Excellent strategy to use your RE income to the max!

[AndyLuchies]

Many investors are familiar with the Smith Maneuver, and I will outline it briefly below, but also, let`s combine that with a few other ideas that result in the best rental property cash flow strategy I`ve ever seen.(For some of you, this will be old hat, but bear with me, I`m excited about sharing for those who haven`t seen this yet)
Here`s the basic benefits:
1. You will switch personal mortgage debt to tax deductible business debt.
2. Stop having thousands of dollars just sitting in your "rental account" that could be working for you.
3. Maximize your tax deductions on your business to make it as profitable as possible.


Step one:

Open a revolving mortgage/matrix mortgage/total equity plan, each bank calls it something different.
Its basically a loan program that says "your house is worth $250,000 so we`ll give you a total of $180,000 in credit." So that means if you only have a mortgage on your home of 120,000, then you get the rest of the credit in a HELOC (home equity line of credit).
Having this allows you to increase your HELOC every time you pay down your mortgage because the bank is keeping your total credit amount the same. As you pay down your mortgage, your line of credit increases.


Only use your HELOC portion for real estate business. Don`t spend that credit on anything but real estate stuff so that 100% of the interest is tax deductible (this keeps things simple and clear for CRA).

Step two:

Have all of your monthly expenses from your rental properties (mortgage, insurance, property tax, utilities, etc) get paid from your HELOC, NOT from some chequing account somewhere.

Step three:

Take every rent cheque that you get from your properties and pay down your principle residence mortgage with them.

Step four:

Make sure the bank keeps raising your HELOC as your mortgage gets paid down.


WHY WOULD I DO THIS?

1. In a few years, you`ll have NO mortgage payment on your principle residence, YEAH! Instead, you`ll have a huge business LOC that`s completely tax deductible. With this, if I buy no more properties, EVER, I`ll have my principle residence mortgage paid off completely in 2 years, instead of 27!!! I like the sound of that.

Once you`re mortgage is paid to zero, simply use your rental income for something else, or pay down your business LOC with it.

2. Why have $3000 sitting in an account for each rental property as a buffer when you can use your Line of credit as a buffer against possible property problems. If you have 3 rental properties, you could easily have $10,000 cash sitting in a bank, while your paying interest on $10,000 that you borrowed from the bank.


IS THIS LEGAL?

Yes, there is no CRA law saying you must use rental income to pay for rental expenses. You can use investment income however you want, I use mine to pay off my mortgage and let my line of credit pay the expenses.

CAUTION: Although many accountants say this is a great strategy, I am not an accountant myself. Although I did research this, take it with a grain of salt.

Comments anyone?

 

[fumbrunner]

QUOTE (AndyLuchies @ Feb 12 2010, 11:25 AM) Many investors are familiar with the Smith Maneuver, and I will outline it briefly below, but also, let`s combine that with a few other ideas that result in the best rental property cash flow strategy I`ve ever seen.
(For some of you, this will be old hat, but bear with me, I`m excited about sharing for those who haven`t seen this yet)

Here`s the basic benefits:
1. You will switch personal mortgage debt to tax deductible business debt.
2. Stop having thousands of dollars just sitting in your "rental account" that could be working for you.
3. Maximize your tax deductions on your business to make it as profitable as possible.


I suspect more do this than you think. I have taken your approach a step forward:

I have readiline accounts on all my properties
I use one of them (60K) to finance downpayments on rentals, which then are renovated and refinanced for a net 0 downpayment

I use rental income for two purposes: Mortgage paydown on my principal residence and RRSP contributions. Why? When I have enough RRSPs and the mortgage is paid down enough, I will hold my mortgage in my RRSP, thus paying interest to my RRSP rather than the bank. It also increases my HELOC, which.....

I use my HELOC on the principal residence to buy high yield dividend stocks. Interest is tax deductable, dividends are taxed at a favourable rate and stocks will appreciate (one hopes). dividends are used to pay down the mortgage. As do tax refunds if any

So, in my personal Belize (7 yrs from now and at the age of 40) I will have the mortgage on my principal residence completely held in my RRSPs, a HELOC worth over 200K holding appreciating high dividend stocks, a goal of holding 10 rentals (conversative estimate) netting 6K per month in revenue (in today`s terms, not adjusted for inflation).

