Episode 107: Cash Damming vs. Smith Maneuver For Canadian Investors

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Are you missing out on tax savings and passive income by not taking advantage of smart debt strategies like cash damming?

Many Canadians are familiar with the Smith Maneuver for converting mortgage interest into tax-deductible debt, but few know about cash damming—another powerful tool that allows you to maximize tax savings and transform your business or rental property expenses into tax-advantaged opportunities. 

Today, Kyle Pearce and Jon Orr dive into the mechanics of cash damming, explaining how it works, why it’s similar to the Smith Maneuver, and how business owners, especially unincorporated ones, can take advantage of it. If you’re aiming to minimize income tax and make your debt work for you, this episode will show you a practical pathway to improve your financial health by maximizing the tax efficiency of your expenses.

• Discover how cash damming can convert personal mortgage interest into tax-deductible debt.
• Learn why debt, when managed strategically, can be a powerful asset rather than a burden.
• Explore how cash damming can reduce your tax liability and increase your passive income potential.

Listen now to find out how to turn your business or rental property expenses into a tax-saving advantage and build wealth with smart debt strategies!

Resources:

• Dig into our Ultimate Investment Book List
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you overcome your current struggle and take the next step in your Canadian Wealth Building Journey!
• Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX.
• Looking for a new mortgage, renewal, refinance, or HELOC? Reach out to Jon to share some options.

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting cordporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

Are you overlooking tax-saving strategies like cash damming and the Smith Maneuver to turn your mortgage into a powerful wealth-building tool? In this episode, we break down how debt, when managed strategically through methods like leveraging HELOCs and converting non-deductible debt, can minimize income taxes, increase passive income, and optimize your real estate investments. From Canadian investing strategies to infinite banking with whole and universal life insurance, discover how smart debt management not only reduces tax liability but also supports long-term estate planning and financial growth. Listen in to learn how to make your debt work for you!

Watch Now!

Transcript:

Jon Orr: All right. Let’s get into this and let’s talk about cash damming and why, you know, why that strategy is maybe often overlooked or less. Let’s dig into it. And really, the idea that we wanted to share here is is to build off the same the same thinking. And as as the Smith maneuver. We’ve got four episodes on the Smith maneuver.

We have episode 44 of 8187 all around this Smith maneuver and how you can you can write off, say, interest expense against, say, a technically against your mortgage. And so that’s that’s it’s kind of like we’ve talked about that one so much good the secret sauce type episode or a secret sauce type idea that helps you save in taxes, puts a little bit more money into your pocket or allows you to kind of use it towards some other things.

So that that idea we’ve shared a lot here, but this idea around cash damming is very, very similar. Let’s dig into it. Give us give us the lowdown. You know, what is it and what are we talking about here?

Kyle Pearce: Absolutely. This is another debt strategy that, you know, we’re trying to get people comfortable with the idea of debt and what we like to call good debt. Right. And with those Smith Maneuver episodes. So we did for why? Because we had such a positive response. So many people were intrigued and interested to really dig in. A lot of people have heard of this Smith maneuver before, but there was a lot of uncertainty around it.

There was a lot of misunderstandings about it. And today, cash damning is something that those who are in will call the Smith Maneuver Camp also tend to employ. But it’s slightly different. It’s for the same purpose. It’s this purpose of paying down your primary mortgage and opening up a non primary borrowing vehicle. Typically a line of credit where you can then write off the interest.

So right off the the starting point here in off the starting blocks, a lot of people get confused with the Smith maneuver and with a lot of other debt strategies as a way to pay down debt sooner. That’s actually not the intended result of the Smith maneuver. It’s about taking whatever you owe now on your home and then slowly converting it into what we call tax deductible debt.

And therefore the net result is the same amount of debt. Technically, some people would even allow that debt to grow by actually compounding the interest if they’re investing. So the same is going to be true here. We’re talking about a debt strategy that’s not actually going to be used to pay off debt sooner, but rather to convert that debt, that non tax deductible interest into the swap tax deductible interest.

