As I have been considering implementing The Smith Manoeuvre, I have been doing some research on the tax benefits and how to make sure that all interest payments stay deductible. I came across some important taxation points that I thought I would share with you.

Is the investment loan tax deductible?

Before I start with the details, make sure that your investment loan is, in fact, an investment loan that is tax deductible.  If you get a loan to invest in a tax-sheltered account, like an RRSP, TFSA, and/or an RESP, then the interest is not tax deductible.

Also, tax deductibility of an investment loan depends on if you use the proceeds to generate business/investment income.  You cannot use a HELOC secured against your rental property on personal expenses and still claim the interest as a tax deduction.

Calculate your interest deductible:

  • To determine the tax return of the interest paid on your investment loan, multiply the total interest paid during the year by your marginal tax rate.
  • For example: if you paid $1,000 in interest for the year and you are in the 40% marginal tax bracket, you will receive $400 back from the government.

CCRA Rules:

  • Canada Customs and Revenue Agency (CCRA) expects that if you use borrowed money to invest that you will receive some sort of income from your investments. The “income” includes interest, dividends, rent, and royalties. Even if a stock that you purchase does NOT currently pay dividends, as long as they have a reasonable “expectation” of future dividend payments, then it “should” remain deductible.
  • Although CRA only expects income from your investment portfolio, in 2003, the finance department declared that in order for investment loans to remain deductible, the interest/dividends must produce a profit. That is, the dividends must EXCEED the interest that you are paying on the loan. I know, the finance department and the CRA are on different pages. According to Tim Cestnick, the CRA will generally ignore the finance department rules and accept the tax deduction as long as it produces income but check with your tax professional for the latest rules.

Keep your interest deductible!

  • Once you use a loan/line of credit to invest, do NOT withdraw from it unless it is from dividends/interest that the investment produces.
  • For example, if you use a $10,000 line of credit to invest, achieve a $5,000 capital gain, and withdraw $5,000 to spend on a vacation. How much of your loan balance is still deductible? $10,000? Nope! According to Tim Cestnick, since you withdrew 1/3 from your investment loan, only 2/3 of your remaining loan is tax deductible.
  • This includes Return Of Capital funds/income trusts also! Technically, as you receive ROC distributions, it will decrease the tax deductibility of the investment loan. This can be avoided by using the ROC to pay down the investment loan, then re-investing if desired. Technically, this “should” be the same as simply leaving the ROC distributions in the investment account (confirm with your accountant).
  • If you gain $300 (or any amount) in dividends though, you can withdraw $300 and spend it as you please. If you’re using an investment loan to perform the “Smith Manoeuvre“, I would suggest to use the dividends to pay down the non-deductible mortgage to further accelerate the conversion to deductible/good debt.

Summary:

  • Make sure your investment loan produces income of some sort.
  • If you are going to withdraw from your investment loan to spend, make sure you only withdraw an amount equal or less than the dividends/interest produced in the account.
  • ROC distributions are undesirable for leveraged investment accounts as they decrease the tax deductibility of the investment loan. There are ways around this, but it can turn out to be an accounting/paper trail nightmare.

217 Comments

  1. CD on November 26, 2012 at 6:04 pm

    Can someone tell me how the following would be viewed in terms of maintaining tax deductibility?

    – Borrow $15,000 from LOC (with intention of deducting interest)
    – Immediately invest $15,000 in eligible stocks through broker margin account
    – Make no other transactions except later on, borrow $5,000 from margin account (secured by stocks) and spend on vacation
    – Later on repay the margin account from disposable income

    Does tax deductibility still remain intact on the original borrowings on your LOC?

    Thx, c.

  2. FrugalTrader on November 26, 2012 at 6:15 pm

    @CD, i’m not sure, but I think a better plan would be to save for vacation using disposable income, then go on vacation when you have the cash.

  3. CD on February 7, 2013 at 6:56 pm

    FT: I was just using vacation as an example.

    Let’s say the margin use was used on something else a little less discretionary. In this case, I’m just trying to figure out if the original loan would still maintain it’s deductibility status…

    Anyone know?

  4. Ed Rempel on February 9, 2013 at 10:30 pm

    Hi Kinoli,

    Sorry, I didn’t see your old post #156. Yes. It is better to have the Smith Manoeuvre taxed in your name, so that you can get the higher tax savings for deducting the interest.

    If you invest for dividends, your wife would pay less tax, but you lose that benefit because then you have to claim the interest deduction on her return at the lower rate.

    If you are in a high tax bracket, then you may be better investing for deferred capital gains.

    I’m not sure what you mean by “I am incorporated and I use dividends to lower my taxable income”. The dividends would be grossed up and are deductible to your corporation, so that would make your taxable income higher for both you and your corporation.

