# Is this tax strategy legit??



## G613 (May 30, 2016)

Hello...here's a scenario for you;

Say I have $200,000 in investments. My mortgage balance is $200,000. I Pay this down to zero. Borrow against the property to reinvest my $200,000 back in the exact same investment. 

Is the interest on my $200,000 tax deductible?

Your feedback is greatly appreciated. 

Thanks.


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## mordko (Jan 23, 2016)

Nope.


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## humble_pie (Jun 7, 2009)

G613 said:


> Say I have $200,000 in investments. My mortgage balance is $200,000. I Pay this down to zero. Borrow against the property to reinvest my $200,000 back in the exact same investment.
> 
> Is the interest on my $200,000 tax deductible?




i think such interest might be tax deductible.

this looks like the Smith manoeuvre to me. Many cmf members practice the Smith. It's worked OK the last few years because borrowing interest rates have been so ultra-low that it has been relatively easy to find investments which yield better.

i have no expertise in Smith so hope others will come along to comment specifically on the OP's scenario. Basically he is exchanging one negative interest rate cost that is not tax deductible for a slightly higher negative interest rate that will, however, be tax deductible.

be aware, though, that there are restrictions on the kinds of investment income whose interest costs can be included in carrying charges. 


.


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## Nerd Investor (Nov 3, 2015)

Yes, the interest would be tax deductible. 
The only potential tax issue would be if you sold any of the investments at a loss. That loss would be suspended if you bought back the exact same investment within 30 days of selling them.


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## Numbersman61 (Jan 26, 2015)

G613 said:


> Hello...here's a scenario for you;
> 
> Say I have $200,000 in investments. My mortgage balance is $200,000. I Pay this down to zero. Borrow against the property to reinvest my $200,000 back in the exact same investment.
> 
> ...


Here is a link (specifically 1.33) CRA interpretation bulletin.
http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s3/f6/s3-f6-c1-eng.html#N1044E


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## humble_pie (Jun 7, 2009)

Nerd Investor said:


> Yes, the interest would be tax deductible.
> The only potential tax issue would be if you sold any of the investments at a loss. That loss would be suspended if you bought back the exact same investment within 30 days of selling them.



i'm no expert on which kinds of investment income qualify for making interest on the capital that was borrowed to buy such investments tax deductible.

but i'd been believing that capital gains do not qualify. I'd been believing that there has to be a reasonable expectation of investment income to be earned by such investments, in order to make interest tax deductible. IE dividends are OK but i'd always heard that capital gains are considered too wild & wooly.


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## mordko (Jan 23, 2016)

While the interest payments on the HELOC amount borrowed would be tax-deductible (subject to a lot of paperwork which has to be found acceptable by CRA), this is a typical "borrow to invest" type of scheme. One would be taking on a substantial investment risk instead of simply getting rid of the loan. Can end up in tears. And to have any benefit, your investment returns would have to beat your current HELOC rate. Far from assured.


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## Numbersman61 (Jan 26, 2015)

mordko said:


> While the interest payments on the HELOC amount borrowed would be tax-deductible (subject to a lot of paperwork which has to be found acceptable by CRA), this is a typical "borrow to invest" type of scheme. One would be taking on a substantial investment risk instead of simply getting rid of the loan. Can end up in tears. And to have any benefit, your investment returns would have to beat your current HELOC rate. Far from assured.


I completely disagree with these comments. This is just arranging a taxpayer's affairs to achieve a tax advantage. Assume the interest on the loan is is 4%, this would result in a deduction of $8,000 in first year. Important to ensure that consideration be given to comments in paragraph 1.69 of link.
Of course, you must be careful that you don't have a superficial loss or a a significant capital gain realized.


