Comments on: DIY Smith Manoeuvre, Part 4

By: Geirge

Geirge — Wed, 10 Mar 2010 21:17:36 +0000

Where is part 2???

By: A Y

A Y — Sun, 16 Mar 2008 12:12:45 +0000

CC / FourPillars,

I searched CRA web site about tax deductibility of the interest on investment loan when the investment distributes ROC, but I couldn’t find any references. How /Where did you learn that ROC portion of the loan is not tax deductable?

Thanks,
A Y

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By: FourPillars

FourPillars — Mon, 17 Dec 2007 16:04:14 +0000

CC is right – if you get a dividend that is return of capital, that is the equivalent of selling some of the shares which means that the portion of the loan covering those shares is no longer tax deductible.

You have to either declare the interest on the portion of the loan that is still tax deductible or do what Phil is doing and pay down the loan by the amount of the ROC dividends.

Mike

By: Phil S

Phil S — Mon, 17 Dec 2007 15:13:36 +0000

I haven’t seen any tax ruling which is that specific about what you can and can’t invest in… It only states that you have to invest for income and as far as I know, REITs qualify as income generating investments – I get a distribution every month. And yes, I use the cash distributions from the REIT to pay down the loan.

By: Canadian Capitalist

Canadian Capitalist — Mon, 17 Dec 2007 12:20:56 +0000

Phil: Just to verify, are you repaying the loan with distributions from the REIT? If almost the entire amount is ROC and you still keep the loan, the deductions will be disallowed.

I occasionally borrow to invest (in the recent market turmoil, it was BMO and RioCan) but I do it sparsely (never exceeding 10% of our portfolios) and rarely (perhaps once every year). Still, leveraging is a tough game to play.

By: Phil S

Phil S — Mon, 17 Dec 2007 04:02:21 +0000

With regards to the taxation side of leveraged investing, your rate of return will clearly depend upon the tax treatment for your investment. For me personally, I’ve borrowed cash from my HELOC to invest in a few junior REITs. My borrowed cash is a tax-deductible 6% and my junior REITs yield about 8-14% and they’re all 100% classified as return of capital (because depreciation and amortization bring the net earnings for these REITs close to zero)… So in reality it is a tax-deferred investment until some day in the distant future when it’s sold. But in the immediate tax year, for all intents and purposes, it is tax-free cash.

So, on a before-tax basis, my leveraged portfolio is returning about 6%, but after I file my taxes, it is like making 8% on that portfolio. The obvious risk to me is that if the investment implodes, then I’m on the hook for the huge hit to my portfolio. The other problem is if you have to sell the investment – such as what I did after the Halloween income trust massacre, I had to sell and realize a capital gain of some ridiculous 75% on one of my investments!

But then later on in the year, Coventree imploded (which I owned shares of), so I did some tax selling on that stock to offset my massive capital gains on that other junior REIT. What a topsy-turvy investment environment we’re in, all compounded by our punishing tax regime! But that’s what the Smith Manoeuvre is all about – manipulating our investments to squeeze the maximum tax efficiency out of everything.