Toronto Condo and Real Estate Blog

Is Your Mortgage Tax Deductible? The Smith Manoeuvre

If you are like most Canadians the answer is NO. The interest you pay on your home mortgage is not tax deductible in Canada. But if you do some smart planning, the interest paid on a mortgage can become tax deductible, even when the mortgage is on your principal residence.

Our American friends already enjoy the luxury of claiming their mortgage interest. So is there a way for you as a Canadian homeowner to make your mortgage interest payments tax deductible? Well, according to Fraser Smith, the author of the best seller book “Is your Mortgage Tax Deductible - The Smith Manoeuvre”, you can.

But before we start to explain how the “Smith Manoeuvre” works let us discuss a couple of background issues:

“Good debt” vs. “bad debt”
When you borrow money to make money, it is an investment. The interest you pay to service that debt can be deducted from your income before you pay your taxes. That’s “good” debt!  On the other side, borrowing money to buy depreciating items (car, television, or to pay for vacations) will always be considered as “bad” debt.

How to convert bad debt to good debt?
The real trick is to convert “bad” debt to “good” debt. The concept of converting your debt from non-tax deductible to deductible debt is gaining popularity in Canada. Many outspoken proponents of the concept believes that every Canadian should be aware of their ability to convert their debt – more specifically, the ability to convert their mortgage into a tax deductible debt.

What is the Smith Manoeuvre?
The Smith Manoeuvre is a financial strategy pioneered by Fraser Smith, a veteran BC-based financial consultant. It is designed to convert the non-tax deductible interest debt of a residential mortgage to the tax deductible debt of an investment loan – generating annual tax deductions.

Most Canadians are unaware of the real cost of their mortgage, or underestimate the amount of interest they would pay on a mortgage and have no idea of the total cost. For example, a $150,000 mortgage at seven per cent paid over a 25-year period would cost the homeowner more than the original mortgage amount ($165,000) just in interest alone. At a 40 per cent tax bracket, the mortgage holder would need to have earned $525,000 to pay off that $150,000 debt. That’s why more and more Canadians are investigating tax-deductibility as an alternative option.

To summarize, the Smith Manoeuvre in a nutshell, is where you borrow against the equity in your home, invest it in income producing entities, and use the tax return to further pay down the mortgage. Repeat until your mortgage is completely paid off, this will leave you with a large portfolio and an investment loan. Your mortgage is now an investment loan, which is tax deductible and hopefully your portfolio is larger than your loan.

As an example, a $200,000 mortgage at seven per cent would cost the homeowner about $1,400 a month. In the first month, roughly $1,150 would go towards interest and $250 towards the principal. According to Smith, To convert that debt to tax deductible borrowings, the homeowner should then take that $250 back out of their home equity and invest it.

By the end of the first year, the homeowner will have re-advanced and invested about $3,100. Borrowing back the money and investing it creates an “investment loan”, the interest on which may now be tax-deductible. This process is repeated year after year.

Although the debt level remains at the original $200,000, more and more of it is being systematically converted to tax-deductible debt. In addition, ever-increasing tax refunds received by the happy homeowner could also be applied against their mortgage, and then re-borrowed and invested. Also, the homeowner could take any non-registered investments and apply those dollars against their mortgage, enabling them to borrow the money back for tax-deductible investing (assuming the costs and potential capital gains triggered by selling the non-registered investment to pay down the mortgage are not prohibitive).

Does this works for you?
It is good to remember that as with any investment program there are risks involved, the program is based on current Canada Revenue Agency (CRA) rulings, which can change over time.

Borrowing to invest is suitable only for investors with higher risk tolerance. You should be fully aware of the risks and benefits associated with investment loans since losses as well as gains may be amplified. The value of your investment will vary and is not necessarily guaranteed, however, you must meet your loan and income tax obligations and repay your loan in full. Any homeowners should consult with their financial advisor. Advisors understand risk tolerance and can assess the appropriateness of the strategy to your specific situation and most importantly, will be able to implement the necessary investment component of the program.