    You may have other options, since you are incorporated. Is your wife a shareholder? Can you pay her dividends from your corporation in order to split income?

    Ed

  5. Ed Rempel on February 9, 2013 at 10:38 pm

    Hi CD,

    If I understand your example correctly, your interest on your LOC would still be tax deductible, but not the margin account.

    I assume you are using the $15,000 from the LOC to buy the stocks, not $15,000 borrowed from your margin account? If so, then your LOC was always used only for a tax deductible purpose. When you borrowed from your margin account for a vacation, that margin account was only used for the vacation, so it would not be deductible.

    If you co-mingled the borrowed money, you can still be okay. You can use the “flexible approach”, as explained in IT-533, to designate which portion of your margin account you paid off when you paid the $5,000.

    You do have to track all the transactions and pro-rate any interest charges between deductible and non-deductible if you co-mingled your money.

    Ed

  6. CD on March 6, 2013 at 7:34 pm

    Ed – thanks for the reply! Your interpretation is the one I was looking for. Cheers, CD

  7. Michael on March 18, 2013 at 11:28 pm

    Hi FT or Ed,

    Thank you for the informative posts. I have a question for you guys:

    I’m still not too clear on the ROC concept, from what i gather some ETFs does this so the amount of ROC will no longer be claimable for tax credit.

    Can you let me know if ZWB is affected by this “ROC”?

  8. Nikolai on April 4, 2013 at 1:10 pm

    Hi,

    Looks like there is no clear answer to this question (until you get to the real argument with CRA, I guess ;) ) but I would like to confirm my current understanding of the interest deductibility for the investments like REITS.

    1. Say, I buy X units of a REIT (IIP.UN or something else). I use borrowed money from HELOC to fund the purchase.

    2. Every distribution I receive I carefully send back to the credit line, down to last penny.

    3. I believe that the declaration of trust for most of the REITs never say specifically that “we will pay you ROC and only ROC, you will never get any interest or dividends as distribution”. Thus, I think this investment should be considered qualified by CRA. The goal of REIT is to earn rental income and pay it to the shareholders in the most tax-efficient form they can, but that does not mean 100% no taxable returns ever.

    4. Obviously, once the ACB is down to 0 a few years later I would start paying capital gain taxes on ROC portion of the distributions.

    5. When I sell it, I repay back at least the amount that is equal to the current ACB of my stock (assuming I have not lost money) back to HELOC.

    So, using this logic – do you think it is sufficient to be able to convince CRA that the interest is indeed deductible should they start questioning it?

  9. FrugalTrader on April 4, 2013 at 1:48 pm

    @Nikolai – I do not see any problems if you withdraw distributions to pay down your investment loan. Just sure to keep track of your adjusted cost base at year end.

  10. Ed Rempel on May 18, 2014 at 1:48 pm

    Hi Nikolai,

    FT is right. If 100% of the distributions are either paid onto the loan or reinvested and you can prove that, then the tax deductibility of the loan should not be in question.

    With REITS, you don’t know how the distribution will be taxed until several months after the year-end, so it is definitely best not to withdraw the distributions for any other purpose. The math of calculating how much of your loan is still deductible would be complicated.

    We don’t have that issue with corporate class mutual funds. The distributions vary, but are 100% capital gains, so we can do whatever we want with them.

    We almost always reinvest them anyway (since the goal of the Smith Manoeuvre is to build a large nest egg for your future without using your cash flow).

    Ed

  11. Brown on May 28, 2014 at 2:23 pm

    Great article here
    The above help surely helped me make up mind about my problem
    Thanks again

  12. Suprbeast on June 23, 2014 at 1:09 am

    Great resource, lots of great information. I have a couple more questions. I understand that I can’t just take money out of the leveraged investment account for non investment spending without seriously impacting the deductibility.

    But:

    1. Can I sell the leveraged investments and then re-invest those funds in something else that produces dividends? i.e. rebalancing a portfolio. I’m assuming yes, but wanted to confirm.

    2. Can I sell the leveraged investments and use the cash to invest into my own small business (which ‘pays dividends’).

  13. Monica on November 14, 2014 at 2:12 pm

    What is the best use of my HELOC? Should I invest it in income-producing investments and then put the proceeds in RRSP? Or should I use it to invest in mutual funds? What will the optimal answer depend on?

  14. lois on January 26, 2015 at 4:30 am

    Hi, I have a question about the eligibility of interest on borrowing usd in margin account. Does the american dollar interest qualify for tax deduction.

