As the installment portion of my mortgage is soon coming to an end, lately I’ve been thinking about my leveraged portfolio and how I’m going to utilize it going forward. I’ve written about the various options available to leveraged investors once their mortgage is paid off, but I didn’t get into the investment plan going forward.
For me, I will most likely keep the existing HELOC balance (and portfolio) but use the freed up cash flow to invest with instead of increasing the investment loan. Perhaps it’s my conservative side coming out, but why leverage if cash is available to invest with? I may, on occasion, dip into the HELOC balance to invest in opportunities that require large amounts of cash, such as an investment real estate transaction.
As that is my tentative plan, the question now is, how should I structure my accounts?
Ideally, to keep it simple (I already have too many investment accounts), I would like to add to my existing leveraged portfolio, but with new cash. However, mingling regular cash with a leveraged investment loan may get messy with regards to the tax deductibility of the investment loan. So I sought out a tax expert, Tax Guy with my concerns. Here is what he came back with:
Co-mingling cash contributions to your leveraged investment account “may” affect the deductibility of interest. Provided you can track each cash contribution, the worst case scenario would be a proportional split of the interest.
Assume you have fully paid off the instalment portion and end up with a HELOC of $200,000 and a portfolio valued at $300,000. At the beginning of the year, you place an additional $10,000 of cash in the brokerage account. The account earns 7% for the year and has a FMV of $331,700 at the end of the year.
The interest you can deduct should be in proportion to the amount of the account you have funded with the loan or 90.4%.
Again his would be a worst case scenario (provided you can always track each dollar). Best case scenario would that the CRA would allow you to deduct the full interest from the HELOC although this would get messed up if you decide to take funds out of the account. Withdrawals would most definitely affect interest deductibility.
I would recommend you use a separate brokerage account for cash investments and keep it separate from your leveraged investments.
The idea of tracking every non-borrowed dollar deposited into the leveraged portfolio does not appeal to me, so I will have to resort to using an existing non leveraged, non-registered account or opening a brand new stock brokerage account. If you’re a tax expert, I’d like to hear your take on this as well. For those of you who are using the Smith Manoeuvre strategy, what are your plans once the installment portion of your mortgage is paid off?
Update: After many questions in the comments, Tax Guy revised his explanation:
Assume you have fully paid off the instalment portion and end up with a HELOC of $200,000 and a portfolio valued at $300,000. At the beginning of the year, you place an additional $10,000 of cash in the brokerage account. The account earns 7% for the year and has a FMV of $331,700 at the end of the year. At the end of the year, you take out the $10,000 and use it for a personal expense.
Prior to the withdrawal, the HELOC funded 97% of the account. This proportion would be preserved following the withdrawal but the same proportion may affect the amount of interest deducted. Thus only 97% of the HELOC interest would be deductible.