Right. And the goal is, if you think about this, if we zoom out a little bit and you think about where you hope to be later, now, I would argue most people want this more than, say, staying the same is that they hope to be earning more income in the future than they’re earning now. So why that matters is because if we have tax deductible interest, what we’re able to do is we’re able to funnel more dollars towards growth asset use, and that also typically means more taxable income.

Why that’s helpful here is because if we have tax deductible interest on money we’ve borrowed, we can then write it off against that high income that you tend to be growing over time. So typically the wealthier you get, the higher your tax bracket becomes. Specifically for those who aren’t actually thinking strategically about this work. And that’s where this and today’s discussion is going to dig in.

We’re going to look at a Smith maneuver like approach for business owners who are not incorporated to those who are incorporated. We have something for you at the end that you can consider. But for those who are not incorporated, so these are people who are sole proprietors or maybe they own rental properties or assessments. At a personal level, this is a way that you can actually kind of swap some of that mortgage that is non tax deductible, that interest, that’s non tax deductible into Smith maneuver like tax deductible interest by simply changing the flow of money a little bit here.

Jon Orr: Yeah yeah and I well so let’s because you’re saying like you know I wanted to make sure we got that in there like we have we like we own properties in our personal name, we also own properties in our, say, corporations, which is so it’s like we just because I’m, I have a corporation doesn’t mean I can’t use this strategy for, say, the assets that I own personally.

So let’s unpack the differences here. We you outlined the idea of the Smith maneuver. We’ve got those four episodes on that. Specifically. What’s the difference here? Because the Smith Mini, in my respect right here, is the Smith Maneuver. We are always kind of thinking, personally, I can I can do this now, since we’re still on the personal side, what is the difference between the Smith Maneuver and cash Damning?

Kyle Pearce: Yeah, I love it. I love. It. So Smith Maneuver is really the idea is the dollars that you were going to be investing in something. It’s up to you what the asset class is. Those dollars. What we’re going to do is we’re going to funnel them towards your mortgage. You’re going to essentially make an overpayment to your mortgage and open up some home equity line of credit room, and then you’re going to borrow that money back and then put it into the investment.

So it’s still a pass through like structure here that we’re just getting a dollar to funnel to your mortgage, paying a dollar off of your mortgage, opening up a dollar of home equity line of credit room, you’re going to borrow that same dollar back and put it into the market. And essentially what you’ve got the result you have is that, hey, if you owed, you know, $100,000 on a mortgage, you now owe a dollar less on your mortgage, but you’ve gained a dollar of debt on your home equity line of credit.

And obviously that’s scalable $1,000, 10,000, whatever the number is that you want to do here. When we talk about debt, sorry, cash damning, what we’re actually doing is we’re doing a similar philosophy, except instead of this being a dollar that’s going to come in and go into an investment itself, It’s actually a dollar that was that was earned from your business or your investment.

So that’s your rental property. If you’re an unincorporated physician and if you’re an unincorporated business owner of any type, you’re earning this money and that money. Some of this money was going to go towards paying down expenses, right? You have all of these overhead costs that you pay every single month. It might be for the employees that are working for you.

It might be for the, you know, the building you’re renting. It might be for any other type of business or or investment expense. That dollar was going to pay off that expense. Well, instead, we’re going to do the same thing here. We’re going to take this dollar and we’re going to put it through the mortgage first. This is your primary home mortgage where interest is not tax deductible.

It’s going to bring the debt on your mortgage down by that dollar and you’re going to borrow it back from the home equity line of credit or whatever line of credit you want. It’s totally up to you. You borrow that up for that dollar back, your net debt owing is the same, but now you have a dollar of tax deductible debt.

That that debt, when it pays interest, when you pay interest on that dollar, you’re now going to be able to write off that interest amount because we borrowed that money back in order to put it back into the business or into investments. And there is a goal of earning income. And that’s essentially what the Income Tax Act is telling you, is saying, listen, if you’re borrowing money in order to make money through business or investment, then you can write off the interest.