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## Eclectic12 (Oct 20, 2010)

humble_pie said:


> i'm no expert on which kinds of investment income qualify for making interest on the capital that was borrowed to buy such investments tax deductible.
> 
> but i'd been believing that capital gains do not qualify. I'd been believing that there has to be a reasonable expectation of investment income to be earned by such investments, in order to make interest tax deductible. IE dividends are OK but i'd always heard that capital gains are considered too wild & wooly.


 There an interpretation bulletin where CRA says ...



> Where an investment does not carry a stated interest or dividend rate, such as some common shares, it is necessary to consider whether the purpose test is met.
> 
> Generally, the CRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that at the time the shares are acquired there is a reasonable expectation that the common shareholder will receive dividends ...
> 
> ...


http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s3/f6/s3-f6-c1-eng.html#p1.69

The full set of info ... http://www.cra-arc.gc.ca/tx/tchncl/ncmtx/fls/s3/f6/s3-f6-c1-eng.html

That's where if one had a O&G dividend paying company that has suspended dividends ... one may have to sell in a down market to keep the interest tax deductible.


I tend to go for stocks that pay dividends outright so if CRA were to come looking at the details, only a small amount would be CG only as they currently don't pay dividends.


Cheers


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## Eclectic12 (Oct 20, 2010)

Numbersman61 said:


> I completely disagree with these comments. This is just arranging a taxpayer's affairs to achieve a tax advantage.


Smith does say to pay the mortgage as usual but instead of leaving the mortgage debt going lower, use the freed up amount for the HELOC loan. For example, pay off $500 from the non-deductible mortgage then borrow $500 for the investment portfolio. This gradually shifts the non-deductible over to deductible + growing investment portfolio.

I have seen advisors say to "sell all investments, pay mortgage, re-advance mortgage then buy investments". So far, the references I have found to people getting into trouble are where the attribution rules were not followed, as opposed to "sell everything, pay mortgage, borrow again" being a problem.

Then too, the 1.33 example seems to be saying that as long as one can trace the use of the borrowed money to the investment portfolio ... it will work.
Where I could see problems is where there was say $30K on the HELOC for home improvements so that when the HELOC is used to buy the replacement investments, the use is co-mingled. Then the allowed interest expense might not be the split one is looking for.




Numbersman61 said:


> ... Assume the interest on the loan is is 4%, this would result in a deduction of $8,000 in first year.


What are HELOCs going for these days?
Mine was arranged years ago so it is less then 3%.




Numbersman61 said:


> ... Of course, you must be careful that you don't have a superficial loss or a a significant capital gain realized.


Which may be the bigger issue with this idea ... unless there is a pool of capital losses to help out with any CG.


Cheers


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## andrewf (Mar 1, 2010)

G613 said:


> Hello...here's a scenario for you;
> 
> Say I have $200,000 in investments. My mortgage balance is $200,000. I Pay this down to zero. Borrow against the property to reinvest my $200,000 back in the exact same investment.
> 
> ...


_Say I have $200,000 in investments._ Do you sell them, and use the proceeds to pay down the mortgage, then reborrow to purchase the same assets? This sounds like the 'Singleton Shuffle', which was decided to be valid.

http://www.financialpost.com/analysis/story.html?id=70a2bd20-afff-4a59-8bae-32f007403e27

"The Lipson case was a variant of an earlier case involving lawyer John Singleton, whose "Singleton Shuffle" was upheld by the Supreme Court in 2001. Golombek describes the shuffle as a "plain-vanilla debt swap" strategy. It's the basis for the common move of selling off non-registered investments, using the proceeds to pay off a mortgage, then borrowing (with the loan secured by the home) to repurchase the securities. The effect, as with Smith, is to make the interest on the investment loan tax deductible."


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## twa2w (Mar 5, 2016)

One issue I see here, that i missed if it was addressed up thread, is the issue of the OP's original 200 k in investments. Depending on the type of investments, he may have a large capital gain. If he sells, pays off the mortgage and re invests, he may suddenly be faced with a hefty tax bill come next spring.