All properties will have readiline accounts and I will likely use the Maneuver on each to paydown their respective principal, again using dividend-paying stocks.

So, its a hybrid of what you had proposed. But that is my plan....

 

[PaulW]

QUOTE (AndyLuchies @ Feb 12 2010, 12:25 PM) Many investors are familiar with the Smith Maneuver, and I will outline it briefly below, but also, let`s combine that with a few other ideas that result in the best rental property cash flow strategy I`ve ever seen.(For some of you, this will be old hat, but bear with me, I`m excited about sharing for those who haven`t seen this yet)
Here`s the basic benefits:
1. You will switch personal mortgage debt to tax deductible business debt.
2. Stop having thousands of dollars just sitting in your "rental account" that could be working for you.
3. Maximize your tax deductions on your business to make it as profitable as possible.


Step one:

Open a revolving mortgage/matrix mortgage/total equity plan, each bank calls it something different.
Its basically a loan program that says "your house is worth $250,000 so we`ll give you a total of $180,000 in credit." So that means if you only have a mortgage on your home of 120,000, then you get the rest of the credit in a HELOC (home equity line of credit).
Having this allows you to increase your HELOC every time you pay down your mortgage because the bank is keeping your total credit amount the same. As you pay down your mortgage, your line of credit increases.


Only use your HELOC portion for real estate business. Don`t spend that credit on anything but real estate stuff so that 100% of the interest is tax deductible (this keeps things simple and clear for CRA).

Step two:

Have all of your monthly expenses from your rental properties (mortgage, insurance, property tax, utilities, etc) get paid from your HELOC, NOT from some chequing account somewhere.

Step three:

Take every rent cheque that you get from your properties and pay down your principle residence mortgage with them.

Step four:

Make sure the bank keeps raising your HELOC as your mortgage gets paid down.


WHY WOULD I DO THIS?

1. In a few years, you`ll have NO mortgage payment on your principle residence, YEAH! Instead, you`ll have a huge business LOC that`s completely tax deductible. With this, if I buy no more properties, EVER, I`ll have my principle residence mortgage paid off completely in 2 years, instead of 27!!! I like the sound of that.

Once you`re mortgage is paid to zero, simply use your rental income for something else, or pay down your business LOC with it.

2. Why have $3000 sitting in an account for each rental property as a buffer when you can use your Line of credit as a buffer against possible property problems. If you have 3 rental properties, you could easily have $10,000 cash sitting in a bank, while your paying interest on $10,000 that you borrowed from the bank.


IS THIS LEGAL?

Yes, there is no CRA law saying you must use rental income to pay for rental expenses. You can use investment income however you want, I use mine to pay off my mortgage and let my line of credit pay the expenses.

CAUTION: Although many accountants say this is a great strategy, I am not an accountant myself. Although I did research this, take it with a grain of salt.

Comments anyone?


Hey Andy...this seems like a viable option although the math is still somewhat confusing to me. You`re technically using 1 credit instrument to pay off the other...I was always curious about the tax implications of "investment mortgages" as I believe you can only write off "interest". So if my rental income was $2,000, my expenses were $500 and my mortgage was $1,200, do I pay tax on $300 (2,000-500-1200) or $1,400 (2000-500-100 (interest)?

Does the Smith manouvre allow you to deduct the whole mortgage amount? not sure.

I found this link where you can order the book.

http://www.smithman.net/faqs.html

 

[TheVancouverMarket]

Sorry,accidental post

 

[fumbrunner]

QUOTE (PaulW @ Feb 12 2010, 11:57 AM) Hey Andy...this seems like a viable option although the math is still somewhat confusing to me. You`re technically using 1 credit instrument to pay off the other...I was always curious about the tax implications of "investment mortgages" as I believe you can only write off "interest". So if my rental income was $2,000, my expenses were $500 and my mortgage was $1,200, do I pay tax on $300 (2,000-500-1200) or $1,400 (2000-500-100 (interest)?

Does the Smith manouvre allow you to deduct the whole mortgage amount? not sure.

