re; Paying interest one year in advance
So i guess if you do it this way then you dont bother about a 15-15 tax variation cause u will be in positive cash flow during the year ? And at the years end you just pay tax based on the rent for the year less building depreciation against your exxisting income. Is that how it works ???
Thanks !
Dave [8D]Hi hwd007,
Why would you want to pre-pay the interest [?]
“All the world’s a stage, and you choose the role you want to play on that stage” William ShakespearThat’s what I thought Michael, but I can’t personally see any logical reason unless as you said you know that your income for the next financial year will be a lot lower. My first thought would be that if you’re in a position to do this (pre-pay interest with the intention of lowering your tax liabilities) then chances are you’re income the following year if anything will probably be higher [
]I would still think that a dollar in your pocket today is worth more than a dollar in your pocket tomorrow, and as such I would defer the payment as far into the next year as possible rather than try and pay it all now. Afterall, you are spending $1 to only get 30-40c back (which you’ll get back at the end of next year anyway – if you don’t fill out the tax adjustment forms prior to that).
There’s also the opportunity cost of the money you’re pre-paying. If the interest rate is say 7% that could be the deposit on another property to increase your income and wealth rather than a pre-payment to lower your tax.
“All the world’s a stage, and you choose the role you want to play on that stage” William ShakespearLeigh
A good example would be if you had sold a property and had a capital gain. Depending on the size of the gain and the size of your other loans, pre paying hte interest could wipe out paying any tax on the capital gain.
Terryw
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Would also depend on how long you have to wait to get the cash back. Some people with high salary and low investments try to bring forward their tax deductions. If you pre-pay on 29 June, you might have 50% of what you paid back in two weeks.
In general this would not be done by a serious investor, unless you were getting a deduction for the interest and paying it with borrowed money. In which case you would get cash back, with no cash outflow. How did that capitalisation of interest case finfish up?
I sold an IP about 2 months ago and will settle at the end of June. I made a decent cap gain of about $90k and was thinking about prepaying my interest bill in advance for FY 2003-2004.
I’ve decided against it because i see it as an endless cycle. If i prepay a year in advance, i’ll have nothing to claim for the following year… unless i do the same thing again.
Of course the banks love it if you do this, and the CBA will also discount the rate by .15% on fixed rates.
It seems like a continuous cycle, and something that would hurt for the year when you catch up and pay normally.
As Leigh says, i can think of better things to do with the $20k than get a bigger tax return back for one year, and then having less deductions the following year.It depends on personal circumstances. It would work well for me if I knew this option few years ago. I could make an IO advanced payment for my IP to reduce my taxable income for my last year at work. I could claim 48.5% on tax for the IO advanced payment & at the same time reduced my superanuation surcharge.
Huey
Now I’m a total newbie at this property stuff so please forgive my naivete in this arena, but here’s my twist.
erm. I just settled on a new property. interest will be about $13,000. Rent received will be about $1000. So given that I have no tax claims to make this year as this is my first property, surely it makes sense to prepay the $13k and claim it on tax for this financial year.
Otherwise this financial year will go unclaimed against and would then have to do a 15-15 tax variation, which would spread the tax rebates over the course of the year.
Now surely, If I can get a refund in less than 4 weeks on the $13K prepaid interest on borrowed money or redraw on my home mortgage where there are NO Tax deductions available, it makes some sense. I get a $13K reduction on my taxable income and get about $6K back from the ATO. Note this $6K is now put back against my home mortgage. Thus I still owe another $7K from the $13K I redrew to pay the interest.
Now because I paid the tax up front and got my refund early, I’m now in positive cash flow to the tune of about $1000 per month for the rest of the year. Thus each month I pump in $1K into my home mortgage to pay off the remaining $7K I owed on the $13K redraw. So in 7 months time I have paid off the full redraw and then have another 5 months of positive cash flow to reduce my home mortgage by another $5K in addition to my normal monthly repayments. Now I assume the tax rebate easily covers the extra interest I would have to pay on the redraw of $13K. I mean $6K is repaid within say 4 weeks ? with the tax rebate. The remaining $7K is repaid within 7 months.
