The Smith Manoeuvre: how mortgage interest becomes tax-deductible in Canada (2026)

This guide is part of Tax-saving strategies for Canadians (2026).

Who this is for

Homeowners with a readvanceable mortgage, a high marginal tax rate, a non-registered investment account, and a genuine tolerance for carrying investment debt for a decade or more. If you would sell in a downturn, or if you are still filling TFSA and RRSP room, this is not the strategy for you yet.

How it works

The rule is in paragraph 20(1)(c) of the Income Tax Act: interest is deductible when the borrowed money is used to earn income from a business or property. Your own home earns no income, so mortgage interest on it is personal. Shares that pay dividends, or a rental property, do earn income, so interest on money borrowed to buy them is deductible on line 22100 of the return.

The CRA’s Folio S3-F6-C1 says the test is the current, direct use of the borrowed money, traced dollar by dollar. That tracing is what the Smith Manoeuvre exploits:

1. You hold a readvanceable mortgage: a mortgage plus a home-equity line of credit whose limit grows by the principal you repay.
2. Each month, after the mortgage payment, you borrow the newly freed room on the line of credit.
3. You invest that money in a non-registered account that is expected to produce income (dividend-paying shares, equity funds, a rental).
4. The interest on the line of credit is deductible. The mortgage interest still is not.

Over time the non-deductible mortgage shrinks and the deductible investment loan grows. Your total debt stays roughly the same; what changes is how much of the interest the CRA lets you deduct. Many people apply the tax refund to the mortgage, which frees more room and speeds up the conversion.

The Supreme Court in Singleton v. Canada (2001 SCC 61) confirmed that a refinancing which re-traces borrowed money to an income-earning use is respected, transaction by transaction. That decision is the legal footing for the manoeuvre.

Worked example: $120,000 salary, $200,000 investment line at 6%

Assume a $200,000 investment line of credit at 6%, so $12,000 of deductible interest for the year, and $6,000 of eligible Canadian dividends from the portfolio. The tax saved and the tax on the dividends come from the 2026 federal and provincial brackets in our data files.

In Ontario the deduction saves $4,345, not the $5,209 a “marginal rate times interest” shortcut would give, because $12,000 of deduction crosses the $117,045 federal bracket edge and part of it saves at the lower rate. After tax, the 6% loan costs about 3.8% in Ontario. The strategy makes money only if the portfolio’s after-tax return beats that number, year after year, and it loses money in any year the portfolio falls.

The rules that trip people up

• Mixing personal and investment borrowing. Folio S3-F6-C1 (paragraph 1.43) says that when one account holds both eligible and ineligible borrowing, every repayment reduces both parts pro rata. One personal draw on the investment line permanently reduces the deductible share. Keep a separate line and never touch it for personal spending; the Folio calls the clean version of this “cash damming”.
• Registered accounts. Interest on money borrowed to buy investments in a TFSA, RRSP or FHSA is not deductible: 20(1)(c) excludes exempt income and subsection 18(11) denies RRSP borrowing outright.
• Reasonable expectation of income. The Folio (paragraph 1.70) accepts common shares because they can pay dividends, but a fund or investment with a stated policy of never distributing income may fail the test.
• Spending return-of-capital distributions. If a fund returns part of your capital and you spend it rather than reinvest or repay the loan, that share of the loan no longer earns income and its interest stops being deductible.
• GAAR. In Lipson v. Canada (2009 SCC 1) the Court applied the general anti-avoidance rule in section 245 to a plan that combined the borrowing with the spousal attribution rules so the higher earner could claim the deduction. The plain version is documented; the clever versions are where the risk lives.
• Leverage. The loan is fixed; the portfolio is not. A variable line-of-credit rate can rise while markets fall.

What to do next

Run the Smith Manoeuvre calculator on your own mortgage, income and province: it shows net worth over 5 to 40 years against just paying the mortgage, and the return you need to break even. Then run Prepay the mortgage or invest?: it compares putting money against the mortgage with investing it, which is the decision underneath this strategy. Use the income tax estimator to see your own marginal rate and the mortgage payment calculator to see how much principal each payment frees. Then read the rest of the tax-saving strategies.