  15. Tito on March 17, 2015 at 11:56 am

    Hi,

    I have a question regarding investment loan on interest tax deductible. I’ve been investing in Mutual Fund with T8 series since 2010, I borrowed 150k with 50K of my capital, total invesment= 200k. I receive ROC 8% every month and i do not reinvest. Each of the year i receive the statements from the investment lending service, one statement indicates the interest paid 5250$ for each year end and the balanced of borrowed money 150k. My question is, when i file the income tax for the year 2014,and my ACB is136K, do i still file the interest payment of 5250$ on 150k as indicate in the statement of 2014? Or do i have to calculate manually?

    Thank you!

  16. Ed Rempel on March 17, 2015 at 10:19 pm

    Hi Tito,

    You are doing the Smith Snyder strategy. There are tax issues. Unfortunately, I have a few pieces of bad news for you. You need to manually calculate the amount of interest that is still deductible.

    So you understand the concept, if you borrow $100,000 to invest and then cash in the investments, the loan is no longer tax deductible. Receiving the ROC (return of capital) is the same thing. You are taking your original amount invested out of the investments.

    In short, all the ROC payments you received reduced the amount of your investment loan that is tax deductible.

    In rough numbers, you have received $16,000/year for 5 years, or $80,000. That is 40% of the $200,000 you invested, so 40% of your loan is no longer tax deductible. If you multiple the $5,250 interest you paid by 60% (the amount still deductible), you should be able to claim roughly $3,150.

    Your deduction could be higher depending on how you paid the interest on the loan or on any T3s or T5s you received for these investments. If you used part of your ROC to pay the interest (and can trace it) or if part of it was taxable (and not ROC), then your tax deduction should be more.

    It also sounds like you claimed too much for the past 4 years, You should really adjust those past years.

    The other thing you should know is that the ROC stops after 12.5 years (7 or 8 years from now). At that point, your ACB will reach zero, so all the payments you received will be capital gains. In addition, when you sell, the entire proceeds are a capital gain (since the ACB will be zero).

    There are several options to fix this, if you want. What are you doing with the ROC payments? Do you need the monthly income for something?

    You can reinvest the ROC (or reduce it to the amount of the interest) and crystallize the capital gains up until this point. You could also convert to doing the Smith Manoeuvre instead, which means you don’t have to do the manual interest calculations (and it is a more robust strategy with other options).

    Sorry to give you the bad news, Tito.

    Ed

  17. Tito on March 18, 2015 at 12:46 am

    Hi Ed Rempel,
    Thank you for the respond! Yes I do receive ROC part of it to pay the interest only and the other to pay my mortgage.

  18. Tito on March 18, 2015 at 1:52 pm

    If half of my Roc is paid to the investment loan ( interest only),is that portion still tax deductible?

  19. Matthew Mantle on March 19, 2015 at 5:48 pm

    Hi FrugalTrader and Ed,

    I’ve been getting closer to the start-date of my Smith Manoeuvre strategy getting underway (had to wait for the mortgage to hit a maturity date) and I notice that on March 6, 2015, there is now a new Folio from the CRA (S3-F6-C1 – http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s3/f6/s3-f6-c1-eng.html) which is meant to update and replace Bulletin IT533, which addressed Interest Deductibility. I’ve read it through, and you can see the effects some of this Smith Manoeuvre strategy has had on the tax code!

    I am not a tax expert, my line of work is in planning and investments, but it seems to me this is meant to give some clarity on a few major points we should care about.

    1.35 – tells us that current use of dollars is the relevant use to determine deductibility

    1.38 – tells us we have the ability to split dollars out between investments and maintain proportion for same-value and capital gain positions, but ONLY use deductibility on the original loan amount (makes sense). This would seem to me to be an opportunity for someone in the midst of converting bad debt (mortgage) to good debt (loan) to remove the capital gain from the investment account, use it (alongside dividends and interest) to reduce the principal of the mortgage in a lump-sum payment, and create new space on the loan to reinvest. That way you are increasing deductibility and reducing bad debt at the same time, instead of simply immediately reinvesting the higher amount.

    1.39 – confirms that where something is sold at a capital loss, the dollars can be reinvested, and the original loan amount is still considered fully deductible. I guess you never want to repay the loan with loss-dollars then, because they’re proportionately more valuable when left outstanding.

    1.40 – this seems to be a bit of a clarification on the RoC issue. Though they don’t state it explicitly (I’m going to suggest during this comment that they do state it explicitly in an example) that we could invest in things that pay out RoC (ex. REITs) and hold on to the payments when they’re made through the course of the year. Once the final RoC split is announced, take that amount, pay back the loan in that amount, and then reinvest to re-establish the loan on that portion. Alternatively, it sounds like taking anything paying regular RoC and putting it onto a DRIP would maintain the ‘current use’ definition throughout the life of the loan without so many mechanics to worry about.

