Hi again,
I have a question about the deductibilty of interest when converting a PPOR to an IP. Please allow me to put forward a scenario:
Purchase PPOR $500,000
P & I Loan $400,000Now let's say I repay $50,000 of principal and the loan balance is now $350,000.
If I was to then move out of the house, and keep it as a rented IP, I could technically claim the interest on the $350,000 loan as 100% deductible right? (This is obviously where the benefit of an initial interest only loan and offset account come in, but assume that I repaid the $50k rather than putting it in the offset).
Is there any way I can re-draw that $50k whilst the property is still a PPOR, and then be able to claim the interest as a tax deduction on the full $400k again once it goes to an IP?
If not, what about if the funds were used specifically to renovate/improve the property? Would this then make the full loan interest deductible once converted to an IP?
Thanks in advance for the always-useful assistance – It's been helping me since 2003!
Regards,
YI.YoungInvestor wrote:Hi again,I have a question about the deductibilty of interest when converting a PPOR to an IP. Please allow me to put forward a scenario:
Purchase PPOR $500,000
P & I Loan $400,000Now let's say I repay $50,000 of principal and the loan balance is now $350,000.
If I was to then move out of the house, and keep it as a rented IP, I could technically claim the interest on the $350,000 loan as 100% deductible right? (This is obviously where the benefit of an initial interest only loan and offset account come in, but assume that I repaid the $50k rather than putting it in the offset).
Is there any way I can re-draw that $50k whilst the property is still a PPOR, and then be able to claim the interest as a tax deduction on the full $400k again once it goes to an IP?
What you have to ask yourself is what marginal tax rate are you on as it is probably 30% max if you earn <$80,000
So you want to lose $100 to get $30 back as a tax deduction.
http://www.ato.gov.au/individuals/content.asp?doc=/content/12333.htm(Be careful as negative gearing is not as attractive as it used to be due to lower tax rate scales)
YoungInvestor wrote:If not, what about if the funds were used specifically to renovate/improve the property? Would this then make the full loan interest deductible once converted to an IP?
Yes if the improvements can be justified as required for income producing purposes but don't forget to claim depreciation on improvements.
Rather than reinvent read these two postings.https://www.propertyinvesting.com/forums/getting-technical/finance/4328443?highlight=redraw
https://www.propertyinvesting.com/forums/property-investing/help-needed/4327731?highlight=redraw#comment-188660Thanks Duckster.
I'm in the 38c tax bracket for the upcoming year, but have a full understanding of the implications of -ve vs +ve gearing.
The consideration was mainly that I would rather use any additional cash as equity into the new PPOR purchase (via an offset account), rather than paying off the current PPOR which will become an IP and have deductible interest.
In an ideal world, i'd have no debt and would be happy to pay tax on all the passive income, but i'll grin and bare a few more years of employment before I start getting too excited about that just yet.
With regards to the deductibility of the interest, I was kind of hoping there might be a way to restructure the loan to make the principal I have already paid deductible once the property becomes an IP, but it would appear not!
The two other links you posted explained it perfectly – Thanks again!
Regards,
YI.It will depend on what the $50,000 withdrawal is used for. if it is used for something associated with the property then the interest will be deductible.
There is also another one around this, slower though more effective. According to TD 2008/27 the principles governing the deductibility of compound interest are the same as those governing the deductibility of ordinary interest. This means that if the interest on a loan is deductible then if you compound the interest (ie capitalise it) it will be deductible. Therefore it is possible for you to set up your loans in such a way as to borrow to pay the interest on the IP loan. Best to talk to a good accountant about setting it up and to apply for a private ruling.
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
Hi Terry,
So let me use another example here just to clarify:
If I take a $100,000 LOC and purchase $50,000 worth of shares, I can let the interest capitalise to the facility and it will be fully deductible? ie: If say $3500 of interest is charged to that facility for the financial year, I can claim on the full amount?