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## Eclectic12 (Oct 20, 2010)

A capital gain of say $100K, which would be cut to $50K is going to be a sizeable amount to be adding to one's income in a single year. Spreading it out over two years would help.

Where one has assets in a TFSA, there would be no tax hit. One could pay off part of the mortgage early, re-invest in a taxable account and then where other assets are sold ... the interest costs would be partially reducing the tax hit from the capital gains.


Just a few choices to think about ... assuming the OP decides to go this route.


Cheers


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## Nerd Investor (Nov 3, 2015)

humble_pie said:


> i'm no expert on which kinds of investment income qualify for making interest on the capital that was borrowed to buy such investments tax deductible.
> 
> but i'd been believing that capital gains do not qualify. I'd been believing that there has to be a reasonable expectation of investment income to be earned by such investments, in order to make interest tax deductible. IE dividends are OK but i'd always heard that capital gains are considered too wild & wooly.


You are correct, but as per the reference from Eclectic12 you are generally only going to get caught if there is no possibility of future investment income (ie: the company has strict policy of never paying dividends). 
Pretty rare for most public companies. If you are risk averse however, than sticking to dividend players should avoid any potential challenge.


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## humble_pie (Jun 7, 2009)

Nerd Investor said:


> You are correct, but as per the reference from Eclectic12 you are generally only going to get caught if there is no possibility of future investment income (ie: the company has strict policy of never paying dividends).
> Pretty rare for most public companies. If you are risk averse however, than sticking to dividend players should avoid any potential challenge.



i guess no hope for option sellers then .each:


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## Nerd Investor (Nov 3, 2015)

humble_pie said:


> i guess no hope for option sellers then .each:


That's OK, when it comes to writing options, I'll take the capital gains treatment please


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## mordko (Jan 23, 2016)

All these tax issues are relatively minor. The main problem is that you are effectively borrowing to invest. A couple of thousand savings on tax isn't going to be much help if one loses 100K on investment while still owing 200K on his line of credit.


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## humble_pie (Jun 7, 2009)

Nerd Investor said:


> That's OK, when it comes to writing options, I'll take the capital gains treatment please




that's what i meant though. No Smith manoeuvre is possible. No borrowing to deduct the interest to create the margin that sells the options that form the gains, all in the house that Jack built.


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## houska (Feb 6, 2010)

A whole range of responses here, some valid, some just fanning smoke.

This is indeed very similar to the "Singleton shuffle" or a one-off iteration of the Smith Manoeuvre (which is usually meant to be a longer, more extended version of converting a mortgage into a tax-deductible investment loan).

Case law and guidance from professionals who promote and execute the S.M. highlight a few key things to watch out for:

In order for the mortgage interest to be deductible, there must be a clear and direct paper trail from the money borrowed directly to (re)making the interest. The easiest way is to transfer it exactly and immediately on receipt, into an investment subaccount with no other funds in it.
The investments you make must be ones which provide a reasonable likelihood of generating income (including dividends, but not just capital gains). That does not mean capital gains are not allowed, or even that you can only invest in stocks that are currently paying dividends, but it must be investments that *could* generate income.
Don't withdraw from the account, not even earned income. You don't want to set up a situation where withdrawal would mean the 100% use of the loan to fund the investments (only) is compromised.
Of course, selling the investments (to pay off the current mortgage) may trigger capital gains taxes.
Some people have commented on the risks of borrowing to invest, which is true, but your ending situation will be no different than it is now: in either case, you own some investments and a house, and against that have some debt (the mortgage, before and after). 

I have myself done this, but as part of a broader set of transactions over a period of about 2 months (liquidating investments, then buying house, getting mortgage, repurchasing similar investments; mortgage interest now tax deductible).


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## andrewf (Mar 1, 2010)

mordko said:


> All these tax issues are relatively minor. The main problem is that you are effectively borrowing to invest. A couple of thousand savings on tax isn't going to be much help if one loses 100K on investment while still owing 200K on his line of credit.


