I have an interest only investment loan with a redraw facility. I got my property manager to plonk the rental payments directly into the loan. I also “parked” some of my extra cash in there to reduce interest and took it out when I needed it for personal use.
My friend recently told me that the ATO regards the “parked” money that I took out to be funds borrowed for personal use ! This is so even though I had no intention of using the extra money to actually pay off the loan !
Looks like my investment is now in a mess as I have been putting extra money in and taking money out for about 6 months.
Not sure what to do now but thought I better tell my storey just in case any newbies like me wasn’t aware.
bennido,
Your facts are correct and there is very little you can do to fix it. The worse thing is that you cannot deposit money into the loan to specifically pay off the private portion. You can refinance and split the loan and make the private portion P&I and leave the deductable portion as interest only. It is even a masive job to work out the portions.
. Based on the principle that the interest on a loan is tax deductible if the money was borrowed for income producing purposes, the interest on a line of credit could easily become non-deductible within 5 years. For example: A $100,000 loan used solely to purchase a rental property is financed as a line of credit. To pay the loan off sooner the borrower deposits his or her monthly pay of $2,000 into the loan account and lives off his or her credit card which has up to 55 days interest-free on purchases. The Commissioner now considers there to be $98,000 owing on the rental property. In say 45 days when the borrower withdraws $1,000 to pay off his or her credit card the loan will be for $99,000. However, as the extra $1,000 was borrowed to pay a private expense, viz the credit card, now 1/99 or 1% of the interest is not tax deductible.
The next time the borrower puts his or her $2,000 pay packet into the account the Commissioner deems it to be paying only 1/99 off the non-deductible portion i.e. at this point there is $96,020 owing on the house and $980 owing for non-deductible purposes. When, 45 days later, the borrower takes another $1,000 out to pay the credit card, there will $96,020 owing on the house and $1,980 owing for non-deductible purposes so now only 98% of the loan is deductible, etc, etc.
In addition to the loss of deductibility, the accounting fees for calculating the percentage deductible could be high if there are frequent transactions to the account. The ATO has released TR2000/2 which confirms this and as it is just a confirmation of the law it is retrospective.
To ensure deductibility and maximise the benefits provided by a line of credit you will need an offset account that provides you with $ for $ credit. These are two separate accounts – one a loan and the other a cheque or savings account. Whenever the bank charges you interest on the amount outstanding on your loan they look at the whole amount you owe the bank i.e. your loan less any funds in the savings or cheque account.
A loan setup incorrectly will lose all deductibility within 5 years on average.It is pretty ironic that the ATO rulings penalises my actions. Considering that I parked extra money in there to reduce interest on the investment loan, which in turn actually benefits the ATO by lowering tax-deductible interest.
You are right, there are a lot of transactions that I did as I deposited my salary into the loan and lived off it. So there were quite a number of redraws for personal use. Oh well, I’ll try to sort it out a bit myself before I go to an accountant.
What a bummer !
Julia,
Is it worth writing to the Commissioner with the statements and a suggested arbitrary division and asking for a private ruling?
This is not my area and I am just trying to have a think about it.
Cheers,
Simon Macks
Mortgage Broker
http://www.mortgagehunter.com.au
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
To prevent the mess from getting worse, I have stopped all parking of funds and only pay off the interest every month.
As the amounts transferred are not much in this case, would the ATO be lenient with me and treat it as an unintentional lodgement error ?
I have never been audited or dealt with the ATO, so I am not sure how strict they are. Are they anything like the US IRS in the movies ?
Hi everyone,
Thanks for bringing this topic up, it makes for good info reading.
I remember seeing Paul Clitharoe (not sure thats spelt right) but I always heard him say that LOCs were ideal coz you had access to money when you needed it for IP purchases and that if you dumped all your money (wages, salary, rental etc) into it (to reduce tax) and live off your credit card, paying it off before interest free period was up, it was a good way of saving $$$. But now I’m reading from you guys, this is not the right way according to the ATO??
What do you mean Julia about having an offset account (savings or cheque account)?? I mean whats the point of having a LOC if the money you put in cant be redrawn?? If that were the case wouldnt you be better of with a P&I home loan or some such setup (and at lower interest rate)?? So on a 100K LOC you’re saying what, 80K LOC for IP purchases and expenses and 20K LOC for personal stuff. What if for arguements sake you spend some of the 80K on repainting an IP which cost say 5K aren’t you in effect “double dipping” by (a) claiming interest paid on 80K (not on 75K less the paint) and (b) 5K for repainting IP – hence two claims??
Seems really complex to me!! [blink] Seems like this splitting of loans is the ATOs way of splitting hairs!! [confused2]
Pepper
I am not a big fan of the LOC. I would rather see a client use an offset accout to park funds in. If a deposit is needed for an IP then a split on the PPOR loan should suffice.
Regards,
Simon Macks
Mortgage Broker
http://www.mortgagehunter.com.au
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
Yeah, I remember Paul C talking about the benefits of LOC, but I think he was referring to PPOR loans and not IP loans.
I think what Julia is saying is that for IP loans, having an offset account is better than LOC for tax simplification. You can move money in and out of the offset account without affecting the tax deductability status of the loan. While at the same time, reducing interest paid. Sorry if I misunderstood you, Julia !
This ruling is not totally obvious on the ATO website and I am fairly sure a lot of mum-dad investors are in the same shoes as me. They’ll probably only realise the implications at FY end when they pay their annual visit to the friendly neighbourhood accountant.
Glad to see that this line of discussion helps !
So Bennido your loan is not a LOC is that right??
And I guess anyone who has a LOC this ruling applies to them to??