So the total interest on the $13K for 1 month, plus the interest on the remaining $7K paid off over 7 months, would surely be miniscule compared to the tax rebate. Lets see $13K @ 6.17% pa, calculated daily for 4 weeks or 31 days is about $69 in accrued interest over that period. Now after 4 weeks I pay off $6K with the tax rebate.
Now for the next 7 months I have to pay the interest on the remaining $7K of the redraw. Now I wont go into it too deep, but oh what the heck, yes I will; Approximates only though ! I’ve rounded them up to the nearest dollar.
Month 1 $7K @ 6.17% over 31 days or 1 month = approx. interest of $37
Month 2 $6K @ 6.17% over 31 days or 1 month = approx. interest of $32
Month 3 $5K @ 6.17% over 31 days or 1 month = approx. interest of $26
Month 4 $4K @ 6.17% over 31 days or 1 month = approx. interest of $22
Month 5 $3K @ 6.17% over 31 days or 1 month = approx. interest of $16
Month 6 $2K @ 6.17% over 31 days or 1 month = approx. interest of $11
Month 7 $1K @ 6.17% over 31 days or 1 month = approx. interest of $6And don’t forget that interest paid will also surely be tax deductible at the end of the year ! Thus the total interest from the redraw being approx. $219 will be tax deductible in the next financial year.
Now come end of next financial year, I pay the delayed income tax on the remaining 11 months rent I received for the financial year against my salary income for that year and less all other expenses associated with the property that could not be claimed in advance, such as depreciation on building and fixtures & fittings etc.. rates, agent fees Corp fees etc…
Surely I just keep doing this each year. The bottom line is that I get jump start to tax claims that will then have a compounding effect each year particularly on my home mortgage repayment schedule, where no tax claims can be made. I thought this was the whole point of it ? Thus for a pre tax interest bill of $219, I gain a $6K tax deduction 11 months early meaning I get an 11 month early $6K injection against my home mortgage. Sure I will have to pay tax on the 11 months rent by next financial year, but then I will have other deductions for that year including payment of interest in advance again ! This savings effect will now compound throughout the remainder of my home mortgage. As I understand , it would be like paying interest on a lesser mount for the remainder of my own home mortgage loan.
Now if I settle on a second property also this financial year, which I am hoping to do with the nod and wink from the bank, then I can claim interest on the two properties up front. This other property returns a bit less, costs less , but over all the two properties interest bill will enable about a $10K tax rebate in total. Thus this $10K will be put against my home mortgage with a $10K compounding interest reduction effect for the life of the loan and the process would be repeated each year.
Admittedly I may have to pay some tax back at the end of the next financial year from the rent received over that period, but against another year interest paid in advance, that tax would partially be offset, depending on the rent cash flow and my income for that period against all other deductible expenses cash and non cash, over the same period.
Please guide me on this as this is just my slant based on what I have read thus far. If I’m an idiot please say so, in order that I can learn fast before the end of this financial year and make the right decision on this.
By the way, can I pay rates and real-estate agent fees and body Corp fees up front ? and claim on tax this year ?
Thanks in Advance ! ( pardon the pun ) Please refund me with the correct advice, well before the end of this financial year ! so I can get a head start in property investment.
newbie. [8D]
27 May 2003Mike,
Thanks for the comment and advice. I will try to look at the ATO rules as you suggested. I guess I will be putting much faith in my H & R Block accountant also. I hope they know the ropes for property. Glad you mentioned the other expenses and being over $1000 so long as they are for a full 12 month period. I guess that means rates and body copy and agent fees could all be paid in advance. Anyway I will discuss with my accountant I guess. Well the way I look at it, for me with such heavy gearing, the faster I get cash back the better. The bottom line for me is reducing my current mortgage as fast as possible and what ever strategy will achive that end.
cheers
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