Disagree. In reality, there is no change in risk, merely a change in tax treatment. The OP has same risk of loss of value on his $200k investment, and same invariant debt in that case.


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## G613 (May 30, 2016)

andrewf said:


> Disagree. In reality, there is no change in risk, merely a change in tax treatment. The OP has same risk of loss of value on his $200k investment, and same invariant debt in that case.


Yes! This is the situation...nothing changes! Even if CRA says, "nope, you cannot deduct it anymore"...then it's back to the original scenario that I simply have a mtg payment that is not deductible. Investments hasn't changed. 

Everybody is assuming capital gains. Say for the utmost conservative investor who is afraid of loss...would this strategy work if the investment was put into a GIC/bond type of investment? Corporate bonds probably for better returns?? 

Would the government allow tax deduction if the borrowed money was invested in a TFSA? Obviously I probably can't invest the entire amount in TFSA because of the limits..but if I put part of it?

Thanks everybody for your feedback. Great information...truly appreciate it. 

G613


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## Woz (Sep 5, 2013)

It works as long as you invest it in something that pays or has the potential to payout dividends and income. GICs/Bonds are fine. Dividend paying companies or companies that may pay dividends in the future is fine. Investing in things that have no potential to pay dividends/income such as options, futures, Horizons swap ETFs, etc, wouldn’t be deductible. Sheltering the borrowed money in registered accounts also wouldn’t be deductible.


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## Eclectic12 (Oct 20, 2010)

G613 said:


> ... Even if CRA says, "nope, you cannot deduct it anymore"...then it's back to the original scenario that I simply have a mtg payment that is not deductible. Investments hasn't changed.


For this to be true ... that would mean the investment portfolio interest charges exactly match the mortgage interest charges (and would have to be on the same amounts). If they are, then yes - it works out the same.

Typically, though - mortgage rates that people are signing up for are lower than the HELOC or loan rates they can get. 




G613 said:


> ... Everybody is assuming capital gains.


As I understand it ... you have investments today that will be sold to pay off the mortgage. Whatever is sold is going to have taxes associated with it ... possibly reducing what's available to pay down the mortgage. 

Or are you saying the $200K investments mentioned in post #1 are all in GICs and savings accounts?




G613 said:


> ... Say for the utmost conservative investor who is afraid of loss...would this strategy work if the investment was put into a GIC/bond type of investment? Corporate bonds probably for better returns??


The focus is equities as these are more likely to have payouts large enough to cover the yearly interest costs plus taxes. As a comparison for rates, a one year GIC may pay 1.39% while something like a utility or bank common stock will pay around 4% or better.

For the tax on income paid, there is the challenge of much higher tax bill for the GIC/bond versus the tax advantage treatment of eligible dividends. Using an Ontario resident with a $50K income, the tax bill for the GIC is something like 29% versus the common stock paying eligible dividends tax rate at about 6.4%. 


Corporate bonds can return more but can also lose more, where the GIC should not have any loss possibility (which is why it typically pays lower income).




G613 said:


> ... Would the government allow tax deduction if the borrowed money was invested in a TFSA?


No ... they announced this basically at the same time as the TFSA was introduced. Similarly, one can't write off interest for an RRSP contribution either.


Cheers


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## gt_23 (Jan 18, 2014)

Yes, interest is deductible if investments are non-reg.

No need for endless back and forth on this.


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## G613 (May 30, 2016)

Eclectic12 said:


> Typically, though - mortgage rates that people are signing up for are lower than the HELOC or loan rates they can get.


Actually, if you factor in the compounding interest and amortization (front end loaded interest) of a mortgage - I believe the interest would be higher compared to a HELOC with simple interest. 




Eclectic12 said:


> The focus is equities as these are more likely to have payouts large enough to cover the yearly interest costs plus taxes. As a comparison for rates, a one year GIC may pay 1.39% while something like a utility or bank common stock will pay around 4% or better.