Sorry if I keep asking silly questions, but it seem strange to me. Why bother with LOCs if you cant access the money as you see fit?? [blink]
Pepper
Actually the answer is – BOTH ! … LOL !
My IP loan is a LOC with redraw and an offset account. For whatever stupid reason, I parked my monies in the loan itself. Actually, it was so I could actually see the amount owed being reduced (albeit temporarily). It was a purely psychological comfort thing which I am really regretting.When I set up the loan, I thought I could redraw the funds without affecting the tax status of the loan. Like I would only take out as much as I had put in extra, and not a cent more. But apparently it doesn’t make a difference to the ATO.
Hmm..so what your telling me Bennido is that in effect that LOC actually stands for Load Of Crock!! [lmao]
Sounds really crazyto me, why would anyone pay a higher interest rate for the prevlidge of flexibility that really they aren’t able to have?? Coz if they try to they get penalized??
And what about the “double dipping” isnt that going cause problems if there is an audit done??
Pepper
I wouldn’t totally agree though about LOC. If you has the discipline and use the redraw to get money for purely investment purposes, the whole interest would still be deductible.
What would be interesting though is if you redrew the money for another IP, would you need to keep track of the how much of the loan is for which IP ??
In short, I would not touch an IP loan with redraw ever again.
Originally posted by bennido:What would be interesting though is if you redrew the money for another IP, would you need to keep track of the how much of the loan is for which IP ??
Id say if you purchased another IP the contract document outlining the price would be evidence enough as would be the paperwork from your solicitior with the breakdown of settlement costs ie. stamp duty, legals etc!!
Pepper
We have two LOCs – one private and one purely for investment purposes. Works well for us and keeps all deductible expenses separate in the one account.
Id say if you purchased another IP the contract document outlining the price would be evidence enough as would be the paperwork from your solicitior with the breakdown of settlement costs ie. stamp duty, legals etc!!
Not as plain as that Pepper.
Taking funds from a loan or from a LOC is deemed as a new loan – the purpose of this loan then determines the deuctibility.
So if you put $10 000 into your LOC then take it out again a month later for personal reasons it is non-deductible.
The only safe place to store this money with an IP is in an offset account.
There are also issues with storing money in a PPOR loan if that PPOR will become an IP at a later date.
This is a minefield folks and you need to be well informed or advised.
Regards,
Simon Macks
Mortgage Broker
http://www.mortgagehunter.com.au
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
Originally posted by MortgageHunter:Taking funds from a loan or from a LOC is deemed as a new loan – the purpose of this loan then determines the deuctibility.
So if you put $10 000 into your LOC then take it out again a month later for personal reasons it is non-deductible.
Excuse my ignorance here Simon, but I was curious when I read your post….surely if what Pepper is saying that is, you take money out of the LOC to purchase say for example a 200K property + 10K for costs hence redraw 210K that is/should be proof of (an investment) purchase??? At the same time, I understand what you’re saying that if you parked 10K into the LOC and then redraw it for personal reasons it is classified as non-deductible, but IMO buying the IP is not “personal” and should be deductible??? Please correct me if I am mistaken here.[blink]
Although I don’t have a LOC myself, I would imagine many people probably are not adequately informed on these differentiations; that in fact there are some “grey” areas which people are unaware of. Hence this thread may help to clarify and hopefully eliminate some of the confusion.
Cheers,
Jo
Jo,
If you buy an IP with a $100K LOC.
You deposit $10K into it for a few months then you use it for a holiday. You figure it will reduce your interest for a while.
However the ATO now see it as a new $10K loan for private purposes.
I hope this example helps clarify it.
kindest regards,
Simon Macks
Mortgage Broker
http://www.mortgagehunter.com.au
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
BUGGER BUGGER!!!
Just reading over this post, it seems i have also made a big doo doo.
This is what i did……..
Re-financed a few IP’s into an interest only set up, locked for 3 years. no money in, none comes out. however I got access to the refinanced money, and deposited it into the loans of a few other Ip’s where the loan was P+I, the whole amount went in, again, all these properties were investments. this left the loans that were P+I with only a few grand oweing. the reason i did this was that the loans were newish, and they would have got little benefit from a refinance, but i also wanted access to the money should i see another good investment…
However …. several months ago i sold an IP and the profit i made was deposited into one of the same the same P+I loans mentioned above. this money was taxed, and seeing as it was a profit from a sale, i guess i could have done what i pleased with the money. thinking that it would have helped out both me and the ATO, by reducing the interest i popped it in as an extra repayment.
Is this money now lost, should i want to go on holiday or buy that new car? meaning, will the difference in interest repayments before and after the deposit and withdraw be not tax deductable for the amount of “my” money that i put in …
i hope i have made sense……
Again… bugger bugger bugger…
Thanx,
Jason
Originally posted by TeacherK6:…. several months ago i sold an IP and the profit i made was deposited into one of the same the same P+I loans mentioned above. this money was taxed, and seeing as it was a profit from a sale, i guess i could have done what i pleased with the money. thinking that it would have helped out both me and the ATO, by reducing the interest i popped it in as an extra repayment.
…
Sounds exactly what I thought too ! That putting money in temporarily would benefit the ATO so they would be OK with it. But apparently not which I think is a really odd ruling to a layman like me at the very least.
Redraw that money for investment purposes only and you will be right.
Use an offset account to store money is the lesson.
Sorry to be the one with the bad news. [glum]
Simon Macks
Mortgage Broker
http://www.mortgagehunter.com.au
0425 228 985Comments may not be relevant to individual circumstances. If you intend making any investment, financial or taxation decision you should consult a professional adviser.
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