-Person buys a bachelor (Property A) and lives in for a few years being financed on a HELOC.
-Person decides to buy a new 1+ den (Property B), but uses the freed up room on the HELOC as down payment.
-Would all of the interest be deductible? If not, how would it be possible to make it so?

The down payment interest is tax deductible. My warning…. tax problems re created by people not understanding how to set things up to avoid tax problems later. CRA is very good at disallowing expenses for reasons that taxpayers don’t understand. So if you are going to do planning on growing your wealth, understand that CRA sees your profits as their money.

Well we can’t all be masters of all trades, to paraphrase the old saw. I have also been corresponding with Fraser Smith, who is a planner, not a mortgage broker, so I think between the three of us we have it covered (if we can agree!). I first met Fraser just before I wrote my article three years ago, and he was very pleased with my good friend Jon Chevreau’s FP article last Saturday sub-titled “Smith Manoeuvre holds up in CRA Challenge”. I hadn’t seen that piece until Fraser pointed it out out me earlier today, and it does indeed seem to contradict your GAAR opinion. Going back to your original response, it seems that as you point out it is all in the promotion and intent.

I have been a student of mortgages for 2 decades, and I am all over any system that helps people get out from under the burden of any loan that is serviced with after tax income. Fraser calls that “bad debt” and that’s the way I think of it too. You call it good debt, but I assume you mean in comparison to consumer debt. I think of them as the same, again because you have to pay tax before you make the payments. My strategies are ALWAYS to get rid of both!

There is a very interesting system out of the US called “Money Merge” that is excellent for the US market, and works well there, but doesn’t carry the same impact in Canada, to my mind. It coaches people who have some discretionary income to maximize their prepayments. It is also US$3,500, unfortunately. My (Canadian) approach is to help people achieve the same end by creatively using the very same readvanceable type of mortgage that Fraser had such a major hand in creating.

Finally I would indeed like to talk to you about your accounting system. It sounds as though it could work very well with what we are planning to do. Let’s grab a coffee and talk about it. Drop me a line and let’s do it in the next few weeks.

Cheers

Tony

I like your response.
It is good that you are the mortgage guy and set me straight. Thanks for that.
I was operation on the belief of the 10% mandatory privilege of paying off a mortgage, even without that written in the contract. This was based on a company I am aware of promoting this in the market. Normally I tend to check my facts. This time I did not because one would assume that the company would have to be pretty sure of themselves to promote it as part of their business. I did some searches now … And I don’t see anything to that effect. Interesting.

I find it interesting that you are really into mortgage strategies… Can you tell me more about why people deal with you… What sets you apart from other brokers… I am always looking for people who know their stuff and go the extra mile.

Feel free to bounce ideas off me on tax or tax reduction strategies.

Also if you are interested… I have a joint venture going where we are going on line with a bookkeeping system that I developed. It is the only audit ready accounting software that I know of… It teaches the user about finance… Let me know if you are interested as it could be very useful for you in working with your clients.

Best Regards

Dan

Well, taxes are your game, and your expert insights are appreciated, but mortgages have been my game for quite a while, and you apparently haven’t had one for a number of years! I say that kindly, and in jest, because total annual prepayment privileges with the vast majority of lenders are now either 15% or 20% (20 especially, but not exclusively in variable rate mortgages which except for when 5 year mortgages were 4.25% I have consistently advocated). Also, most lenders now have sophisticated mortgage systems, and to compete with mortgage brokers even banks have had to set up prepayments to be made on any payment date, as long as they are $100 or more. If you have a weekly payment mortgage you can make 52 extra payments if you want!

This factor is what has led to the programs that incorporate extra payments monthly, typically but not always from T-SWP distributions. It also facilitates more rapid amortization for the frugal who somehow manage to find extra money to pay the mortgage down quite frequently, but not necessarily on the anniversary date.

Anyway, your tax/CRA insights are very helpful, and especially encouraging for me, as I am advising a company on structuring a rapid mortgage paydown program that is also a business, and that has incidental tax benefits that are by no means the main purpose. I will certainly heed your pragmatic suggestions in this regard.

Thanks again!

Cheers

Tony

I think you have it pretty clear now.

If I were going to do this program which has some smarts built in, (I don’t agree that it is genius in anything but marketing.) I would simply freeze/identify my existing mortgage amount, and then I could taking my allowable 10% annual mortgage prepayment allowed by law. The financial penalty for exercising the legal right to prepay is pretty small.

I would make my mortgage payments regularly as usual… Showing I am not playing games with my non tax deductable mortgage payments. At the end of each year, I would make my 10% prepayment. Simple, clear and legal. No games at this juncture.

I would arrange a HELOC, and invest my money in my chosen area. I would claim the income from the program/business and would take that money to make annual payments on my first mortgage. I would claim the HELOC interest as tax deductable.