    1.69 – FINALLY! Something specific from the CRA that I was concerned about. “where an investment carries a stated interest or dividend rate, the income earning test will be met…, …interest will neither be denied in full nor restricted to the amount of actual income from the investment where the income does not exceed the interest expense.” Right on! Clearly stated full deductibility for all investments…except…

    1.70 – If a corporation doesn’t pay a dividend, and it has explicitly said it WILL NEVER pay a dividend (ex. Berkshire Hathaway), then the purpose test for deductibility will not be met. Too bad. However, “if a corporation is silent with respect to its dividend policy…the purpose test will likely be met”. Hmm, a bit ambiguous, but we should be investing for income anyways, right?

    There’s a bunch more that addresses Cash Damming and specific personal and corporate situations and some specific exclusions too, but I feel a lot more comfortable with my plan now!

    Now…please feel free to compare my interpretations to yours and tear any holes in my assumptions to shreds? I think that’d be good for all of us…

    MM

  20. Ed Rempel on March 21, 2015 at 7:49 pm

    Hi Tito,

    Yes, if you use your return of capital (ROC) payment to pay the interest (and can track it) on your investment loan, then that portion does not reduce the tax deductibility.

    My suggestion would be to invest half in a fund that does not pay out the ROC and instead reinvests any distribution. Then only use the ROC payment to pay the interest.

    There is no benefit whatsoever in using any ROC to pay down your mortgage. In fact, you are losing money every month with this. You are converting the higher interest investment loan to non-deductible.

    For example, you pay $1,000 onto your mortgage which is at 2.5%. That means $1,000 of the investment loan at 4% is no longer tax deductible. After making this extra mortgage payment, you are worse off.

    There was a big marking campaign to sell this as a smart strategy years ago, but there is no benefit at all from using your ROC payment to pay down your mortgage.

    Ed

    • HondaGuy on October 17, 2015 at 8:20 pm

      Hi Ed,

      Thanks for all your contributions to this site. They’ve made for very interesting (and educational) reading.

      I’m slightly confused by your statement above where you indicate that interest deductibility is not affected if an ROC distribution is used to pay the interest on a loan. I’m thinking of ROC as a return of my funds, and if I spend it on interest then it is no longer directly involved in creating income, so therefore shouldn’t I lose the ability to deduct interest against the portion of my principal that the ROC corresponds to?

      Any clarification or additional reference material that you could offer could be helpful. I’ve struggled to find anything on the CRA website that discusses this particular scenario. I’ve no trouble understanding how interest deductibility is unaffected if an ROC distribution is promptly applied against a principal, but applying the ROC to interest confuses me.

      Thanks in advance. I can provide additional detail if needed.

      • Nikolai on October 18, 2015 at 1:17 pm

        @HondaGuy,

        I look at it in a simple way. If you have qualified investment of $10,000 (qualified is the keyword) then the interest on these borrowed $10,000 is tax-deductible. If that investment pays you back $100 in form of ROC and you put it immediately on your loan, it means your principal is reduced to $9,900 and the interest on this money is still deductible. I believe there is a bit relaxed definition of “immediately” because often you do not know if it is ROC or not until they announce it. Anyway, that’s the logic.

        If you choose not to repay this $100 back to your loan, then the things get complicated over time. Since not the entire balance of your loan is now qualified for investment purposes, not all the interest you pay on it is tax deductible.

        I believe if you do DRIP this won’t be a problem either – it is like you get your $100, pay it back to your loan and immediately borrow it to purchase more units of the same stock/fund.



      • HondaGuy on October 18, 2015 at 4:48 pm

        @Nikolai

        Thank you for your reply. I appreciate it. However, I think the scenario I’m wondering about is slightly different than the example you provided. Your example indicates a repayment of the loan’s principal. In the case you offered, $100 was paid down against a $10,000 loan leaving a balance of $9,900. This scenario makes perfect sense to me as the ROC is being used to repay the loan that originally funded it, so in such a case the interest deduction would fall as well as the balance of principal has been lowered. (And of course, as you said, the same amount could then be immediately re-borrowed and reinvested.)

        What I was enquiring about was the impact of using the ROC to pay the interest without affecting deductibility.

        For example, many lines of credit allow the borrower to make interest-only payments. Using your example again, we can imagine that the $10,000 loan was taken at 4%. A month rolls by and an interest payment of ~$33 comes due. The $100 ROC payout could then be taken to pay the interest due (~$33) with the balance (~$77) being applied to the principal. This would yield a remaining principal balance of $9,923, and the process repeats as more time moves on.

        But now, we see that we have taken distribution of $100 of ROC but only returned $77 of it to the source of the original funds as the other $33 was used to service the interest expense due. This is where I become confused, because it seems like even though $9,923 of balance remains I would only be able to claim interest deduction against $9,900 of it.

