All Topics / Legal & Accounting / Cash flow strategy. Is this Legal

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  • Profile photo of ruffy1ruffy1
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    @ruffy1
    Join Date: 2008
    Post Count: 2

    Hi All,
    We are looking at purchasing our first IP
    Our broker has suggested using a Strategy that maximisers Tax benefits.
    It works like this.

    HL 200000         IL 240000 (IO)      LOC  200000(Int capitalise)
    Offset ACC         

    All our income goes into our offset account

    LOC receives rental income and pays IL and any other expenses associated with IP, The LOC will slowly go up but at the same time our offset will be increasing by putting excess cash into it, We then pay off the nondeductible debt quicker while the deductible debt increases. In effect we are claiming interest on the IL and on the LOC thus maximising tax benefits.

    Is this strategy any good?

    Thankyou
    Paul

    Profile photo of TerrywTerryw
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    @terryw
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    This looks very similar to being a scheme to increase tax deductions. Read the case of Hart v FCT (2004) and read it in full before you try this.

    Your broker shouldn't be providing tax or legal advice unless qualified so run it by your accountant or lawyer first.

    Capitalising interest is allowable as is borrowing to pay business expenses. There are various private rulings from the ATO as well as a recent draft determination which says capitalised interest can be deductible as long as the original purpose of the loan was investment/business related.
    I think to make your case stronger you should use at least 2 different lenders to make it look less like a scheme.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Profile photo of Ben EllingsenBen Ellingsen
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    Paul
    Providing the finance products are separate products and not "under the one umbrella" as one facility, I don't see a problem – from a Tax Office perspective. If they are one facility, the Tax Office would apply Part IVA of the Tax Act which basically says that what you have set up is a sham and they remove the tax benefit and charge interest and penalties.
    Obviously any strategy that reduces your non-deductible debt quicker than deductible debt will have some after tax cash flow benefits.

    Profile photo of TerrywTerryw
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    @terryw
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    I just reread the original post – and it seems less aggressive than the Harts.

    In the Harts case it was a product marketed by a lender with the specific aim of increasing tax deductions. The Harts put all of their income and rental income into the home loan portion and let the whole interest on the LOC capitalise.

    Paul is using the rent to pay part of the LOC loan

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Profile photo of Richard TaylorRichard Taylor
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    @qlds007
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    Away from the validity of the scheme I would be more concerned that as Terry mentioned that your mortgage broker has given you advice on everything from an Offset Account to Tax minimisation which unless he is Licensed to do he cannot provide any advice in regards to such products.

    Richard Taylor | Australia's leading private lender

    Profile photo of ruffy1ruffy1
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    @ruffy1
    Join Date: 2008
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    Thankyou for your replies.

    The loans (all three) would be set up at the same time by the same lender. However we will keep the IL and LOC completely seperate to our HL mortgage. Is this a common way for investors to set it up?

    Ben, What classifies as 'not being under the one umbrella'. We will have three seperate products from the one lender. Is this OK

    Profile photo of YossarianYossarian
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    @yossarian
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    The tax office get's very interested in any arrangement, the structure of which, cannot be "explained" other than as a mechanism to avoid or minimise tax. As with all these things (a) don't establish a tax efficient structure based on the advice of someone not licensed or qualified to do so and (b) if there is any doubt, get a private ruling.

    Profile photo of TerrywTerryw
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    @terryw
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    Really, all you are trying to do is to fund the shortfall on an investment property and want to borrow to do this.

    Run it by your accountant.

    I ran something more aggressive past my friend who was high up in the ATO for many years. I asked him what he thought of paying all the rent into the offset account (not the LOC) and then borrowing from the LOC to pay the interest on the investment loan and all costs, and then just paying the interest on the LOC every month. He seemed to think it was ok and just suggested using the offset rather than paying down the PPOR loan as it looks less like a scheme to pay down the PPOR faster (IO for this) and he suggested using 2 separate lenders.

