Real Estate

Smith Manoeuvre

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Deal Addict
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Oct 25, 2001
3165 posts
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Toronto
beonice wrote: Question to Ed (or anyone else who's had experience with the SM):

I have a decent income today but had a couple of very lean years a few years ago that wiped out my savings and left me with a large debt load. Over the past two years, I've slowly built back my credit rating and have enough in savings and RRSPs that I have qualified for a mortgage loan. However, this is only with a 5% down payment, not the 20% you say is required for the SM.

What I'd like to know is, is there something I can do today (or as soon as I have a mortgage, which will be in two to three months depending on when the condo is registered), in terms of setting up a re-advanceable HELOC? I understand the math behind it, just don't know whether I should (or even *can*) set this up now or should wait until the percentage of equity in my condo (downtown Toronto, *very* pricey) goes up to 20% of the value.

Thanks in advance!
Unless there is an additional cost (e.g. higher interest rate, or more onerous terms) OR you are concerned that you may not have full control over your spending, I can think of no downside of going for a readvanceable mortgage now and then take advantage of it when you can. However, you may not be granted one simply because you only have 5% down.

It would be a good idea to get a much better understanding of leveraged investing before embarking on it. The market gyrations right now are a good lesson to see if you can stomach such a strategy because you will have more (perhaps much more) $ invested and thus absolute paper losses/profits will be larger.
Newbie
Nov 19, 2010
63 posts
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cannon_fodder wrote: Unless there is an additional cost (e.g. higher interest rate, or more onerous terms) OR you are concerned that you may not have full control over your spending, I can think of no downside of going for a readvanceable mortgage now and then take advantage of it when you can. However, you may not be granted one simply because you only have 5% down.

It would be a good idea to get a much better understanding of leveraged investing before embarking on it. The market gyrations right now are a good lesson to see if you can stomach such a strategy because you will have more (perhaps much more) $ invested and thus absolute paper losses/profits will be larger.

Thank you! That was pretty much my guess, too, that there isn't particularly a downside, that perhaps it's just a question of not qualifying for one of the readvanceable mortgages without 20% equity.

Oh well, it doesn't hurt to talk to the banks and see what they have to offer, I guess.
Jr. Member
Aug 3, 2011
104 posts
11 upvotes
AJAX
Over the past few years the smith manouver has brought a couple cases that are before our courts. Proceed with caution, thats all.
Deal Fanatic
May 31, 2007
5018 posts
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There is nothing illegal with the SM. The one before the courts was not SM. A couple were loaning money to each other to deduct interest costs and then using it for his business to pay dividends in the lower earner's name. Quite a scheme to defeat taxes-was ruled as abusive and evasive tax avoidance.
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Jan 11, 2007
430 posts
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Toronto
roweandmalidotcom wrote: Over the past few years the smith manouver has brought a couple cases that are before our courts. Proceed with caution, thats all.

Hi Roweandmall,

There is no question that the Smith Manoeuvre is legal. In fact, the main tax issue is simple. It is essentially just borrowing to invest, which every company and business owner in Canada does. I am a financial advisor, but also an accountant and registered e-filer, and have done a lot of tax returns for people doing the Smith Manoeuvre.

None of the court cases you are referring to affect the Smith Manoeuvre. They used a complex series of transactions that affected GAAR, but are irrelevant for the Smith Manoeuvre.

The only caution is that the Smith Manoeuvre has been marketed by some groups including a monthly tax-free payment coming from the investments, which is a tax problem. Almost any version involving monthly payments from the investments is a tax problem. The actual Smith Manoeuvre involves no monthly payments and has no tax issues.


Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
Newbie
Sep 4, 2006
48 posts
2 upvotes
Should I be writing off CCA on my rental? I'm not yet into a readvanceable mortgage so it should be okay right?

Once in the SM mortgage then I can use my LOC to pay for capital expenses...

S.
Deal Fanatic
May 31, 2007
5018 posts
2172 upvotes
Do you think the SM beats TFSA and RSP for a MTR of 24% and 31%?
Newbie
Aug 26, 2011
11 posts
1 upvote
PARADISE
sharp21 wrote: Should I be writing off CCA on my rental? I'm not yet into a readvanceable mortgage so it should be okay right?

Once in the SM mortgage then I can use my LOC to pay for capital expenses...

S.

