The Smith Maneuver

If you have income from property or from investments, we're paying upwards of 50% tax on those investments. Let's say you have a $50,000 income inclusion, but you also have a $50,000 personal debt that if we could just get access to the deduction related to that personal interest, we would wipe out our taxable income related to our income from property or from investment. Good day and welcome to the Wealthy Entrepreneur Podcast. My name is Bob Goberrow. I will be your host today. Excited to have you here. And I want to talk about something today which is going to be around the idea of interest deductibility. One of the major problems that I see in a lot of businesses is that we have good debt and not good debt, also known as bad debt, but not bad debt. Like we're going to write off something that somebody's not going to pay, but debt that doesn't get us interest deductibility. I'm going to talk about that in some detail in just a moment, but I do want to welcome you to the Wealthy Entrepreneur Podcast. This is a place where we dissect the elements that contribute to entrepreneurial success, from mindset and leadership to profits and revenue. We're going to call this episode the Smith Maneuver. Now, as I was mentioning before, this is really a situation that I see quite often and it's something where many business owners, again, they have good debt and they have bad debt and not write offs. Not bad loans that you have outstanding that people aren't going to pay you for, but more so that you have debt that is deductible, meaning that we get to expense that debt, or you have debt in your life that is not deductible, meaning we don't get to deduct that debt. And so typically when we're talking about debt that's not good, it's bad debt. What we're talking about is a mortgage on your home, for example. The interest on our home mortgage, which can be quite substantial, is not deductible. But there are ways to make it deductible if we do the right way. Other types of interest that aren't deductible, credit card charges not that are for personal use. If you've got interest that you pay on a loan related to registered investments, like a tax free savings account or an RSP contribution, that debt is technically not deductible. So what we have to do is we have to come up with a way strategically so that one of the largest expenses that we have in our life becomes deductible and for some people, you're looking at 20, 30, $50,000 a year in interest expense. Now just imagine if for your business, if you have income from property or from investments, we're paying upwards of 50% tax on those investments. Let's say you have a $50,000 income inclusion, but you also have a $50,000 personal debt that if we could just get access to the deduction related to that personal interest, we would wipe out our taxable income related to our income from property or from investments. So why not do that? How would we possibly do that? And for many of you, this maybe is something you haven't heard before, but there is one particular technique that has been named after the individual who came up with it, and that's called the Smith Maneuver. So the Smith Maneuver by definition employs refined and proven debt conversion techniques to transform mortgage interest into tax deductions. The outcome is that this strategy has a remarkable snowball effect that generates large and growing annual tax refunds, enables the homeowner to knock years off the life of a non deductible mortgage, and builds an impressive financial portfolio at the same time. So back to my scenario, right? Let's say we have interest income or income from property. So rental, where we have dividend income and so $50,000 a year and we continue to pay tax on that. And the challenge is it's, it's taxed at a high rate and it's not great tax. But if we could convert some of our principal, principal house or our mortgage to being deductible, we should likely do that because you know, it would probably save us 20 plus thousand dollars a year. So this is a problem that I see with many business owners, especially if you have a rental property. If you have a rental property, the likelihood of you being able to get access to a full tax deduction would be high. And I'm going to walk you through how to exactly do this. But again, this is going to be from converting non deductible debt into deductible debt. So here's how we do it. Let's put a scenario on the table. Okay, so let's say I have $1 million home, I have a million dollar rental property. Both of them are going to require that there's some equity in this property. Typically, you know, 30%, 20 to 30% meaning that 80% is going to be a loan, or 70%, maybe 60. So on the million dollar property, I have 2 to $300,000 of equity. I also have 2 to $300,000 of equity on my real estate portfolio that I'm renting. So in this case, I've got, you know, upwards of 400 to $600,000 in equity that I have in these two properties. Now, here's the situation, right? If you take those two properties, you've got $2 million in equity. If you combine the two of them and you look at the situation and you say, okay, what do we want to do? Well, we want to pay off our principal mortgage because it's not deductible on our home. And we want to maximize the deductibility of the interest on the rental property. So the easiest way in many cases is, is that I see people renting their property and they're accelerating their mortgages to go and to pay