        I think my question has additional relevance to people who may be investing using leverage that is set up in a form that automatically groups the interest and principal sections of each payment (e.g. a mortgage). In that case, on a payment by payment basis it’s difficult (though not impossible) to determine how much of each payment is actually principal and how much is interest, therefore muddying the issue of what exactly their distribution is being used to repay.

        Hopefully my additional example has helped to clarify my specific area of concern further. Thanks again for your reply. The discussion material on this site is fantastic.



      • Nikolai on October 18, 2015 at 9:37 pm

        @HondaGuy

        Hi,

        Ok, I see what you mean. At least I think I do :) I think it is important to separate two different things: your relationships with the lender (e.g. your interest payments etc) and your relationships with CRA in case they start asking questions :)

        I would treat the ROC as if you have sold $100 of your investments at cost base – and return it back to the principal of the loan. Interest payments are what you owe to the bank. This is why I personally make interest payments regardless of what I receive as dividends and I also pay back to my HELOC the dividends. So, in your example I would still pay $33 interest due and pay back $100 of ROC received. I believe in this case CRA won’t challenge this approach. But here I rely on the common sense only. I assume that as long as I am not claiming the investment interest expenses on an amount that exceeds my cost base (ROC decreases it) I should be OK.

        Also I think that regardless of how the loan payments are structured, the financial institution should be able to tell you precisely how much interest and principal did they charge over a given period, e.g. to provide you the cost of borrowing. Personally I would probably avoid this sort of arrangement but…it is not that bad if you receive regular dividends and ROC that cover the payments.



      • HondaGuy on October 21, 2015 at 12:58 am

        @Nikolai

        I’m replying here to your October 18th – 9:37pm post as it seems we’ve hit max comment depth :).

        Thanks for your reply. I really like your way of separating the relationships with the lender and the CRA. I’ll for sure be keeping that in mind.

        I maintain that there are some complexities with the scenario we’ve been discussing that can make the process quite confusing and difficult. This certainly serves to enforce the opinion of FrugalTrader (and others) that ROC distributions really create headaches when they are in a leveraged portfolio.

        It’s true as you say that lending institutions provide a breakdown of all interest and principal that was paid, but in the case of mortgages, this information is usually only provided as part of the annual summary. ETFs that spit out ROC as part of their distributions (many do) also only tally up how much ROC was distributed after the tax year has completed. So, if an investor wants use leverage to hold ETFs (for easy diversification) and make use of the distributions during the year, they’re placed in a difficult position. Without knowing how much ROC is included in each distribution (if any) it seems the cleanest path is to commit the entire distribution back to the principal and re-borrow to reinvest. True, this is easy enough, but it does seem to mean that the interest component has to be paid with other funds, potentially coming from outside the portfolio, making the whole portfolio look a lot less self-sufficient.

        In your most recent example, if only ROC distributing ETFs were held, the entire $100 distribution could be applied to the principal as you stated, and the $33 of interest would have to be paid “out of pocket” from elsewhere, creating an ongoing need for cash to service the interest even though the portfolio could probably be self-sufficient.

        I think I may just opt to avoid the whole thing and stick with holdings that don’t include ROC for any leveraged portfolios. ETFs have many advantages, but use within a leveraged portfolio doesn’t seem to be one of them.

        Thanks again for all your input.



  21. Ty on March 23, 2015 at 9:11 pm

    Hey guys,

    If I invest in a US held foreign etf which pays ROC in addition to dividends, will I be able to withdraw the entire distribution to pay down the mortgage and maintain the deductability of the HELOC. Assuming the distribution is treated entirely as foreign income as required by CRA.

  22. Tarun on April 25, 2015 at 4:23 am

    Hey Guys,
    I am planning to do a DIY Smith manouvre (to minimise fees and other taxes) with minimal hassles. I would like to know if BRK would be an eligible investment for my strategy?
    Else what should be my strategy for a rental property?
    Also Should I proceed with capitalisation of interest OR pay it myself? (I can pay interest from my pocket- at least for initial few years)

    • FrugalTrader on April 25, 2015 at 9:22 am

      Tarun,

      My understanding is that if BRK has in their mandate that they will “never” pay a dividend, then they would not be eligible. It’s really up to you whether or not you capitalize the interest on your rental property. Have you considered just keeping it simple and using the rent to pay down the rental mortgage?

  23. Ed Rempel on April 26, 2015 at 1:09 am

    Hi Tarun,

    My understanding is that Berkshire Hathaway is allowed to pay a dividend, but Warren Buffett chooses not to. The tax rule is that generally only investments where their prospectus prevents them from paying dividends would be excluded as leverage investments. Buffett believes that companies should use their capital first to reinvest in their business, second for positive acquisitions, third for share buybacks, and then only if there is no opportunity in the main 3 uses of cash should they pay a dividend. In short, I believe it is acceptable.