    Paul, why not just use 2 different lenders to put some extra distance between the 2.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of Dan42Dan42
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    @dan42
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    Paul,

    My question is, what are the funds from the LOC being used for? Is all of the $200k from this loan to be used for the IP?

    Profile photo of WJ HookerWJ Hooker
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    @wj-hooker
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    My question is…. How can you claim the deductions on the LOC if it is not associated with the Investment?
    The IL is for the house, so how can the LOC you build up be put against the house???
    You can only claim the interest against the property that is getting rental.
    I cannot get a loan for $400,000 against a $350,000 rental property??

    Am I missing something here??

    Profile photo of ducksterduckster
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    @duckster
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    The ATO can sometimes remove an allowable tax deduction and back date it if it rules it not to be allowable and sees it as a scheme to avoid tax. Meaning you could end up having to pay it back 5 years of deductions in 2014 when they change their mind and change the ruling.

    Ask your broker for their financial advice license number before accepting any financial advice.

    Also you are using the dark side of the force. Compound loan interest !
    As your investment loan increases so to does the force of compounding interest work against you.

    Profile photo of TerrywTerryw
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    @terryw
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    WJ Hooker wrote:
    My question is…. How can you claim the deductions on the LOC if it is not associated with the Investment?
    The IL is for the house, so how can the LOC you build up be put against the house???
    You can only claim the interest against the property that is getting rental.
    I cannot get a loan for $400,000 against a $350,000 rental property??

    Am I missing something here??

    WL

    The LOC will be used to pay for expenses and the interest (partial) on the investment property. ie borrowed money will be used to fund the shortfall of the investment property.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of TerrywTerryw
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    duckster wrote:
    The ATO can sometimes remove an allowable tax deduction and back date it if it rules it not to be allowable and sees it as a scheme to avoid tax. Meaning you could end up having to pay it back 5 years of deductions in 2014 when they change their mind and change the ruling.

    Ask your broker for their financial advice license number before accepting any financial advice.

    Also you are using the dark side of the force. Compound loan interest !
    As your investment loan increases so to does the force of compounding interest work against you.

    Duckster

    I don't think the ATO can suddenly change the law on what is deductible and then backdate it! can u give any examples where this has happened.

    What they can do is decide that someone is doing something as a scheme and declare it invalid. This happened in the Hart case. It wasn't that an allowable deduction was suddenly outlawed and this backdated. The judgment in Harts even says that capitalising interest is allowable and that they probably could have done something similar and had it accepted if it wasn't setup as a scheme. It seems they set their loans up with the dominant purpose of gaining tax benefits, over and above the commercial benefits.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of holdandrefinanceholdandrefinance
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    @holdandrefinance
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    apply for a private ruling i have last financial year had it was appproved.there is a tax lawyer named julia hartman who writes in australian poperty investor and is very knowledgeable on this subject it might be worth reading some of her articles regarding capitalised interest or go to the ato website and look up private ruling numbers 69725 and 63384.its worth a try

    Profile photo of TerrywTerryw
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    thats a good idea Holdandrefinance. Julia's website is http://www.bantacs.com.au and there are a lot of free articles on there with many concerning capitalising interest.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of WJ HookerWJ Hooker
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    Terryw,
                Thanks for reply and education.
    I can understand what you are saying and understand the tax claim, but , boy it seems so dodgy to me. Basically, its saying, Hey I got this loan which I can't repay. So I'll borrow some more to pay the shortfall and claim it as a tax deduction??

    Profile photo of TerrywTerryw
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    @terryw
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    WJ

    But as the investment LOC goes up, the home loan will be going down at the same or faster rate. You are just structuring it to reduce non-deductible debt faster – of course not for tax purposes, but for cashflow reasons.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of holdandrefinanceholdandrefinance
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    @holdandrefinance
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    Post Count: 38

    its never for tax purposes is it?

    Profile photo of TerrywTerryw
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    @terryw
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    never

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of WJ HookerWJ Hooker
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    Terryw,
                Thanks again for reply. Understand more now.
    I will do some maths and look at it over time. I have never tried one of these before, I guess I am just too conservative.

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