this down. But what's happening is they're accelerating the mortgage on the rental property and they continue to pay interest on their principal residence. So what they should be doing is looking at accelerating their principal residence and paying as much interest as they can inside the rental property. Now, obviously, we don't want to add extra interest in total, but if we can make the interest on the rental property fully deductible, we accelerate down the payments on our, our principal house or our principal residence, that's going to be a positive outcome for us. So here's one of the ways that we do it. What we do is we typically look and say, how can we get rid of our mortgage? So could we borrow and refinance on a larger portfolio? So with our investment properties, refinance up to 100% on that property and pay that, you know, $600,000 of equity down on our principal residence. So knocking it from 200 to $300,000 of equity on our principal residence, but then building that up to 600,000 and having zero equity in our investment property. So, yes, we can do that. We can go back and we can talk to our mortgage broker, we can get them to look at the entire package, say it's $2 million. We want to fund this, but our objective is to pay off our principal residence. So here's one of the ways that we do it. We refinance up on the investment property, we pay down. Now we also can look at getting a home equity line of credit. And this is where it's going to be really handy for you. So you get a home equity line of credit on whatever capital that you have inside your principal residence. You have that separate. You can take that money and invest it, pull those funds out and invest it into income from property. So into your rental property. So what you can do is you can get that home equity line. Let's just say it's $100,000. You put the $100,000, you take it out of the home equity line. And because you are investing that money in income from property interest or dividends, so all investment income that becomes deductible, then $100,000 now becomes deductible. We put that in our real estate or our income from property. Now we've got more equity there. So what do we do? We borrow against the property, that extra $100,000, and we pay down our mortgage. All right, and now once our mortgage is paid down another $100,000, guess what happens? Our home equity line goes up because we now have home equity here, our home. So now our property or home equity line goes from 100 to 200,000. You then take the additional $100,000 that's just been created in our home equity line. We pull it out, we invest it in income from property, put it back into our real estate. So we pay that down, and now we've got an extra $100,000 in equity there. We then pull out that equity, we pay down our mortgage, we now have an extra $100,000 of equity. We pull that equity out, now we've got an extra $100,000. And we keep going until that mortgage is paid off and everything is in our home equity line of credit. And every dollar that we've pulled out of that home equity line of credit goes into investing in our real estate portfolio. So now all of our debt is actually being used to generate new income. Now, that sounded like a sequence of transactions. This is something that we can work with our mortgage advisors. If you've got private banking at any of the major banks, they can help work with you on this. So that we're essentially paying off our mortgage. We're converting the equity in our home to a home equity line of credit, and we're pulling that money out to finance our properties that we're generating income on. This is the Smith maneuver. And this is converting that debt that was our principal residence into a home equity line that the dollars have been used there for investment related income. This pays off our bad debt, converts it to good debt. What's the difference? Well, the interest that we're paying is the exact same, but now all of our interest is deductible because it's all related to earning income from property. We're just securing our personal asset in order to leverage and get Access to cash to, to invest in income from property. So that converts that bad debt into good debt. This is a fantastic situation. So the other side, the other situation that I want to address as well, so that was the Smith maneuver, that's converting bad debt, good debt, getting access to our deduction where we otherwise weren't. Super smart move. I see it all the time. Again, one of the scenarios I see is that we're accelerating a mortgage pay down on real estate properties that we own that are part of earning income. Instead of doing that, we use the equity in there to pay down our mortgage. We get a home equity line and we reinvest back into our income properties that will allow us to get access to tax deductibility related to this. So one of the other situations that I see is that we have essentially a principal, principal residence and we've got a bunch of cash in the corporation. So here's one of the things that we can do as well in this situation. So if you've got cash inside your corporation, we know that the private banking arms of the banks will leverage you up to 70% loan to value on that investment. So let's take RBC. So RBC, for example, you get private banking with RBC, you've got $100,000 in investments inside your corporation. You don't want to pull that out and pay down your debt because we just, we don't want to do that because we don't