    If you are trying to minimize tax, then you should obviously capitalize the interest. That may or may not make sense in your situation, but capitalizing the interest is definitely more tax-efficient. You can use your cash to invest, which is probably a better use than paying 2.2% tax deductible interest.

    Ed

    • Matthew Mantle on April 26, 2015 at 1:53 am

      Ed,

      The problem is that Mr. Buffett has very explicitly said that BRK will never pay a dividend, very publically, on a number of occasions. Since he’s Chairman, President, and CEO, you run into an issue with the new CRA Folio S3-F6-C1 which specifically prohibits deducting interest in shares where there is a Corporate policy against paying dividends, since there is no reasonable expectation of making income from the investment (section 1.70).

      Now, whether or not the CRA will challenge you on it is another issue…but do you really care to take the risk?

      MM

      • Matthew Mantle on April 26, 2015 at 2:01 am

        I suppose I should clarify that Mr. Buffett has always left himself an out…in the early days of BRK (1967)he claimed he was in the washroom when the dividend was approved, and more recently in 2012 (when he dedicated 2000+ words of the shareholder letter against the payment of dividends) he still did say they might reconsider that stance if there were nothing else possible whatsoever…which in his long career he has never been in the situation of considering.

        So yes, by definition, it’s not an explicit anti-dividend policy on record…just a potential argument waiting to happen with an ornery auditor I suppose



  24. Tito on May 7, 2015 at 7:11 pm

    Hi, if I were to borrow and invest in a corporate class mutual fund , would my interest on the loan be deductible? As corporate class will generate capital gain…

  25. Ed Rempel on May 9, 2015 at 2:10 pm

    Hi Matthew,

    Buffett does not pay a dividend because he doesn’t think it’s a good idea, not because there is anything preventing him. In fact, there was a motion to pay a dividend last year at which 97% of shareholders voted against the dividend. Everyone is confident that Warren can reinvest that money more effectively than they can.

    Warren’s position is that companies should only pay a dividend if they do not have a better way to use the money. They should first look at ways to invest effectively in their own business, then they should buy other businesses if they can effectively, then they should buy back their own shares if their are cheap. Only if there is no opportunity in those 3 areas, should they pay a dividend.

    Bottom line, there is nothing preventing Berkshire from paying a dividend if they wanted to, so interest on borrowing to invest in Berkshire should be deductible. With a price of over $220,000 US per share, many people would find it hard to buy the shares within a portfolio any other way.

    Ed

  26. Ed Rempel on May 9, 2015 at 2:17 pm

    Hi Tito,

    Yes, the interest should be deductible investing in corporate class mutual funds. If you choose them well, you may be able to invest for decades with hardly any taxable distributions at all, but there is nothing in their prospectus that prevents them from paying distributions, so you should be able to deduct your interest every year.

    This has been our strategy. Our clients usually have a net tax refund from investments virtually every year – even after decades and after they retire and are taking income from their investments.

    We try to defer all dividends and capital gains as long as possible. There are special features (such as the “capital gains refund mechanism”) that make this possible.

    Ed

    • Tito on May 11, 2015 at 3:16 pm

      Thank you ED for the information.

  27. Kevin on December 4, 2015 at 2:50 pm

    Hello, if you fully leverage an investment, upon selling it is the gain taxed as capital (50%) or income (100%)?

    Thanks

    • FrugalTrader on December 4, 2015 at 6:11 pm

      @Kevin, my understanding is that the investment would be taxed as capital gain.

  28. Ed Rempel on December 5, 2015 at 12:08 am

    Hi Kevin,

    The taxation of investment income is not dependent on the degree of leverage. It only depends on the type of income. Gains are normally taxed as capital gains. Payments from the investment could be taxed as dividends, interest or return of capital, depending on the investment.

    Ed

  29. Kevin on December 8, 2015 at 11:41 am

    Thank you Ed and Frugal Trader for all the great insights.

    I do have one more question: I am ready to start borrowing and investing in a non-registered account and I do not have a mortgage.
    1) Do I need to open a new bank account and new investment account (currently have a non-registered account with questrade)
    2) Any advice as to where to get the HELOC?

    Thank you so much!

  30. Johnny on December 30, 2015 at 5:40 pm

    Hi,
    How is the proceeds collected from writing covered call option be treated in the leverage SM investment portfolio? For example, if I received $100 from writing covered call option.

    1. Will this $100 proceeds be consider capital gains/interest?
    2. Can I withdraw this $100 amount for personal use like dividend payout from the leverage investment?
    3. Or do I need to pay down the $100 proceeds back into the borrow HELOC loan to maintain tax deductible?
    4. What are your recommendation for CRA tax audit purposes for treating proceeds from covered call option in the SM strategy?

