and still be tax deductible.
Why an investor should not do this - YOU HAVE SO MUCH MONEY YOU DON'T CARE. I would argue if you have so much money do it anyway and make a charity very very happy . . . oh and you will get a tax receipt."
Ok so that's the plan and that's how it is gonna go down. I'm posting the following below, just in case over time I lose the links as this is good proof for legal requirements:
Who wants to have a tax deductible mortgage in Canada?
The Supreme Court of Canada have paved the way, with proper planning, for mortgage interest to be tax deductible.
Most people do not write off the interest on their mortgage. Yes many homeowners write off a portion of their mortgage payment as it relates to a home office space. But that is not the same as writing off the interest on their mortgage.
Your principal homes mortgage interest is deductible, when the borrowed money is used to earn income from a business or investment that has an expectation of making a profit, even if your home is the pledged security.
How the funds are spent determines interest deductibility of your mortgage, not the collateral. If a direct link can be established between the loan and its business/investment use, it is immaterial that the security for the loan is a mortgage against your principal residence.
Example: You have money invested in the equity market, and you want to buy real estate. Assume you liquidate the equities, buy real estate all cash, then mortgage the real estate and reinvest the borrowed funds in equities. Could you then write off the mortgage interest, arguing the proceeds were used to buy stocks rather than the house?
That was the issue facing the Supreme Court of Canada, in a decision handed down September 28th 2001.
Some background:
On October 27th, 1988, John Singleton had $300,000 in his business capital account. The court noted, he wanted to use $300,000 of his equity to assist in the purchase of a house. He then borrowed that same amount, in the form of a mortgage on the real estate he just purchased, to refinance his partnership capital account. He did all that on the very same day.
When the dust settled, Singleton had a new house,a mortgage on the new house, and $300,000 back in his capital account.
Singleton deducts the mortgage interest on his 1988 and 1989 tax returns.. The government disallows the deduction. Singleton sues - he loses in the Tax Court of Canada - wins the next round in the Federal Court of Appeals.- in October 2001 the Supreme Court of Canada sides with Singleton.
This case boiled down to one issue: were the borrowed funds used to earn income from his law firm, or finance his home purchase? Put another way, should the same day transactions be viewed as a series of connected activities, or each a distinct tranaction? The Supreme Court of Canada ruled they are distinct seperate transactions.
The Honourable Mr. Justice Major said, "It is an error to treat this as one transaction - the transactions must be viewed independently." The direct use of the borrowed funds was to refinance Singleton's capital account. Treating the borrowed funds as used for financing the purchase of the home ignores what Singleton did, ie used the borrowed funds to replace the funds required for his capital account at the firm.
Structuring your affairs to shrink your tax burden is 100% legal, the Courts have ruled that Singleton could write off his mortgage interest.
The way is paved for homeowners, who apply the same principles, to make non-deductible principal mortgage interest tax deductible.
When you are ready to explore the possibility of making your own mortgage tax deductible give me a call. Who should call: everyone self-employed, everyone who owns a business, everyone with investments, and anyone who wants a tax rebate at the end of the year. Best of all it is free.
Proper professional advice before proceeding is a must.
A taxpayer borrows moneyIs the interest deductible? When is borrowed money considered personal use or to earn income? This question was asked in 1988 by John Singleton and answered in September 2001 by the Supreme Court of Canada.
The Loan
In 1988, John Singleton, a partner in a law firm, withdrew $300,000 from his partnership capital account. He used the funds to purchase a house. Singleton then mortgaged the house by borrowing $298,750 from the Bank and deposited the money into his partnership account, along with $1250 of his own money.
The Fun Begins
When time came to do his tax return, Singleton deducted $3,688 of interest on his 1988 tax return and $27,415 on his 1989 return. Singleton believed the borrowed funds, not the withdrawn funds, were used for investment purposes. A required distinction to understand this question and answer. Of course the tax guys disagreed and disallowed his deductions.
Very Appealing Case
Singleton appealed to the Tax Court of Canada, but his case was dismissed. He then appealed to the Federal Court of Appeal which allowed his appeal by a majority decision. Not wanting to be less appealing the Tax Guys look for a friendlier decision from the Supreme Court of Canada.
The Decision
By a five to two decision, the Supreme Court dismissed the Tax
Guys appeal.
The Court held the opinion that Singleton used the borrowed funds to invest in his partnership. Therefore, the direct use of the funds was for the purpose of producing income, making the interest deductible.
Tax Planning Mantra
The Court quoted the mantra of tax planning in making the decision. Taxpayers are entitled to structure their transactions
in a manner that reduces taxes; the fact that the structures may be complex arrangements does not remove the right to do so.
The Court was unequivocal in its view that the funds were borrowed to refinance Singleton's capital account. It stated:
Viewing the transactions as one simultaneous transaction, thereby treating the borrowed funds as used for financing the purchase of the home, ignores what the respondent actually did: he used the borrowed funds to replace the funds required for his capital account at the firm..
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