Smith Manoeuvre, It Does Not Make Your Mortgage Tax Deductible

Smith Manoeuvre seems to be a famous and hot trick to make your mortgage payment tax deductible, at least I believed so. However, It turns out not that simple. Let’s take a look at the following example:

In Month 1, I paid down the principal on my mortgage for $500. And immediately, I invested $500 from my HELOC. Asumming the interest rate and HELOC is the same as 5%, the $25 interest from my HELOC account is tax deductible. But what about the $25 interest which has already been paid on my mortgage? I paid two $25 interest, but only get one $25 interest as tax deductible, right? The interest I paid to my mortgage is still not tax deductible. Assuming my marginal tax rate is 35%, I am actually paying $25 more interest in order to get $8.75 back.

Smith Manoeuvre does not make your mortgage payment tax deductible, but a trick to transfer a debt into a loan product that is tax deductible.  If it does not do the trick, why many people are doing it? Well, it is because that there is a hope that you can get the extra interest paid back from your investment with capital gains, dividends paid and etc.  If not, then Smith Manoeuvre is a losing strategy. It is also a risk that an individual should take when implementing it.