I found this link where you can order the book.

http://www.smithman.net/faqs.html

It`s the latter. Only interest payments are tax deductable. Which is why the strategy usually uses stocks that pay dividends since dividends are taxed at a lower rate. You can also claim CCA to reduce the amount of tax payable on rentals, but it is recaptured when sold. Which is why I try to max my RRSPs to offset the taxes paid on my rental income.

 

[EdRenkema]

QUOTE (AndyLuchies @ Feb 12 2010, 11:25 AM) Yes, there is no CRA law saying you must use rental income to pay for rental expenses. You can use investment income however you want, I use mine to pay off my mortgage and let my line of credit pay the expenses.

CAUTION: Although many accountants say this is a great strategy, I am not an accountant myself. Although I did research this, take it with a grain of salt.

Comments anyone?

All good ideas and I`ve used the strategy myself the past 3 yrs except for one thing, my principal residence mortgage is prime minus .8 which is 1.45% and I`m in no hurry to pay off the remaining amount

 

[kevindv10]

This seems too good to be true.

Let assume these numbers:
Principle mortgage balance = $100,000
HELOC limit = $50,000 (in a fleximortgage or whatever you want to call it)

I withdrawn the $50,000 from my HELOC and pay off that amount on my principle residence mortgage, having the following effect:

1. The interest I pay on the $50,000 loan from my HELOC is tax deductable.
2. I`ve reduced the balance of my mortgage by $50,000, so my continued monthly payments will pay off more principal, faster.
3. Also because I`ve reduced the principle on my mortgage, my HELOC limit increases by $50,000 (from $50,000 to $100,000), allowing me to spend that money again (that part seems fishy).

What`s stopping me from doing it all over again and eliminating (well, moving) the principal on my mortgage altogether, AND still having that $50,000 to spend on whatever I choose? Am I completely misunderstanding something, or is this the whole point of the manoeuvre? I`m going to the bookstore in 5 minutes to pick buy the book!

I feel like I`ve been living under a rock! What an epiphany!

 

[Rickson9]

Just a few more pieces of reading if anybody is interested:

The Smith Manoeuvre - A Wealth Strategy
http://www.milliondollarjourney.com/the-sm...tegy-part-1.htm
http://www.milliondollarjourney.com/the-sm...tegy-part-2.htm

Anti-Smith Manoeuvre
http://www.milliondollarjourney.com/anti-smith-manoeuvre.htm

 

[AndyLuchies]

QUOTE (PaulW @ Feb 12 2010, 12:57 PM) Hey Andy...this seems like a viable option although the math is still somewhat confusing to me. You`re technically using 1 credit instrument to pay off the other...I was always curious about the tax implications of "investment mortgages" as I believe you can only write off "interest". So if my rental income was $2,000, my expenses were $500 and my mortgage was $1,200, do I pay tax on $300 (2,000-500-1200) or $1,400 (2000-500-100 (interest)?

Does the Smith manouvre allow you to deduct the whole mortgage amount? not sure.

I found this link where you can order the book.

http://www.smithman.net/faqs.html

Already read the book.
The smith maneuver has little to do with the rental property itself. It only deals with how to convert your personal mortgage into an investment loan. Your rental property that you buy with the loan is a totally different tax question. As already mentioned, only the interest is tax deductible on your rental. But that`s irrelevant. If you do the research you should be buying a rental property that cashflows anyways. This strategy assumes you already have a rental property thats bringing in cashflow (hence why I posted on a real estate forum) and now you can use that income to get rid of your personal mortgage.

 

[AndyLuchies]

QUOTE (kevindv10 @ Feb 13 2010, 12:18 PM) This seems too good to be true.
Let assume these numbers:
Principle mortgage balance = $100,000
HELOC limit = $50,000 (in a fleximortgage or whatever you want to call it)

I withdrawn the $50,000 from my HELOC and pay off that amount on my principle residence mortgage, having the following effect:

1. The interest I pay on the $50,000 loan from my HELOC is tax deductable.
2. I`ve reduced the balance of my mortgage by $50,000, so my continued monthly payments will pay off more principal, faster.
3. Also because I`ve reduced the principle on my mortgage, my HELOC limit increases by $50,000 (from $50,000 to $100,000), allowing me to spend that money again (that part seems fishy).