So we really have the same exact strategy, except one was a dollar that was going to go straight into investments. The other one was a dollar that was going to pay off expenses in business anyway. It was money that was going out the window anyway.

Jon Orr. Yeah. So, so it’s like when you said because you’re what you’re doing is you have to pay expenses anyway. And what you’re saying is take a chunk of money, put it in the mortgage first instead of paying your expenses. Like normally we just be like, I’m going to pay expenses every month. And then I would take what’s left and maybe do something with that.

You’re saying pass it to the mortgage first. It’s kind of like the pay yourself first model that we talked about a long time ago. It’s like a similar idea. It’s like instead of subtracting expenses to get your profit, you know, subtract, like figure out that part first is almost like put it on your on your mortgage. Now borrow it back to pay the expenses afterwards 100%.

And then. And then now. So so now you’ve got that you can you deduct that because you borrowed you bought that for say business expenses. Okay. It makes sense to me. Now, how this is the part, I think. Right. Like and this is the same idea with the Smith maneuver and the difference between the Smith maneuver, I think was why?

Why I say maybe more people are using this is because you can see that if I borrow this, if I borrow this money off my line of credit and invest, I’m going to make like I’m going to use that interest rate advantage and it’s going to like it’s, oh, I got to pay interest on the borrow amount and then I’m going to make more money on the investment.

And therefore, I can feel like mathematically this makes sense to me. Now if I’m going to borrow the money for my expenses, isn’t it just more expenses? Like tell me more about that because. Because I’m going to borrow the money for expenses. Well, yeah, I’m creating this taxable or this reduction in the amount of tax that I’m going to pay because I’m borrowing this.

I have this, this, this tax deduction. I can I can claim, but I also have to pay the interest for.

Kyle Pearce: That year 100%. So like this is the part in Smith maneuver. This is often missed. We’ve set it in four episodes and we’re saying it in a fifth one with the Smith Maneuver. A lot of people forget the fact that it’s like your debt hasn’t gone down, like you still haven’t paid debt down. And in the kind of perfect world of the Smith Maneuver, you’d actually never pay that debt down because that deductibility is so valuable to you later when you’re taking income.

Right. So this idea is that basically if you’re a Smith Maneuver advocate, as it is sort of designed, if you’re like, Yup, I’m going to do that and I’m all in, you have to be comfortable with this idea that that mortgage number is going to go down. But your actual overall debt owing on your home is the same.

Kyle Pearce So you actually are being comfortable that you know what? Because rationally this makes sense. I’m going to grow investments and I’m going to keep this debt and my net worth is going to be higher. You’re actually saying I’m going to play the game to win. I’m not just going to play the game to feel good about myself, which is I pay that debt off, right?

Instead of investing with cash. Damning, though, this is a little bit harder and this is where it becomes a better and a more specific individual. And you really have to do an analysis to figure out does this work for you? Because it’s not like easy out of the bag. Like in I would say it’s hard to find someone where the Smith maneuver doesn’t make sense simply because you are borrowing money to make an investment, right?

So like, that part makes a ton of sense. So unless the interest rates are so far apart on the home equity line of credit and on the actual mortgage, let’s it’s like extreme. You’re likely going to be much, much better ahead. Whereas with cash standing, that’s not necessarily true. And I’m going to talk about the main concern that we have to think about here is that you have expenses in your business or from your rental property or whatever this income is being generated by and that, you know, bucket of money was going to be allotted towards paying down what you planned for these certain expenses that you have.

And that’s fine. But if I take that money and I put it on to my mortgage and then borrow it back on the line of credit and the arbitrage between those two interest rates doesn’t actually give you a positive result. You could actually be putting yourself in a worse spot. Now, what do I mean by that? Okay, there’s two ways this can happen.

