Tax Free Mortgages

In the United States, homeowners have been permitted to write off the interest on their mortgage for decades.  In Canada however, the CRA does not let taxpayers to write off their interest.  There is a way however to accomplish this here, but care must be taken!  Mainly, you need to be able to prove the money was used for investments, rather than personal expenses.

Sounds easier than it really is though.  A few key issues will help you on this path.
First of all, and probably the most important component of this whole “scheme”, is how the mortgage is structured.  When setting up the plan, make sure there is a way to have several components under the collateral, such as a line of credit, mortgage, even credit cards which can be held under the equity of the house.  Most lenders do offer these.  The point of this is so that you can track and report the interest in each independently, which is necessary for the plan to work.

Next, use the mortgage funds you borrowed for investments!  Its best to get in touch with a financial advisor to help with this, and they will more than likely tell you to also get in touch with your accountant to discuss what you are doing.  This isn’t something you want to do on your own, as there is a ton of regulations to follow, and the CRA does keep very close tabs on this.

The payments for the mortgage are all paid as you normally would, and as the principal on the mortgage is paid down, the line of credit component of the mortgage is increased.  The key here is when the room becomes available on the line of credit, you take that money and transfer it directly to investment bank account.  This can be set up automatically by your financial advisor. 

The money in the investment bank account can then be reinvested, and the money becomes tax deductable.  Your best to invest in conservative investment, not take on more risk than necessary.  Remember, the point of this isn’t to make huge profits off investments, but rather be able to make the interest on the mortgage tax deductable.
On average, a typical 25-year mortgage can become fully tax deductible in 22.5 years.
Typically, this sort of strategy appeals to professionals and high income earners, who have paid off at least 20% of their mortgage.  Their debt ratios will be low, and will have excellent credit.

The risks

There are obvious risks associated with the smith maneuver, as I have touched on a bit.  The financial benefits are indisputable and justify the risks to the right borrower. But if it isn’t executed properly, or if the homeowner spends the funds on something other than investments, you may get audited.  As well, make sure any tax refunds you receive are used to directly pay down the mortgage, as this will greatly speed up the process of converting the full amount of the mortgage to being tax deductable. 
There is some short term financial risk involved, if for instance interest rates go steeply up at the same time as the market where you have invested fall.  This is prevalent mainly in the first two to four years though, as risk is mitigated eventually from stockpiling equity.
Finally, as I mentioned earlier, the CRA does keep a close eye on this.  They don’t like loopholes, and as such will pounce on you if you abuse this one.