[daniel]

My dad has a house he's been diligently paying off the last 15 years. He's got around $350k in equity in this house (with $80k left on his mortgage). He was looking to buy a second investment property with the way the markets are right now. He has a HELOC of whch he's only using around $8k.

I was thinking of suggesting the Smith Manoeuvre to him. Specifically, to pay for the investment entirely out of the HELOC. If I understand the Smith Manoeuvre this is the best way for him to go (as opposed to borrowing from HELOC only enough for a downpayment and getting a second mortgage). Is that right?

One or two (or three) more questions:
-How is the income generated from an investment property taxed? At marginal rate?
-Do you need to incorporate or get a business number to be a landlord and write-off expenses?
-You can only write-off the HELOC interest from the income generated from the property.. correct?

 

[FrugalTrader]

One or two (or three) more questions:
-How is the income generated from an investment property taxed? At marginal rate?
-Do you need to incorporate or get a business number to be a landlord and write-off expenses?
-You can only write-off the HELOC interest from the income generated from the property.. correct?

To answer your questions,

• Income from rental properties are taxed at your marginal rate. However, only the income AFTER expenses are taxed.
• No, you do not need a corporation to be a landlord/rental investor. In fact, there is very little benefit for real estate investors to incorporate.
• AFAIK, if your rental results in a loss, the investment loan can still be applied against regular income. However, you'll need to consult with a tax pro to make sure.

 

[balexis]

Daniel,
I don't think the Smith Manoeuvre is what you think it is. From what I understand, to do the SM, your dad would sell his investments, pay the mortgage and borrow money to rebuy the previously sold investments. That way the mortgage that once was non-deductible suddently becomes deductible.

Now to your specific situation:
The general rule is that any interest paid on money used for investment purposes (such as a rental property) are entirely deductible. It really does not matter where the money comes from (HELOC, mortgage on non-rental property, mortgage on rental property, ...), what counts is where the money is spent.

The income generated by an investment property is added to your other income (such as employment income), so yes it is taxed at your marginal rate.

You do not have to incorporate or get a business number. An individual can declare rental revenues and write off expenses (some special forms to fill out in your tax report).

Regular expenses related to your rental property can be written off your global income, not only your rental income. So yes you can declare a net loss (kind of usual for the first years when the interests you paid on the mortgage are very high).

By regular expenses I mean interests, general repairs, office expenses, etc. If you make repairs that give 'value' to the property such as changing the windows, putting a new fireplace, etc, these kind of expenses can't be written off, they must be capitalized.

Hope this makes sense, feel free to ask more questions and i'll do my best to answer.

Alexis
ps I bought my 1st rental property 10 months ago so I'm not a pro yet.

 

[daniel]

Thanks for the replies FrugalTrader and balexis.

Daniel,
I don't think the Smith Manoeuvre is what you think it is. From what I understand, to do the SM, your dad would sell his investments, pay the mortgage and borrow money to rebuy the previously sold investments. That way the mortgage that once was non-deductible suddently becomes deductible.

My father has no investments outside of his RRSPs (his RRSP portfolio is nothing to brag about anyway), as 90% of his effort went to paying down his mortgage.

As for SM? MillionDollarJourney defines it as follows: "To summarize the Smith Manoeuvre in a nutshell, it’s 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." It seems like what I'm asking is inline with SM.

I suppose another question I would have is.. is the idea behind SM that your investments cover your (after-deduction) interest payments? That is, if you have an income producing property or dividend stock, those should, theoretically, more than cover the interest payments you have to shell out to service the loan (even if that interest is tax deductible you still pay something after all). As such, is one pretty much limited to investing in income producing investments? For example, if you invest in ETFs or index funds the growth in those might be just in capital gains so you'll have to service the loan out of pocket. Right?

Hope this makes sense, feel free to ask more questions and i'll do my best to answer.

Alexis
ps I bought my 1st rental property 10 months ago so I'm not a pro yet.

Your points were very informative for me. Thanks a lot. (If you're new, then I'm complete newbie =) )

Are you doing SM? If not.. why not?

Dan.

 

[FrugalTrader]

Thanks for the replies FrugalTrader and balexis.

I suppose another question I would have is.. is the idea behind SM that your investments cover your (after-deduction) interest payments? That is, if you have an income producing property or dividend stock, those should, theoretically, more than cover the interest payments you have to shell out to service the loan (even if that interest is tax deductible you still pay something after all). As such, is one pretty much limited to investing in income producing investments? For example, if you invest in ETFs or index funds the growth in those might be just in capital gains so you'll have to service the loan out of pocket. Right?


Dan.

No, the SM does not require that income generated from the investments to cover the interest on the loan. That's the "twist" to the SM that I have implemented. CRA only requires that the investment has the "potential" to produce income, so non dividend paying stock is ok as well.

 

[daniel]

No, the SM does not require that income generated from the investments to cover the interest on the loan. That's the "twist" to the SM that I have implemented. CRA only requires that the investment has the "potential" to produce income, so non dividend paying stock is ok as well.

Right. That makes sense. Basically you just have to be able to cover the interest payments however way you can. I suppose that's something people might have a problem with. If you invest in passive index funds (for example), you'll have to make mortgage payments + increasing interest. You can recapitalize the interest, but that seems to take a bit of work to do month after month.

On another matter:
Is inflation your friend with this strategy (the principle is being slowly eroded after all). Or does it all balance out in the end?

Thanks FT.

Dan.

 

[FrugalTrader]

Right. That makes sense. Basically you just have to be able to cover the interest payments however way you can. I suppose that's something people might have a problem with. If you invest in passive index funds (for example), you'll have to make mortgage payments + increasing interest. You can recapitalize the interest, but that seems to take a bit of work to do month after month.

On another matter:
Is inflation your friend with this strategy (the principle is being slowly eroded after all). Or does it all balance out in the end?

Thanks FT.

Dan.

Anyone with debt benefits from inflation (rising inflation is another story), but there are always aspects where inflation works against you. Personally, I do not account for the benefits of inflation when implementing the SM.