If you claim CCA on your rental property it will only be an issue whenever you sell the house. You'll get hit with a bigger cap gain as you will have to subtract any CCA from the original cost of the house (thus rising your cap gain).
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Feb 28, 2006
1116 posts
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Does anyone know how much normally would a Consultants charge on setting up a Smith Manoeuvre account?
One time Lump sum or by percentage of investment?
Also would it make sense for a guy (like me) who just barley have 20% downpayment to apply SM?
Should I save up more (25% or even 30%) before I start to consider using SM?

Anyone?
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Feb 15, 2008
26318 posts
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Calgary
buy.A.gift wrote: Does anyone know how much normally would a Consultants charge on setting up a Smith Manoeuvre account?
One time Lump sum or by percentage of investment?
Also would it make sense for a guy (like me) who just barley have 20% downpayment to apply SM?
Should I save up more (25% or even 30%) before I start to consider using SM?

Anyone?

Yeah, its my view that with the SM, you really don't want to have so little equity in the house that you're going to be caught in a funding trap when it comes time to renew your mortgage during a housing downturn.

You could definitely start the process of getting the SM going with only 20% down, but it would be my suggestion that you do not use anywhere near the maximum amount of leverage possible.
TodayHello wrote: ...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...
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May 31, 2007
5018 posts
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Jungle wrote: Do you think the SM beats TFSA and RSP for a MTR of 24% and 31%?

Have not thought about sheltered compounding, but RSP and TFSA would not be subject to interest rate risk.
Member
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Jan 11, 2007
430 posts
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Toronto
sharp21 wrote: Should I be writing off CCA on my rental? I'm not yet into a readvanceable mortgage so it should be okay right?

Once in the SM mortgage then I can use my LOC to pay for capital expenses...

S.

Hi Sharp 21,

I don''t fully understand your question. What does the readvanceable have to do with CCA? You can claim CCA and still borrow against the property to invest at the same time.

Claiming CCA on a rental is a tax deferral that makes sense in most cases, especially if you plan to hold it for a long time. You get a tax deduction for the CCA (only to the extent that you have taxable net rent income after expenses), which you have to "recapture" when you sell the property. The recapture is fully taxable when you sell. This does not affect your capital gain.

For example, you buy a property for $100,000. Let's say you claim $50,000 CCA every year over 20 years. Then you sell the property for $150,000. You will have a $50,000 recapture plus a $50,000 capital gain. The total income added to your income is $75,000, since the capital gain is only 50% taxable.

The result is that you paid less tax for 20 years and then paid more in the last year. Because of the time value of money, you would normally be ahead. However, depending on your tax bracket today and how high your tax bracket would get when you sell and add $75,000 to your income, you may or may not be ahead.

Make sure your rental is 100% a rental and not a portion of your home. You cannot claim principal residence deduction on the property if you claimed CCA at the same time.



Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
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Jan 11, 2007
430 posts
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Toronto
Jungle wrote: Do you think the SM beats TFSA and RSP for a MTR of 24% and 31%?

Hi Jungle,

To fully answer your question, I would have to know your projected tax bracket when you retire (including possible clawbacks), how tax-efficiently you invest and how this fits with your plan.

In general, Smith Manoeuvre beats TFSA if you invest tax-efficiently, since you should be able to defer most or all of your investment income for many years, but still claim the tax deduction for the interest every year. That is why we try to invest in order to get little or no tax on the investments over the years.

TFSA might be better if you invest so there is tax on your investments every year.

RRSP often beats Smith Manoeuvre, since the entire amount is tax deductible, while with SM only the interest on the amount is tax deductible. For example, if you have $10,000 cash, you would get a $10,000 tax deduction by contributing it to an RRSP, but if you pay it down on your mortgage and borrow back to invest, you only get an additional tax deduction for the interest on $10,000. However, this is only a benefit if your tax bracket is noticeably less when you retire and access this money, since the RRSP tax deduction is only a deferral, while the SM provides a much smaller, but permanent tax deduction.

Therefore, with an MTR of only 24-31%, it is unlikely that you will retire with a lower tax bracket, so SM is probably better than RRSP.



Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
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Jan 11, 2007
430 posts
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Toronto
buy.A.gift wrote: Does anyone know how much normally would a Consultants charge on setting up a Smith Manoeuvre account?
One time Lump sum or by percentage of investment?
Also would it make sense for a guy (like me) who just barley have 20% downpayment to apply SM?
Should I save up more (25% or even 30%) before I start to consider using SM?