At the moment I have my investment facility interest come directly out of my Offset account, but if capitalised interest can be deducted then I will let it accrue to the investment facility and keep more cash in my offset (which is against non deductible debt).
Am I off the mark here? I was told previously that capitalised interest was not deductible so just want to make sure.
YI
Yes. if you get a LOC and use it to purchase an income producing asset and then let the interest capitalise it can be deductible. ie you just let the loan increase, not pay the interest, but still claim it and then use the income from that asset to pay down non-deductible debt – or even better to keep the income in the offset.
You could also set up a LOC and then use this to pay the interest on the investment loan and put all income into your offset – wage and rents.
But you have to be careful and should get a private ruling otherwise the ATO may deem it a scheme to avoid tax.
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
Two questions:
1. Are you suggesting to get an individual tax ruling for the interest capitalising issue, or only the seperate loan to pay the interest issue (or both!?). Just want to find out if you are 100% sure on the interest capitalisation question, or if you think it is best to speak with the ATO for that one too.
2. Could the same thing potentially be done with a PPOR before converting to an IP? ie: Let the interest capitalise against the PPOR loan, and then you would have a higher, deductible loan when you swap over?
Thanks mate,
YIHere is the TD i referred to which says capitalised interest retains its character:
http://law.ato.gov.au/atolaw/view.htm?docid=TXD/TD200827/NAT/ATO/00001
I think it is pretty clear, but the ATO can still apply Part IVA and say you are setting up a scheme to avoid tax, so best to get a rling on the overall setup. ie letting interest capitalise and not applying any income for that asset to this loan but applying it to the PPOR loan or offset account.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
Very interesting Terry.
After reading that, I will be comfortable in allowing the LOC I use to purchase shares to capitalise interest (until it reaches the limit of course).
I will definitely obtain a seperate ruling on setting up a seperate loan though – Seems a bit more risky and may come off as setting up a scheme.
Just ran some numbers on allowing the LOC interest to capitalise vs putting into offset. Should save me between $1500-200 p.a until such time as my offset balance reaches my home loan balance so thanks for the info
The only way I can repay you for you info is by spreading your name amongst my network and directing my NSW clients to you (very small number as I am based in Melb, but even one new customer for you would help so I'll see how I go).
Regards,
YIby the way… I love the ATO's 'get out of jail free card' to make sure they don't put their foot in it…
"16. This Determination does not deal with the question of the application of Part IVA of the ITAA 1936 to arrangements involving compound interest."
sneaky
Can someone explain to me what capitalised interest is……..please
not paying the interest on a loan, but letting it build up.
Or borrowing from another loan to pay interest.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
YoungInvestor wrote:Very interesting Terry.After reading that, I will be comfortable in allowing the LOC I use to purchase shares to capitalise interest (until it reaches the limit of course).
I will definitely obtain a seperate ruling on setting up a seperate loan though – Seems a bit more risky and may come off as setting up a scheme.
Just ran some numbers on allowing the LOC interest to capitalise vs putting into offset. Should save me between $1500-200 p.a until such time as my offset balance reaches my home loan balance so thanks for the info
The only way I can repay you for you info is by spreading your name amongst my network and directing my NSW clients to you (very small number as I am based in Melb, but even one new customer for you would help so I'll see how I go).
Regards,
YISomeone with a few properties with some available equity could very quickly pay off their home loan using this method. Imagine if you had say $50,000 pa in rent coming in from 3 properites and could plough this all into your home loan.
It is a very powerful technique!
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
Very powerful indeed – What you have described is exactly my situation.
I have IP's and shares as well as a PPOR (overall gearing about 50%), so if I can divert all the income from the investments to the PPOR then I can probably pay it off before I'm 30 – That would be massive!
Thanks again for your help – I'll let you know about the ruling I get from the ATO.
Regards,
YI.It can also be a way to live off equity and to retire early. ie let loans capitalise and live on rents and dividends.
Goodluck with the ATO
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
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