One way is that the actual interest rates are two apart to two far apart, I should say, just like with the Smith maneuver. But the reality is, is that here it’s more important because there is no upside in terms of investment. Right. Right. Your business is going to operate as it would with or without this strategy. So it’s not like your business is necessarily going to grow by you doing cash damming.

What you’re trying to do is you’re trying to say, listen, if I’m borrowing at, let’s say, 7%, all right, on the home equity line of credit, and my mortgage was 5%. All right. I need to make sure that my tax deduction is going to make it seem like I’m paying less than 5% on my traditional mortgage for this to make sense.

Now I’m going to give a really easy example. Okay? If you’re in a 50% tax bracket, your marginal rate is at the 50% level ish and you’re going to borrow against your home equity line of credit at, say, 7%. You’re going to save half of that money in interest because you’re going to get the write off. You’re going to get that 50% tax chunk back.

It’s like you’re borrowing at three and a half percent. So in order for that to make sense for you as a cash d’amour, you need to make sure that your mortgage amount isn’t actually lower than three and a half percent in that specific case, because if it is, then it’s actually costing you more money in this particular case than it’s worth.

And the opposite would be true as well, is that, hey, listen, if we’re in a if we’re in a low tax bracket already, if I’m in a the highest tax bracket I’m in is, say, 30%. Right now, I have to think about this and say, listen, I can only shave 30% off my borrowing rate on my home equity line of credit to really try to figure out, does it make sense for me to do cash standing now or use me as an example right now?

And again, total luck here, but I’m at under 2% on my personal primary residence fixed until December 2025. So that under 2% is a really tough one for me to beat. If I want to use cash damning. So at this time, cash damning doesn’t actually make sense for me in my situation, whereas the Smith Maneuver can still potentially make sense because I am going to make investments.

And I do know that I only have that low interest rate for this next year or so, right? So it’s like one year of benefit and then guess what? My fixed rate is going to pop back up and I’m probably going to be in good shape again with cash damning. You’ve just got to make sure that, hey, if I’m going to do this, am I in a high enough tax bracket at a personal level where I’m going to benefit from this work?

Right. Because it is effort. I’ve got to funnel this money through the mortgage. I got to borrow it back and then I also have to take on potentially the emotional strain knowing that there is debt there. Right. That there is debt. And I want to know that and feel confident that by using this strategy, it’s actually going to give me a net positive result most years.

Jon Orr: Yeah. Yeah. And let’s let’s talk about the you know, because we preface this with, you know, this is for non incorporated business owners. And again, it’s just because you may be on your own an asset, your own, say, rental property or of income or a business that’s not incorporated, you’re that sole proprietor. This makes sense because of your personal mortgage and making it tax deductible.

Now if I’m a business owner that I’m incorporated and you’re thinking like, can I do this here? You know, like, like, why can’t I like, let’s say if I have a mortgage in the businesses name, why can’t I say do something similar here in the, in the idea here is that your business, you know, because you say own a mortgage and the businesses name the businesses interest is already tax deductible.

It’s a business expense because it’s owned by the business. So you’re not saving on say that that deduction that you would be personally and all, but you can still do it. It’s just all you’re doing is like like for example, you could still go like, I want to pay less interest on my mortgage as a business owner. So what I can do is put all like this, almost like that.

Pay yourself first strategy. I’m going to take all my revenue or a bunch of my revenue. I’m going to pay it down to the mortgage. That’s going to reduce the interest that I’m paying on the mortgage. And then I can use my line of credit to pay any expenses out. When I have those expenses. And all you’re doing, as Powell said before, is you’re really swapping that debt.

You’re not you don’t really saving any say tax because it’s already say it’s already a deductible all on that. So that’s that’s the way you want to think. But if you’re already unincorporated business, it doesn’t help you any more. You know, the idea still can be helpful as long as you’ve is honest. You’re okay with, say, having, say, swapping that debt.