want to pay tax on pulling $100,000 out in dividends. But what we do want to do is make sure that our principal residents, that mortgage, we convert that to being deductible. So one of the things we do, we go to our private banking, we get that 70% loan to value on investments. It's going to be in the RBC platform, it's going to be invested. We're likely going to be making 5 to 10% on that income as well. So you're going to go from 100 to 105 to 110, whatever that looks like. And you get to choose the investments you want because they have access to that. They see it on their platform, they're investing it on your behalf or you're self directed, but they can still see it. What we do is then we get access to a 70% loan to value loan personally. And that is a personal line of credit that's secured essentially by the corporate asset. They're going to give you this because your entire net worth is, is what it is, right? So why wouldn't we get access to personal borrowing because our company has value. That's essentially what's happening is they're just saying, well, your credit and your net worth is higher. We're going to be able to give you more personal borrowing power because of the value of your company, which is great. So we then get this $70,000 personal line of credit. What we can do is we can actually take that $70,000 out, we transfer it into the company, it's now invested, it's a shareholder loan into the company. We then can look at repaying this in a future period. And what we do, so we invest it in, but then we take it back out in the future as proceeds or as income is being generated in the company. We take that $70,000 back out, no tax on that, because you've invested it in. It's a loan due back to you. We essentially take $70,000 out as retained earnings with proceeds that we had in there in the past. We're essentially just paying down some of that loan. But what we're going to do is we're going to take that money and we're going to pay down our mortgage with it. So we've invested, we've pulled the money from our personal line of credit, we've invested it in the company, we're going to pull money out and pay down our principal residence. So there's a way to get $70,000 of equity there. As you can imagine, that's converting again, a non deductible debt that we have on our personal mortgage. We're using personal equity that we have because our company is worth more money. And we're taking that, we're investing it into our company, which is earning us dividend income as shareholders. So that is deductible debt because you borrowed it and invested it in the company. We're not going to repay that loan with the bank. But what we're going to do is we're going to pull that money back out of the company, we're going to pay down your principal residence. So you've got a loan that you put into the company. The company has earned money. You've taken dividends throughout the year, and as part of that, we've paid down your mortgage in an accelerated way. It's taken $70,000 of bad debt, converted it to good debt, and now that interest is deductible. Okay, I'm going to leave it there. I just want to say, you know, one last thing. I do see this a lot, right, where we have business owners who have multiple sources of debt and we're not getting access to the deductibility of all of those debt elements. And really that is just us leaving money on the table. Right? Again, if, if we're paying, let's say $1,000 a month in interest, that's $12,000 a year likely that is $6,000 of tax savings related to investment income. That's a pretty big deal. That's just converting $12,000. If your mortgage is a little bit higher like mine is substantially more. So we're in the multiple five figures in getting access to tax savings just by converting our debt from bad debt to good debt, meaning non deductible debt to now being deductible. Check out the Smith Maneuver. If you need any support with this, feel free to reach out to our team Gobro CPA Cat. Our tax team can help you understand what options you have and we'll also work with the financial financial institutions to be able to implement this strategy for you so that you convert your non deductible debt to deductible debt. This has been the Wealthy Entrepreneur podcast. I hope this has been very valuable because I know there's lots of tax savings sitting on the table for people who have any bad debt but also have business loans as well. So let's take full advantage of this. If you found this insightful, feel free to leave a note. Share it Follow the podcast though make sure that you like the podcast. Every single week we release a new episode. This one particularly about how to maximize our interest deductibility of our debt. But there's many more. We focus on leadership, tax planning, business growth strategies. If you feel like someone you know would benefit from understanding how they can deduct all of their debt, convert bad debt to good debt. Share it. We would love to get this in the hands of anybody. Our team is on a mission to empower all entrepreneurs with good financial information, minimize their tax so that all of us entrepreneurs can continue to make a huge impact in the world and change it together. This is Bob Govreau. It's been a pleasure to be here with you today. I look forward to next week. Check us out, make sure you follow. Have a fantastic day and let's make sure that all of our interest is fully deductible going forward. Thanks guys. Have a good day.