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Contact the Jeffrey Team for more information - 416-388-1960

By James Rusk - Globe and Mail

Fights involving condo owners and condo boards are one of the most rapidly growing areas of law in Canada, a Toronto lawyer who specializes in condominium law said yesterday.

“We’re at a situation now where I said: If they stop developing now, we’d still be busier than ever. But they are not. It is just unbelievable the kind of situations that come up,” Marko Djurdevac of the law firm of Deacon Spears Fedson & Montizambert said in an interview.

Mr. Djurdevac, who edits a newsletter on condominium law, said that the disputes can range from issues such as the three p’s - people, parking and pets - to matters such as fights over finances and repairs.

Since they are about people’s homes, the battles are often quite fierce and quite emotional. “In a condo, it is communal, and it is a highly political environment. People are very serious about everything that is going on, no matter how insignificant it may seem to a third-party observer,” he said.

Often condo corporations find themselves in court, fighting owners who do not understand either the limits on what they can do with their property or the line between personal property and common elements shared by all owners.

For instance, he once had to seek a court order preventing a townhouse owner who ran a construction company from keeping a commercial cement mixer in his garage and a construction truck in the common driveway.

As condominium law has evolved, provinces have sought ways to keep the disputes out of court, he noted.

Since 2001, Ontario law, borrowing from an earlier provision in British Columbia law, requires most disputes to go through a mandatory mediation-arbitration process before getting to court, and most provinces have similar rules, he said.

The exceptions to the arbitration process are cases involving a breach of the provincial condominium law itself, but judges have been clamping down on what they think are frivolous attempts to avoid arbitration, he said.

Even though the law prohibits an owner from damaging the common property of the condo corporation, he said, a judge refused to hear a suit brought by a condo corporation against an owner whose dog was urinating on lawns and flower beds and referred the case to arbitration.

On the other hand, he had a case where the courts moved quickly to issue a court order against a property owner with a history of mental problems who was setting fires in her unit.

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Contact the Jeffrey Team for more information - 416-388-1960

Except for some first-time buyers, levy is now a fact of life

By Kathy Flaxman - Globe and Mail

Like many people who were house-hunting as 2008 approached, Sherille Layton and her husband, Edward, wanted to stay ahead of Toronto’s new land-transfer tax. They wound up signing an agreement to buy a North Toronto home, closed the deal, and even moved in — all before Christmas.

Ms. Layton was well aware that had they waited until January to buy the house on Erskine Avenue, and pushed the closing date to Feb. 1 or after, they would have had to pay the new tax on top of a selling price of more than $800,000, and the provincial land-transfer tax.

She figures they saved a cool $13,000 thanks to the good timing.

“That’s an awful lot of extra money,” she says.

Now that the tax is a reality — it came into effect on Feb. 1 — home buyers other than some first-time purchasers won’t be able to avoid it as the Laytons did.

But there are some things buyers should keep in mind when they are figuring out their overall financing arrangements.

The new tax, which was passed by council in October, generated a lot of opposition when Mayor David Miller introduced it last summer. He argued that the additional revenue was badly needed by the cash-strapped city to maintain services and fund new projects.

But some groups — including the Toronto real estate industry — condemned the tax.

The critics said the tax would hurt the Toronto real estate market, and jeopardize the chances of many people — especially first-time buyers — of owning a home.

Ms. Layton calls the new measure, “a crazy tax that doesn’t make any sense.

“Buyers have spent ages saving and have set aside their closing costs and worked-out budgets. This tax throws quite a spanner in the works,” she says. For some potential owners, “the extra $4,000 or $5,000″ in tax may be just what puts owning a home out of reach, Ms. Layton adds.

“The market has been very busy so far this winter,” she says. “In February, we will start to see what the effect [of the new tax] will be.”