    Johnny

  31. Mark on January 5, 2017 at 4:24 pm

    I would like to use the Smith Manoeuvre but I am still stuck on this ROC issue. Can’t I simply reinvest all of my ROC distributions and keep my investment loan fully deductible? This article seems to suggest so:

    http://www.advisor.ca/my-practice/investment-loans-and-interest-deductibility-be-mindful-of-roc-99887

    Quoting this blog post: “Technically, this “should” be the same as simply leaving the ROC distributions in the investment account (confirm with your accountant).” Do I really have to confirm with my accountant?

  32. Ed Rempel on January 13, 2017 at 12:05 am

    Hi Mark,

    Yes, if you reinvest the entire ROC distribution, your loan should remain tax deductible. It is the same as leaving all the money invested.

    The issue can come with mixed distributions and time delays. You receive the distribution, but do not know until after year-end how much is ROC and how much is capital gains or dividends.

    Therefore, the simplest solution is to reinvest the entire distribution.

    You don’t have to panic about this too much, Mark. Losing a bit of tax deductibility is not necessarily a big deal. You do need to track it and only deduct the portion of the interest that is deductible.

    For example, I have retired clients taking regular cash flow withdrawals or T8 distributions that include ROC. I set it up this way to minimize tax on withdrawals to lower tax rates than dividends. I call this “self-made dividends”.

    However, the tax deductibility of the credit line slowly declines. I track this on a spreadsheet. There are a few factors and the spreadsheet is a bit complex, but is doable.

    The tax deductibility tends to decline very slowly, with most of the credit line remaining deductible for many years. Part of the ROC is used to pay the interest on the credit line, and sometimes to pay down the credit line.

    My point is, don’t get totally stuck on the ROC. If you do get a bit of ROC, you just need to do a calculation to correctly record the amount of the interest deduction.

    Ed

    • Mark on January 13, 2017 at 12:14 am

      Thanks, Ed. That’s good to know because avoiding ROC can limit my investment options. I’ll just keep all distributions invested.

  33. Frank on September 16, 2017 at 4:46 pm

    Hi,

    If you invest the HELOC into a TFSA is it still tax deductible?

    • FT on September 16, 2017 at 9:41 pm

      Hi Frank, if you borrow to invest in a tax-sheltered account (RRSP, TFSA, RESP), the interest on the investment loan is not tax deductible.

      • Frank on September 17, 2017 at 12:28 am

        Gotcha. Thanks FT!



  34. Warren on September 16, 2017 at 9:49 pm

    If I start a HELOC on a fully paid for rental property, are all of the startup fees tax deductible as well as interest?

    • FT on September 17, 2017 at 8:23 am

      Warren, the key to understanding tax deductibility of a loan is clearly demonstrating how the proceeds are used. If the loan is used to generate taxable business/investment income, then the interest on the loan is likely tax deductible. In your case, if you go to the bank and get a HELOC secured against your rental, the interest is tax deductible IF you use the proceeds to invest (but not in a tax sheltered account). Hope this helps!

      • Mark on September 17, 2017 at 11:43 am

        What about the initial fees associated with setting up the HELOC?



  35. FT on September 17, 2017 at 8:31 pm

    If the HELOC is setup and used for business purposes only, then I would guess that the setup fees are tax deductible. A tax pro would need to confirm this.

  36. Invetoronto on October 27, 2017 at 4:02 pm

    Hi there, I have a few questions on how to make my mortgage interest tax deductible:
    1) Do I need to show that I already owned the investment (interest bearing or dividends), liquidated it to pay off mortgage, and then refinanced mortgage to purchase investments of equal value? If so, is there a minimum amount of time for, owning the original asset, liquidating before paying off mortgage and then purchasing the actual assets after refinancing the mortgage? (I know about the minimum time for the superficial loss rule) Is it ok for the money to sit in a brokerage account for say a few months and then I purchase the investments?

    2) If I own two houses (A and B) with two separate mortgages (A and B), then I sell house A and I port the mortage over to house B, will that porting count as a refinancing of house B and then I can use the amount in mortgage A to invest and deduct the interest on that mortgage amount? (Both houses were principal residences and did not produce any rental income ever. Both mortgages are fixed term conventional mortgages)

    I know that’s more than just two questions, but I’m a bit confused about it.

    Thanks.

  37. Investoronto on October 28, 2017 at 12:24 am

    Hi there, I have a few questions on how to make my mortgage interest tax deductible:
    1) Do I need to show that I already owned the investment (interest bearing or dividends), liquidated it to pay off mortgage, and then refinanced mortgage to purchase investments of equal value? If so, is there a minimum amount of time for, owning the original asset, liquidating before paying off mortgage and then purchasing the actual assets after refinancing the mortgage? (I know about the minimum time for the superficial loss rule) Is it ok for the money to sit in a brokerage account for say a few months and then I purchase the investments?