What`s stopping me from doing it all over again and eliminating (well, moving) the principal on my mortgage altogether, AND still having that $50,000 to spend on whatever I choose? Am I completely misunderstanding something, or is this the whole point of the manoeuvre? I`m going to the bookstore in 5 minutes to pick buy the book!

I feel like I`ve been living under a rock! What an epiphany!

Wrong. Sorry, but you forgot one important thing. The HELOC must be spent on an INVESTMENT. You can`t simply use it to pay down your mortgage or you`re just trading a personal mortgage for personal debt, both of which aren`t tax deductible. That`s why you siphon the funds through a rental property (paying expenses from HELOC, but using rental income to pay down mortgage).

Although your strategy, slightly modified, has been tried in the past where investors use HELOC to buy an investment, then sell the investment back in a few months and use all of money to pay down mortgage....but that`s tax fraud because CRA says loan interest is only tax deductible if there is an intent to make money on the investment. If they think you`re just trying to get rid of personal debt, they won`t let you claim it....all this from simply reading Smith`s book.

As for others comments concerning investments other than real estate. The benefit of using real estate is that the conversion happens MUCH quicker. The key difference is that with a stock you`re earning dividends AFTER the company pays its expenses. In real estate, you take 100% of income BEFORE expenses and pay off your mortgage. Yes, I may pay more taxes on my NET income, but I don`t care because I`m averaging about 30% ROI per annum on my real estate so my after tax returns are better than the stockmarket anyways. This is also the reason I have yet to start my RRSPs, I`d rather have 30% ROI taxed, than tax free RRSPs that only yield 8-10%.

 

[Nir]

Thanks Andy, to open a revolving mortgage/matrix mortgage/total equity plan, should I work with the same banker/mortgage broker who approved the original mortgage?
also, for each mortgage work with a different banker (if with different banks), not the mortgage broker? TX.

 

[Rickson9]

I forgot to mention this, but thanks for the post Andy. I enjoyed reading it!
Jim

 

[jeffjas]

IS THIS LEGAL?
Yes, there is no CRA law saying you must use rental income to pay for rental expenses. You can use investment income however you want, I use mine to pay off my mortgage and let my line of credit pay the expenses.

CAUTION: Although many accountants say this is a great strategy, I am not an accountant myself. Although I did research this, take it with a grain of salt.

Comments anyone?



Whoa....I agree that you can pay your expenses however you wish, but it is extremely risky to think that you can deduct HELOC interest on your rental expenses and in addition to your mortagage interest on the investment when you had the means to pay for it without incurring additional interest.

I think that they would disallow the additional interest payments on the HELOC unless you could show it was the only way you could meet the requirements of your rental operation ie. normal rental income was inadequate to cover expenses)....very questionable and risky.

You may face appealing a CRA audit

 

[fumbrunner]

QUOTE (jeffjas @ Feb 14 2010, 01:57 PM) IS THIS LEGAL?Yes, there is no CRA law saying you must use rental income to pay for rental expenses. You can use investment income however you want, I use mine to pay off my mortgage and let my line of credit pay the expenses.

CAUTION: Although many accountants say this is a great strategy, I am not an accountant myself. Although I did research this, take it with a grain of salt.

Comments anyone?



Whoa....I agree that you can pay your expenses however you wish, but it is extremely risky to think that you can deduct HELOC interest on your rental expenses and in addition to your mortagage interest on the investment when you had the means to pay for it without incurring additional interest.

I think that they would disallow the additional interest payments on the HELOC unless you could show it was the only way you could meet the requirements of your rental operation ie. normal rental income was inadequate to cover expenses)....very questionable and risky.

You may face appealing a CRA audit

Agreed.  I misread the original post.  If you are referring to interest on the HELOC from a purchase, you are ok.  If you are referring to expenses such as management fees, repairs, utilities, etc.  that could be more problematic.

 

[tbarcier]

It`s called cash damming. CRA has a section about this. http://www.cra-arc.gc.ca/E/pub/tp/it533/it...html#P144_15954.