Anyone?

Hi Buy.a.Gift,

Oops, I think I have the CAPS wrong. :)

There are 2 main types of "consultants" to setup the Smith Manoeuvre - a financial planner or a mortgage broker.

The Smith Manoeuvre is a riskier strategy, because you are borrowing to invest. You also need to make sure you are the right temperament to be able to stick with it long term and that you don't make a mistake (such as taking monthly income from the investments) that can mess up the tax deductibility of your investment credit line. You will also need a sound investment strategy. For these reasons, it is generally best to use a financial planner and make the Smith Manoeuvre part of your long term financial plan.

When you are charged a fee, it is probably because you are working with a mortgage broker or a marketing company. A financial planner will not normally charge you to setup the Smith Manoeuvre, because he can make money from the investments you buy.


There are many ways to setup the Smith Manoeuvre. The right setup depends on your long term goals, how aggressively you want to build wealth, and your risk tolerance.

If you have no more than the 20% down, then there are 2 main strategies available to you - the "Plain Jane" Smith Manoeuvre and the Rempel Maximum. With the Plain Jane, you just reinvest from your credit line the amount of principal you pay down on the mortgage with each mortgage payment. You start with zero investments and invest every 2 weeks. With the Rempel Maximum, you get a separate investment loan and use this principal portion to make the payments on the leverage loan. You invest a lump sum from the investment loan where you don't have to use your cash flow to make the interest payments.

The Plain Jane is the less risky of the 2 and still has significant long term benefits from regular investing over many years combined with the dollar cost averaging benefit. The Rempel Maximum is more aggressive, but has significantly more long term potential because you start with a lump sum.



Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
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Jan 11, 2007
430 posts
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Toronto
Mark77 wrote: Yeah, its my view that with the SM, you really don't want to have so little equity in the house that you're going to be caught in a funding trap when it comes time to renew your mortgage during a housing downturn.

You could definitely start the process of getting the SM going with only 20% down, but it would be my suggestion that you do not use anywhere near the maximum amount of leverage possible.

Hi Mark,

It sounds like you are expecting a real estate crash? The funding trap you are referring to would likely only be a problem if your home drops in value plus you want to move or refinance. Normally, the banks will do a straight renewal in which you only negotiate the rate and term. With a straight renewal, they normally do not do an appraisal or credit check, which means they would not reduce your credit limit if your home has declined in value.

Back in the early 90s when real estate in Toronto dropped by 30%, in all the cases I was aware of, the banks did not reduce the credit limit on secured credit lines, unless you want to refinance or sell. As long as your mortgage was in good standing, you could just renew it on the due date.

For example, let's say you own a home worth $500,000. The banks will lend you up to 80%, or $400,000. You can start the Smith Manoeuvre at that point, which means your mortgage plus investment credit line generally add up to about $400,000. Then let's say real estate crashes by 20%, so your home is only worth $400,000 when your mortgage comes due. That means that the bank would only lend you $320,000 if you want to refinance in some way, but you can still do a simple renewal and just negotiate a new rate and term and renew - maintaining your credit limit of $400,000.

If you want to sell, you may not be able to fully pay off the mortgage and credit line from the house proceeds. However, you still have the investments. You have not lost your equity by doing the Smith Manoeuvre - you have invested your equity. You could sell a bit in order to make sure you can cover the shortfall on selling your house, if you really need to sell.

In short, as long as you are not refinancing or selling your home, and if you have made all the payments on your mortgage, based on our experience in the early 90s and what our mortgage contacts tell us, you should be able to do a simple renewal and keep your credit limit, even if your home has declined in value.




Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
Deal Addict
Oct 1, 2006
2525 posts
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Montreal
If house prices crashes line of credits will be adjusted (see USA) and you might be in deep trouble if you are heavily leveraged.

In the nineties the amount of money borrowed via LOCs was low, so the risk to the banks was also kind of low, so I guess they did not mind renewing the LOCs at the same conditions.

However, since around 2000 money borrowed via LOCs exploded. If the collateral falls in value (House) it will be very risky for the banks this time due to the huge amount of money borrowed forcing them to reduce the LOCs.
http://www.theeconomicanalyst.com/sites ... credit.jpg

Leveraging is only for a very small percentage of investors and you are probably not one of them. The only one getting rich using this strategy will be Ed Remple or your financial advisor.
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Feb 15, 2008
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Germack wrote: Leveraging is only for a very small percentage of investors and you are probably not one of them. The only one getting rich using this strategy will be Ed Remple or your financial advisor.