Kyle Pearce: Yeah. Yeah. And something I guess to think about is like if you know that some of these expenses, it’s like you keep money there because you know this quarter you have certain expenses coming up or this half of the year. This year I have certain expenses. By doing that, what you’re doing is you’re basically saving the overall balance of money, owing while that money is sitting there in that account doing nothing.

Right. So if you have like I talked to business owners all the time, they keep 100,000, 200,000, sometimes sitting in a in a bank account because they know that anything can happen. Right. So for some of those people, if they know that they don’t want to take that money and put it into, say, long term asset, one thing they could do is they could put it right into, say, some of the debt that they might have in the business.

It could be the mortgage on the building that this the that as long as they have that credit facility that they’re able to borrow back when the time comes. But the challenge that you run into playing that game is that, listen, if the rate is high, right. Which line of credit, the rate may be high. You’re not actually arbitrage ing on tax savings at all.

It’s more just playing the game of like, how much more can I put over here to save some interest rate so that I’m not borrowing too much from the line of credit? Because if it ends up being a complete debt swap, you’re going to likely be behind. You probably have a cheaper rate at the fixed rate against a building or against, you know, a piece of equipment or whatever it is you have then to be pulling from the line of credit.

So I might argue for those business owners who are thinking about a strategy like this or like I’ve got money sitting and it’s their it’s like my quote unquote emergency fund and or it’s money that I know that sometime in the future I may have to lean on, especially if maybe revenues late in this year. Right. It’s this arbitrage game.

So what I recommend for some of those business owners is that they actually start a small permanent policy inside the corporation they own it corporately owned because it’s so liquid. So it can it can earn money. No passive income tax on the cash value, it’s growing. And then they can actually leverage against when they do need to lean on some of those funds.

And I say when. So if they know they’re using it later this month, probably not the best move. But if they’ve got like I call it the war chest, the under the corporate mattress, you know, stash of cash kind of doing nothing or earning very low rates in a savings account and then getting taxed at 50% of it.

Passive income could be a good idea to actually instead of funneling it onto a building’s, you know, mortgage because again, probably favorable interest rate there and then having to borrow back against the line of credit, you could actually build it into, say, a policy which is going to give you a much better long term result. You know, you’ve got the cash value growth.

It will continue to compound even if you leverage against it for whatever these expenses or these, you know, these unexpected expenses might be. And then you also get this wonderful death benefit that sort of helps to take care of your estate planning because of the capital dividend account, where the net death benefit will actually pay out down the road.

So kind of solves many problems while you’re not just letting that money sort of sit there and sort of inflate away in a savings or a checking account.

Jon Orr: Yeah. And one of the added bonuses there too, is, is the you said it was is quite it’s it’s liquid but it’s also not, you know because especially if you use the you know the policy loan is contractually obligated for the for the insurance company to say earmark a chunk of money for you to borrow against that policy like it’s you just say, hey, where do I want this money?

They just say, you know, I want it in this bank account. A couple of days later, it’s going to be there. You don’t have to go ask for permission now if you already like. If you had if you didn’t have a line of credit, you know, set up, you have to go get approved. You have to like make sure that all the all the you know, all the you get you get all this paperwork and sign and all of a sudden, you know, things things kind of balloon up a little bit like that.

And you don’t have to do that with your policy. The other thing is, like all of a sudden, let’s say your mortgage refinances and now all of a sudden you have to kind of decide what are you going to do there? And maybe the qualifications are different at that point. The interest rates are different. That point. You don’t have to worry about that if you’re going to go the policy road.

It’s like completely liquid to borrow in that emergency fund or borrow in that way. It’s true whether you’re a business owner or say you own a policy in your personal name as well. This is not, say, just a business owner. Now, I think we wanted to specifically talk about cash. Deming is in addition to the Smith maneuver is just another example of why like of like how to use tools at your disposal to like optimize your tax implications and put more money in your pocket like those secret sources.