Under the new bylaw, buyers will pay 0.5% on the first $55,000 of their home’s value, 1% between $55,000 and $400,000, and 2% on any amount over $400,000.

There is one group that can avoid the tax, or at least a part of it: first-time buyers. They are eligible for rebates of up to $3,725 on residences costing up to $400,000. The provision covers homes with one but no more than two self-contained units under one ownership — a detached house, semi-detached single-family residence, townhouse, row house, duplex or condominium. That includes a home with a second suite, for instance, but not a triplex.

For a buyer whose budget leaves no room to manoeuvre, some lending institutions will, for a limited time, cover it — in the form of a loan — if the purchaser negotiates a mortgage with them.

TD Canada Trust, for instance, will cover the tax to a maximum of $15,000 if a customer agrees to a five- or seven-year fixed mortgage. The offer, which is good until March 21, is meant to help consumers “make the purchase they had hoped to and not miss this home-buying opportunity,” says Joan Dal Bianco, vice-president for real estate-secured products for TD Financial Group.

“We decided not to make it specifically tied to the amount of the tax, but to give 1.5% in cash back to help the consumer meet the land-transfer tax increase [on top of the existing Ontario land-transfer tax],” Ms. Dal Bianco explains. “If they happen to have found the funds elsewhere, they can use the [new] funds for some other purpose.”

The Bank of Montreal will cover the tax for up to 1.5% of the mortgage amount for regular customers who take out a new fixed-rate, closed mortgage with a minimum five-year term.

“The funds go to the lawyer and they can close their transaction,” BMO mortgage expert John Turner says. “If they submit an offer to us before Feb. 29, because of our rate guaranty program, the property does not have to close until 90 days after Feb. 29.”

But some tax experts urge consumers to make sure they understand the nature of these offers.

Broker Paula Roberts of Mortgage Intelligence sees merit in them, with a proviso. “This type of product does help, and a number of financial institutions are offering them, but the cost of borrowing the money will be built into the rate charged for the loan. In one case, the rate charged is about 40 basis points higher.

“There are a lot of ways that people in the business are suggesting to get buyers into the market and this type of financing is one,” she adds. “As a broker, I can offer products from a number of financial institutions and I educate the client, too. Hopefully, consumers will sit down with someone who knows something about mortgages and have all their options explained.”

Giles Osborne, Toronto-based manager of Parker Prins Seel Lebano, Chartered Accountants, stresses that “this type of product is not something that is black or white, ‘Yes, it’s good, or no, it’s bad.’ If people need the funds, then the funds are available. But what I think is important is that people understand the interest rate they are actually paying on the extra money on top of their mortgage.”

He also points out that the smaller the loan, the higher the interest rate.

“The customer is actually getting an unsecured loan and the rates reflect the amount of the loan and the fact that that this is not like a mortgage secured by the house itself,” he says.

“Whether someone should take advantage of products like these really depends on what other sources of funds they have available,” Mr. Osborne advises. “I understand the motivation of the client. On an expensive house, it’s a lot of cash to come up with. I would recommend that purchasers, if they are creditworthy, who are negotiating their mortgage, even in this instance, try to negotiate the interest rate. Try to reduce the extra basis points downward.”

How will the new tax impact the Toronto real estate market? Some of those in the business say that sales could be affected for a while, but, like the federal goods and services tax, this tax will eventually be considered a normal thing.

“I’m sure that in a matter of months it will become a sad fact of life and will be absorbed by the equity in the transaction,” says Karen Davis of Sutton Group-Bayview Realty Inc.

Dorothy Wong of ReMax Goldenway Realty Inc. doesn’t mince words: “The Toronto real estate market is so hot and so rich right now that those who wish to live in Toronto will pay the tax. Just like smokers who cry about cigarette prices, they will pay to continue their habit regardless of all the tobacco tax increases and price increases,” she says.

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Contact the Jeffrey Team for more information - 416-388-1960