Agreed. The deductibility of an outgoing is wholly dependent on the purpose for which the outgoing was incurred.  Therefore, the interest incurred on interest that is attributable to a loan originally taken out for an income producing purpose is generally tax-deductible. 

Dan42 is right though – if the sole or dominant purpose of letting the first lot interest be capitalised is to obtain a tax deduction on the second lot of interest, it could be argued that the second lot of interest was incurred for the purpose of obtaining a tax benefit.  It follows that in the absence of an income producing purpose, the second lot of interest will not be tax-deductible. 

Practically though, it shouldn't be difficult to argue otherwise.

Eddie
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Agreed with most of this, Terry. However, my view is that you can on-lend money to a discretionary trust and get a tax-deduction for the interest on the loan you drew down from the bank in the first instance, provided that the trust pays you interest on the on-lent funds.  The nexus that gives rise to the deduction in your hands, in this circumstance, is the derivation of interest income by you on-lending the funds you obtained from the bank to the trust.  This is in contrast to the situation where you borrow to buy units (fixed entitlement) in a unit trust, which is one of the issues with certain hybrid trusts.

I do agree that third party borrowing is harder these days.  Having said that, my bank did that for me recently without too much hassles.  If the issue is the corporate trustee, perhaps use an individual trustee who is also the borrower. 

Also agree with you that there is no point charging more interest to the trust because the amount by which the interest paid by the trust to you exceeds the interest payable by you to the bank will only give rise to tax in your hands.

Incidentally, there is no point negative gearing in a trust unless the trust derives other income.  Otherwise, the net loss is trapped within the trust until the trust derives income in future, if any, to recoup the carried forward tax losses.

Eddie
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This is theoretically correct.  You generally have 6 months to treat both properties (the one with the house on it and the new block on which you are building) as your tax-free main residence, subject to certain timing conditions.  You need to satisfy yourself that you qualify – the law is in section 118-140 of the Income Tax Assessment Act 1997 (alternatively, speak to your accountant). 

On the other side of the coin, if you have always had the intention to profit from executing the arrangement, there is a risk that the transaction may be treated as a one-off profitmaking undertaking, which means that the entire gain will be taxed as normal income, rather than CGT.  In which case, the main residence exemption will not be relevant. 

Again, I recommend that you speak to your accountant to ensure that you are comfortable with the tax implications before proceeding.

Eddie
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Be mindful though that transferring the assets from the existing company to a new trust may give rise to income tax (eg, CGT) and stamp duty. 

To manage the income tax and/or stamp duty, consider setting up a holding company a unit trust and form a tax consolidated group.  Once consolidated, any intra-group transactions (eg, transfer of assets) will be disregarded.  There may also be some relief for stamp duty under the corporate restructure exemption – however, I think there will be difficulties in respect of assets transferred to a unit trust.

Eddie
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Good point, Terry. The only instances I have seen wages being paid was when the trust consisted of several big personalities in families and everyone wanted to deal with the DT at arm's length, so the "active manager" who looked after the trust was treated as an employee under a bona fide employment arrangement.  Also, paying wages may come in handy if the person is an outsider of the family for the purpose of the Family Trust Election and any distribution to whom may have triggered the Family Trust Distribution Tax. 

But you're right, it's just easier to pay a distribution in 99% of the cases.

Eddie
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Agreed – provided that the trust deed does not prohibit the arrangement.

Eddie
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There is a strategy I am aware of that protects the equity of a property in an individual's name.  However, you will still need to use a trust on the side. 

The property will be treated for income tax purposes as if it is owned by the individual, not the trust.  If you go travelling, the potential tax implications will depend on whether you have ceased your Australian tax residency, whether you earn other income while you are overseas, etc, etc. 

All these issues are starting to get quite complex and I encourage you to see your accountant to resolve. 

Eddie
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Don't recommend artificially inflating the rent – the Commissioner can apply the general anti-avoidance provisions in Part IVA to unravel the arrangement.  On top of that, they can hit you with penalties up to almost double the tax shortfall.  Definitely worth it in my view. 

For future planning, you need to ask yourself: Am I doing this with the dominant purpose of obtaining a tax benefit? If so, Part IVA can arguably apply.  There is of course of a lot of grey in many circumstances – that is why there are so many court cases between the Commissioner and taxpayers.

The CGT main residence exemption will be relevant if you intend to hold for the medium to long term.  As a rule of thumb, if the expected future capital gain is material, I generally advise people to buy in their own name and use a separate strategy to protect the equity.  If capital gain is not an issue, it is probably okay to buy in a trust and get the trust to rent you the property under market rates.  But this will only provide a tax benefit if the trust derives other income to effectively negative gear against the property.

Eddie
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Sounds fine from a tax perspective because no cash actually moves in and out of the actual investment loans, which means that any interest incurred on the loans will remain tax-deductible, albeit the interest incurred may be reduced when there is money in the offset account.  This is so regardless of whether the spare money gets put into you or your wife's or both of you offset accounts.  As long as you don't actually touch the loan accounts, your proposal sounds ok for tax purposes.

Eddie
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There are certain "roll-overs" in the tax law, which provides for a similar tax outcome but the roll-overs are limited to very specific circumstance, eg, a small business selling its premises and buying a replacement property, matrimonial breakdown, etc.  In general, these roll-overs are not available to every day buy/sell transactions between arm's length parties.

Eddie
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