Yeah no kidding, in a housing market downturn situation, I'd make darn sure your bank doesn't know about your SM assets. Because if they do, and if you're underwater equity-wise, the bank will very likely lean on you heavily to redeem the assets to bring the loan back into equity on a renewal.

This is one of the instances where consolidating all of your banking at one bank may very well be a bad idea.

However, in the 1990s, doing the SM was a way that one was able to hedge out house price decreases, as the stock market rose as the housing market was falling in Canada.
TodayHello wrote: ...The Banks are smarter than you - they have floors full of people whose job it is to read Mark77 posts...
Newbie
Sep 4, 2006
48 posts
2 upvotes
edrempel wrote: Hi Sharp 21,

I don''t fully understand your question. What does the readvanceable have to do with CCA? You can claim CCA and still borrow against the property to invest at the same time.

Claiming CCA on a rental is a tax deferral that makes sense in most cases, especially if you plan to hold it for a long time. You get a tax deduction for the CCA (only to the extent that you have taxable net rent income after expenses), which you have to "recapture" when you sell the property. The recapture is fully taxable when you sell. This does not affect your capital gain.

For example, you buy a property for $100,000. Let's say you claim $50,000 CCA every year over 20 years. Then you sell the property for $150,000. You will have a $50,000 recapture plus a $50,000 capital gain. The total income added to your income is $75,000, since the capital gain is only 50% taxable.

The result is that you paid less tax for 20 years and then paid more in the last year. Because of the time value of money, you would normally be ahead. However, depending on your tax bracket today and how high your tax bracket would get when you sell and add $75,000 to your income, you may or may not be ahead.

Make sure your rental is 100% a rental and not a portion of your home. You cannot claim principal residence deduction on the property if you claimed CCA at the same time.



Ed
Thanks Ed.

My taxable income today is likely higher than it will be in 20years so it would probably be a better idea to write off CCA.

However, I plan on selling this property in 5-6 years, in order to keep my fleet new. As it won't be paid off I'd rather not get hit with the recapture so I'll just pay the tax.

Especially as I can pay it off with the tax deductible investment loan...

S.
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Jan 11, 2007
430 posts
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Toronto
Mark77 wrote: Yeah no kidding, in a housing market downturn situation, I'd make darn sure your bank doesn't know about your SM assets. Because if they do, and if you're underwater equity-wise, the bank will very likely lean on you heavily to redeem the assets to bring the loan back into equity on a renewal.

This is one of the instances where consolidating all of your banking at one bank may very well be a bad idea.

However, in the 1990s, doing the SM was a way that one was able to hedge out house price decreases, as the stock market rose as the housing market was falling in Canada.

Hi Mark,

We have specifically asked our bank contacts what they will do if real estate crashes 20% or 30%. They all said the bank would do the same as they did in the 1990s - as long as you are making your payments and are not refinancing, they would just leave the credit limit the same.

The same principal applies to unsecured credit lines. If you qualify for a $30,000 unsecured credit line, the bank normally does not take it away from you if your financial situation or income decline. As long as the credit line is in good standing and you are not refinancing it, banks tend to leave the limit.

If there is a real estate crash and you have leveraged up to 80% of your home's value, you might have trouble refinancing or moving your readvanceable mortgage to a new bank, but we do not anticipate any trouble renewing your mortgage or keeping your credit limit.


Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson
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Jan 11, 2007
430 posts
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Toronto
Hi Everyone,

If you are thinking at the Smith Manoeuvre, a good time to start is when the markets are very cheap, like today. We have not had P/Es under 12 combined with low interest rates since the early 1950s.

There is a lot of negative news, but there is always negative news when the markets are cheap. Plus, we think that NONE of the major items feared in the news will happen. "Fear of a False Factor is Favourable"

If you stay focused on the long term, the markets have always gone up over 15-year periods, and the worst ever 25-year period is 5%/year (more than tripling your money).




Ed
Ed Rempel
FEE-FOR SERVICE FINANCIAL PLANNER & TAX ACCOUNTANT
Email: [email protected]
Unconventional Wisdom blog: www.edrempel.com
To have unconventional success, you can’t be guided by conventional wisdom.” -David Swenson

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