    2) If I own two houses (A and B) with two separate mortgages (A and B), then I sell house A and I port the mortage over to house B, will that porting count as a refinancing of house B and then I can use the amount in mortgage A to invest and deduct the interest on that mortgage amount? (Both houses were principal residences and did not produce any rental income ever. Both mortgages are fixed term conventional mortgages)

    I know that’s more than just two questions, but I’m a bit confused about it.

    Thanks.

    • FT on October 28, 2017 at 2:06 pm

      Hello, to answer 1) there is no need to own investments prior to starting the SM. Essentially with the SM you are borrowing to invest. So you obtain a HELOC on a property and take the proceeds to invest (and produce income). The key word is HOW you use the loan. I think this answers 2) as well. If these are houses that you live in, you cannot deduct the interest unless you use the loan proceeds to invest in an asset that produces income.

    • Ed Rempel on December 21, 2017 at 1:10 am

      Hi Investoronto,

      To add to FT’s comments, you can only have on principal residence, so one of the properties is taxable.

      CRA is concerned about the current use of the borrowed money. If you port a mortgage, that does not change what the money was originally used for.

      For example, if you port mortgage A to home B, the money from mortgage A was still used to purchase home A. Mortgage A would only have been deductible if home A was taxable – even after porting the mortgage. Now that you have sold Home A, mortgage A is not deductible.

      Ed

  38. Earlierretirement on February 17, 2019 at 12:12 pm

    I’m a bit confused. Let’s say I borrow 100k at 5% interest. I buy REITs that pay 8% yield all ROC.
    I use the 8k income to pay both the loan interest and the loan principal.
    Is it still tax deductible for the interest part as well?

    Thank you so much!

    • FT on February 18, 2019 at 4:22 pm

      If you use the distributions to pay down your loan, the interest should remain tax deductible.

      • Earlierretirement on February 26, 2019 at 11:00 am

        Amazing! Going for a high yield stable REITs, easily paying off the loan



  39. Al on July 1, 2019 at 12:44 am

    If I use my HELOC to pay off a $50,000 investment loan, is my HELOC tax deductible?

    I’ve been using the HELOC for the SM, as well as paying the interest on the above mentioned investment loan. I’ve recently renewed my mortgage, and we have enough room in the HELOC to add the investment loan. With a better interest rate on the HELOC at prime + 0%, thought it might be a good idea.

    • FT on July 1, 2019 at 12:28 pm

      Might want to check with an accountant, but my understanding is that you can use a loan to pay for the interest on an investment loan, and the new interest would also be tax deductible. I’m not sure about the rules if you pay off one loan with another. I assume that it should be onside as the new loan is used towards investments.

  40. Earlierretirement on July 9, 2019 at 10:27 pm

    Hi quick question:
    Suppose I have:
    – 60k employment income (quebec)
    – 100k loc at 4% interest rate invested in 5% eligible dividend income company

    I will be paying 4k interest. Can I deduct the interest from the employment income instead of the dividend since employment income is taxed at a much higher rate?

    Scenario one:
    Deduct interest from employment income.
    Employment income: 56k
    Eligible dividend: 5k
    After tax income (used simpletax): $ 44,362

    Scenario two:
    Deduct interest from eligible dividend.
    Employment income: 60k
    Eligible dividend: 1k
    After tax income (used simpletax): $ 43,515

    That’s $847 after tax difference!

  41. Giuseppe on March 20, 2020 at 11:24 am

    Hello… thanks for all the great info.
    I am getting ready to put 200 000 LOC into the market in a taxable account and want to deduct the interest. Do i have to put it into a full Dividend ETF or can i put it into a fund like VEQT that will only pay 1.89% as a dividend.
    Also if my LOC is at 3.45% do i have to make sure that the fund i buy pays at least 3.34% in dividends to qualify me to deduct the interest.
    any clarification would help…. thanks

    • Kyle Prevost on March 20, 2020 at 1:32 pm

      Any income-producing investment works Guiseppe. Just make sure to take very detailed notes on the path of money through your accounts, and what your purchase price on the units is.

      I’m not 100% sure that I’d be putting 200K into the market just yet, but that’s obviously your call!

      • Giuseppe on March 20, 2020 at 2:04 pm

        I agree…. just getting my ducks in a row… my confusion was that i read in some tax info that i could only deduct the amount of interest that was equal to or less then the dividend i was receiving. is this correct or is it Ok if the dividend payment like in VEQT is only 1.89% and my interest is more then that say at 3%. Could i still deduct the whole amount of interest

        thanks



Leave a Comment





This site uses Akismet to reduce spam. Learn how your comment data is processed.