That’s what we talk about here in the show, right? Is is what are the secret sources? And what I love about the tools here is is making sure or thinking about how do I use debt appropriately, good debt and how do I how do I make sure I’m okay and mentally okay, you know, so and emotionally okay with using debt as a tool because if I can get if I if I can get my mind wrapped around that, that debt can be used in a good way to benefit myself and benefit my corporations, then I’m almost like in a way, like home free.

It’s like I soon as you learn and feel comfortable, their options open up. But if you’re if you’re like, I’m not I’m not there yet. I’m like, I feel like all debt is is just it’s just eating away at me or I’m not going to sleep at night. If I have this, then then you may be missing out a little bit because you can be strategic.

You can use the numbers in your favor because there are some logical reasons to be using the debt to help create these opportunities for you. And that’s why we want to share them here on this podcast is is help think about why you can use debt to help build up your wealth, how you can how you can do that.

What are the options here? We want to give you a glimpse about cash standing today.

Kyle Pearce: Yeah, the big piece here is that, you know, debt is definitely, you know, something that we have learned to become afraid of. Right. And and I think for good reason. Again, if you’re either irresponsible with that, if it’s bad debt, if it’s you know, it’s interesting and I find it slightly ironic that we’ve been trained to be okay with massive amounts of debt on depreciating things.

Right. So, for example, like now, like to buy a new vehicle, for example, people are buying cars and SUVs and trucks for over $100,000. And for some reason, we’re okay with that debt, even though that that vehicle will eventually end up in a landfill, like it’s not going to grow in value. And yet we have been sort sort of like trained so inappropriately to think that debt against assets is like a no go.

Like that’s risky. Right. And in reality, it’s quite it’s quite the opposite. The idea that really people struggle with when they get to their retirement or their financial freedom years is this idea that they’ve planned with an accumulation strategy. And the implied accumulation strategy, I’d say implied because no one really addresses it. But the problem becomes is that unless you have you’ve accumulated enough income or enough assets, I should say, where you can live off of the growth, that number is going to actually slowly decrease.

And I say slowly, it can be fast if you’re you’re spending a lot of money. And the problem is when you start pulling money from assets and that cumulation strategy where you’re trading in assets to live, you lose the compound effect of that large pile of assets, right? Whereas when we leverage against that pile of assets, you get to continue compounding this really large number, this really large value over each and every year while you borrow up to that amount.

And the reality is, is that if that pile is growing at anywhere close to the equivalent rate at which you’re borrowing, right, which generally is the case with assets, with most assets, you can be very conservative and still be outpacing the quote unquote rate of interest you might be paying on that debt. So in today’s episode, what we’re hoping you’ll get is this idea of of starting to we’ll call it mend your relationship with debt and start thinking about how can I use debt more in my favor so that I end up net ahead instead of following the typical debt advice, which is to essentially use it in the worst possible scenarios, buying new vehicles

And, you know, financing all of these depreciating things that make us feel good in the moment. The reality is, is we should actually be saving our use for debt against assets so that we can actually live a better life style. We can pay less tax because, hey, on debt, there is no income tax and be able to allow those assets to continue growing in the future.

So we actually don’t get this perspective or this thought that, oh my gosh, all of this hard work I’ve worked my entire life to build is now sort of depleting away and making you feel as though, you know, you’re in worse shape than you were when you first started. So if any of this is intriguing to you and if you are a incorporated business owner or maybe you are not incorporated, but you have a significant amount of personal assets, we encourage you to reach out to us for a discovery call so we can discuss some of the strategies that might be available to you.

Reach out over at Canadian Wealth Secrets dot com forward slash discovery and we can hop on a discovery call so we can get you optimized so that you can maximize the use of your assets and be introduced to some interesting strategies that will mean paying less tax and simply having a better financial future.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance. The show also digs into the underutilized corporate owned life insurance as a wealth building and Canadian tax planning tool through the use of participating whole life insurance that can not only resolve the issue of removing the income tax target from the back of your corporations retained earnings and put more money in your personal pocket both now and in the future.

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