I would consider not using the income from my investments to pay down my HELOC. Rather I would put the returns back into my HELOC funded business, continue writing off the interest, and use the income to generate more returns on my income.

I see debt as both good and bad depending on the type of debt.

It is bad if you are paying for something decreasing in value.

I see debt is good if it is being used to accumulate wealth. That is why I would not pay down the HELOC… It is a good debt with tax deductible interest.

I would do my investment as an active business and not a passive investment activity. (I did mean income in my previous response.)

My right to pay off my mortgage with after tax dollars is undisputable. However a mortgage is a good debt and can only be paid with after tax income. To try otherwise will trap the person in GAAR.

So long as I am not doing the conversion process, I am fine.

I would be happy to defend any client who was doing it my way, in court as I know I would win.

In response to your last question the answer is “yes.”

How I would word it would be along the lines of…..

Convert your home equity to a money making machine. We can show you exactly how to do this and how you can grow your wealth. If you do this right, the side benefit to earning greater wealth is savings on income taxes. Interest paid on genuine business activities and specified investments is tax deductable. As a matter of fact, if you do this right, none of your income from this process will be taxable and you could earn enough income to more than pay off your home debt, should you decide that is what you want to do.

Best Regards

Dan

Thanks for your in-depth response. I see your point. It’s fine - important in fact - to pay off your mortgage, and it’s fine to use a line of credit secured by your home to invest and generate investment income (you said interest, but I think you meant income?), but what’s not fine is to participate in or construct a program whose stated or obvious purpose is to avoid taxes, rather than to undertake either of the above. Would that be a fair assessment of your point of view as regards GAAR?

One observation I’d like to make is that the “genius” of the Smith Manoeuvre, as I see it, was the invention of the re-advanceable line of credit that increases as the amortizing mortgage decreases. Anything one does to reduce the principle, which happens to generate non-deductible interest, would appear to be a good thing; and depending upon your point of view on leverage, anything one does to invest for the future on a regular, averaging basis would also appear to be a good thing, especially if the interest you’re charged on it is deductible.

My final question to you then is “if the promoter were not to advertize tax savings as main purpose of a program, or construct a program that is clearly set up for the purpose of converting a mortgage to tax deductibility, but to indicate that the paydown of a mortgage and the accumulation of an investment are the main reasons for the program, the tax savings being incidental, would that fact help the consumer when CRA comes calling, as long as the mortgagor keeps clear records of his investments, as you indicate in your response?”

Interesting debate!

Cheers

Tony

I do a lot of tax work helping clients who are attacked by CRA and I do a lot of tax strategies. Therefore I am used to dealing with how CRA thinks about GAAR and other approaches they have to decrease tax deductions by citizens.

Basically I see this as fundamentally simple. 90% of an auditors time is in dealing with how expenses relate to business. Auditors and Appeals Officers have the right to assume facts in absence of statements of fact on business expenses. Investing is a business activity to earn interest.

Where the SM and the SS fall in with the Lipson case is that they all look at “conversion” as a predominant purpose of the procedure.

While as you state the SM takes the long term process, it still leaves a paper trail that leaves it smelling like an avoidance procedure. That certainly is how I see it. A key issue is always that if in your heart you know you are trying to beat the system by a coy procedure, you know you are really doing illegal tax avoidance. I see it a bit different than tax evasion.

The common thread in these strategies is to have mortgage interest become tax deductible by making them appear legitimate through various proceedures. No matter how you slice it, if you are playing that Game, GAAR will get you.

There is a ton of 680 News and other ads on “conversion of mortgage interest to tax deductible interest.” This is where things fall apart.

What the simple insight is…. just intend to borrow money to invest…and have the paper trail to prove it and you are fine. Just keep paying off your mortgage as a separate activity.

CRA loves these plans as they get triple the money when they collect.

I looked very closely at the SM because I really wanted to be sound. I love doing this stuff. But I was very sure that this would get caught in GAAR.

I hope this helps to see my perspective, if I can help further, please let me know.

Best Regards

Dan

I have written a couple of articles on the Smith Manoeuvre, one of which was in my guest column spot for the Financial Post. Your headline “the Smith Manoeuvre bites the dust” seems to be referencing the Lipson and Singleton cases in particular, which are transaction based, rather than the long term process that Smith’s book proposes. Wouldn’t the long term process support deductibility, as opposed to the “abusive” transactions that are represented by Lipson and Singleton. My article a few years ago held that SM helps people become investors while they still have a mortgage, and can benefit from the spread between deductible mortgage rates and deferred capital gains on investments. I still feel that is true, but your comments seem to cast all such “swaps” in the same light.

I am also aware of aggressive programs (presumably only used with high net worth clients) that use leverage and distributions from T-SWP accounts to accelerate the effect. Suitability would be the watchword here, of course, but as a process it would not seem to be abusive, as Lipson and Singleton clearly seem to be. What are your thoughts on this observation?

Thanks

Tony