 

[AndyLuchies]

(JefJas, fumbrunner, tbarcier )
For the record, I am talking about daily business expenses, utilities, etc.

Interesting, your reactions are my initial reaction as well, however Fraser Smith in his book on his Maneuver disagrees with you, and (more importantly) my accountant who is top level at Parker and Simone in Mississauga disagrees with you as well.

As tbarcier says, its called cash-damming, and is a legal maneuver according to the aforementioned authorities.
In any event, I`m not too worried about an audit, I have nothing to hide and will probably get one anyway as my income has shifted dramatically over 2009.

Any other comments?

 

[AndyLuchies]

Hi All,



Not trying to reopen an old thread, just needed to read some of my old posts to get information that was pushed out of my brain years ago and figured I'd post an update seeing as I haven't been here in years. My wife and I have no mortgage payment on our principal residence now, thanks to the Smith Maneuvre, just tax-deductible interest only payment on our HELOC which is next in line at the chopping block.

 

[Matt Crowley]

[quote user=jeffjas]

Whoa....I agree that you can pay your expenses however you wish, but it is extremely risky to think that you can deduct HELOC interest on your rental expenses and in addition to your mortagage interest on the investment when you had the means to pay for it without incurring additional interest.



I think that they would disallow the additional interest payments on the HELOC unless you could show it was the only way you could meet the requirements of your rental operation ie. normal rental income was inadequate to cover expenses)....very questionable and risky.



You may face appealing a CRA audit




Hi Jeff,



I've always been nervous about this strategy as well. I think that if the CRA was looking to call in the interest deducted on "HELOC interest paid on expenses" it would be very easy to do so. It may violate basic accounting principles like revenue matching and faithful representation; both of which are becoming borderless accounting standards.



Very sophisticated strategy. I think a lawyer and accountant advice would be needed here. To me, moving a personal mortgage to a HELOC with investment properties is still a personal mortgage in a HELOC with investment properties. Still not tax deductible. It's not like you ran an IPO on your personal net worth and securitized it, which this strategy seems to be suggesting you can do.



Secondly, when I read about "cash damming" it talks about separate uses of cash kept in separate accounts. (http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.html#P144_15954). Separate "accounts" doesn't mean physical bank accounts. It means classification of use. To me, a personal mortgage in an another account is still a personal non-interest deductible account. That debt is still secured by the same asset - a personal residence.



The real benefit is the interest multiplied by your personal tax rate. A writeoff is only worth the amount of its tax shield - its true cash value. That could be twenty cents to forty five cents on the dollar (depending on your personal tax rate). That's the value of the tax shield. Pay an accountant $500, broker $500, and lawyer $500 to understand how this works. If you want to recoup that money in your first year, you need to start paying an additional $3,333 - $7,500 in interest.



In the same way for every dollar you pay in interest-deductible interest, your true cash savings are only 20 cents to 45 cents.



For those who know how to do this and have done so successfully, I am going to continue reading your posts and learning about this strategy. It is just too much risk to me and I can't logically understand why you can change the classification of the debt in this way.

 

[AndyLuchies]

Technically, you're not changing the classification of any debt. Rather, you are declining to use your rental income to pay down rental expenses. These rental expenses were incurred trying to run a profitable business; therefore, they are tax deductible and any interest on them is tax deductible even if you could have used your money wisely to pay them off.



The rental income you are making from the cheques you cash each month can be used however you want. It doesn't have to be used to pay down rental expenses (although in most cases you'd be a fool not to, especially if you post a loss every year to the CRA). I used the rental income to pay down my principle residence mortgage instead. (Which is the first half of the Smith Maneuvre) I ran this by my accountant who was a partner at a firm in Toronto until he opened his own business. He is VERY conservative and by the books and he said its completely legit, although he figures if too many people started doing this, the CRA would likely put an end to it because they always want to make sure they get a piece of the pie anytime money is changing hands (not because it's an unacceptable behaviour).



From a logical investor's stand point it makes sense as well- first pay off the debt that costs you the most. Which is usually the non-tax deductible debt (all other factors being equal).



In the end it's just dollars and cents. I just think it's nice to be 32 and have no mortgage payment on my house....