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The Smith Maneuver: What Is it?, How It Works?, and How to Use It?

Last updated: May 12, 2023

If you browse finance-oriented forums, whether it be on Reddit or Redflagdeals, you may have come across the highly popular “Smith Maneuver” which some homeowners have been using to grow their wealth. The Smith Maneuver is a financial strategy used by homeowners to make part of their mortgage interest tax-deductible and significantly reduce their tax burden.

Let’s explore how the Smith Maneuver works and whether it might be the right idea for you.

Key takeaways:

  • The Smith Maneuver is a legal tax minimization strategy in Canada
  • When you take out a HELOC and invest the funds, the interest on the loan is tax deductible.
  • The more equity you have in your home, the more advantageous the Smith Maneuver will be

What is the Smith Maneuver? Is the Smith Maneuver legal in Canada?

The Smith Maneuver is a strategy used by homeowners to convert the non-tax-deductible interest on a residential mortgage into tax deductible investment loan interest. Using the Smith Maneuver can reduce your tax burden, speed up your mortgage repayment, and build your investment portfolio simultaneously. Disclaimer: This strategy isn’t without risk, and you should consult with a financial advisor before trying to implement it.

How does the Smith Maneuver work?

The Smith Maneuver makes use of the fact that in Canada, interest owed on loans used for investment purposes is tax deductible. If you took out a mortgage to purchase a rental property, the interest portion of the loan can be deducted from your rental income as part of your expenses.

When you purchase your primary residence, you can’t deduct your mortgage interest. The Smith Maneuver attempts to change this. As you build equity in your home, you can borrow against that equity in the form of a home owner’s line of credit (HELOC). The interest on a loan borrowed against the equity of your home and then put into investments is tax deductible. Thus, by paying off the principal of your primary residence and borrowing against the equity you own, your loan is tax deductible.

How much equity do I need to have in my home to use the Smith Maneuver?

Commonly, the Smith Maneuver is used by homeowners who have already built some equity in their home. However, if you’re not yet a homeowner you can still start planning your mortgage strategy.
Let’s say you have enough capital to make a larger down payment on your home than you would otherwise choose to make. Using the Smith Maneuver you could sell your investments, use the proceeds to increase your down payment, then borrow against that equity and reinvest in the same assets, thus acquiring a loan that is tax deductible. In the end, you will have the same assets and amount of debt, the only difference being that a portion of your debt will be tax deductible.

If you plan on selling investments to employ the Smith Maneuver, it’s important to consider the tax implications of doing so. If your portfolio is in your TFSA, this won’t be an issue, but if you have significant capital gains to claim after selling, then it might not be a good idea to sell your assets just to use the Smith Maneuver.

Recommended reading: How taxes work on a rental home

What is an example of the Smith Maneuver?

Here’s a simplified example to help you understand the Smith Maneuver and how it would look applied to a typical homeowner’s situation.

Let’s imagine a hypothetical homeowner, John, who has a good job making $100,000 currently, and owns $1,000,000 home in Toronto with $500,000 paid in principal on the home.

The remaining $500,000 mortgage John has on his home currently offers him no tax benefits, so let’s take a look at how John could employ the Smith Maneuver to his benefit.

First, John obtains a readvanceable mortgage, which consists of a mortgage and a home equity line of credit (HELOC). In this case, let’s say John can borrow, at most, 80% of the home’s value. This is typically the maximum debt to loan ratio a mortgage lender will allow.

Since John has already paid $500,000 in principal, he qualifies to borrow $400,000 (80% of principal) against the equity he has in his home in the form of a HELOC.

John withdraws $400,000 from the HELOC and invests it in a diversified investment portfolio. The interest generated from the HELOC is now tax-deductible, because the funds are used for investment purposes.

Each month, John makes his regular mortgage payment. A portion of the payment goes towards the principal, which in turn increases the available credit in the HELOC by the same amount.

John then withdraws the increased HELOC amount and reinvests it. The interest on this new borrowed amount is also tax-deductible.

John continues this process each month until his mortgage is fully paid off. At this point, John’s mortgage is replaced entirely by a tax-deductible investment loan (the HELOC).

The tax deductions from the investment loan interest can be used to reduce John’s overall tax liability, potentially increasing his after-tax income.

It’s important to note that the Smith Maneuver relies on the assumption that the investments will yield a higher return than the cost of borrowing (HELOC interest). The strategy also involves leveraging (borrowing to invest), which increases risk. For a full breakdown on the risks of utilizing leverage check out our guide to leveraged investing.

Recommended reading: An introductory guide to leveraged investing