Eclectic12 said:


> For the tax on income paid, there is the challenge of much higher tax bill for the GIC/bond versus the tax advantage treatment of eligible dividends. Using an Ontario resident with a $50K income, the tax bill for the GIC is something like 29% versus the common stock paying eligible dividends tax rate at about 6.4%.


Good point! Fix interest investments doesn't look to be a good option. But that being said, I realize that the investment must be considered on a tax level because any gains I make will be reduced by the CRA.


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## houska (Feb 6, 2010)

The example in this article today is exactly the situation discussed in this thread:
http://www.theglobeandmail.com/report-on-business/rob-commentary/we-need-courts-to-uphold-the-spirit-of-our-tax-laws/article30250994/

I somewhat empathize with the author's frustration with a generally permissive legal environment for tax avoidance and its social implications. However, her reaction to this example shows the pitfalls of being more strict. To her: "It is transparently obvious that the real purpose of these transactions is to obtain a mortgage to finance a home purchase." This is far from clear-cut, it is just as plausible that the real purpose of these transactions is to borrow to [continue to] invest, rather than have one's assets overly concentrated in just a house. The latter was my intent when I set it up for ourselves (accumulated a sizable investment portfolio while single, mobile and renting; liquidated to buy house after marriage, then borrowed back -- via a mortgage -- to invest) and it is impossible without mind-reading to differentiate which of the two (sometimes both) was the "purpose" of someone doing this.

Basically, in my opinion it is less a "tax loophole" and more an inevitable opportunity as long as we stick to our philosophy of 1. tax minimization is OK, tax evasion is not, and 2. tax-deductibility of interest expenses is determined by the [trackable] use of the monies borrowed. Tax policy could of course shut this loophole(?) down by changing to a system where a secured loan is presumed to be Used for the purposes of holding the asset it is secured against, rather than tracking the usage trail of the monies advanced. But all that would achieve would to push those of us using this approach to borrowing on margin from our investment broker rather than from the bank as a mortgage.


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## Eclectic12 (Oct 20, 2010)

G613 said:


> Actually, if you factor in the compounding interest and amortization (front end loaded interest) of a mortgage - I believe the interest would be higher compared to a HELOC with simple interest.


YMMV ... for some of the spreads between the two, this will be true and for others, not so much.




G613 said:


> ... I realize that the investment must be considered on a tax level because any gains I make will be reduced by the CRA.


The key is the first hit when the investments are liquidated to pay off the mortgage.

If it is say a GIC, then the net is likely at or above the $200K needed.

If it is equities, what the after-tax proceeds will be is unclear. Picking some numbers out of the air to illustrate what one has to plan for, say the adjusted cost base (ACB) is $150K for the equity investments. Then the proceeds is $210K and one has a capital loss (CL) of $6K.

One will have the $210K cash to pay off the mortgage but this won't be after tax dollars. When one files the 2016 tax return, on schedule 3 part 3 one will report the individual investment sales (i.e. a line for BCE shares, a line for BNS, a line for TRP etc.) to end up with the capital gain (CG).

The totals would work out as Proceeds minus Cost equals CG (I am simplifying a bit). So $210K - $150K = $60K CG. If the CL was from 2016, then it is subtracted off on the form. If not, one has to elect to have it applied. Net is a CG of $54K.

This is reduced by 50% to end up with a taxable CG of $27K that is included as taxable income. This is on top of any income paid by the investments as well as other sources of income (ex. employment income, income from the investments to the point they were sold then starting up again when re-purchased).

One will have to cash to pay out the mortgage but may need to be saying more $$ for the coming tax bill. Depending on the factors, it might work better to covert over a couple of years instead of one big liquidation, pay off the mortgage in full then re-buy the investments.


My apologies if you've already worked this out where this is a repetition. The $200K mortgage being wiped out by $200k investments suggests the selling part is being overlooked.


Cheers


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