Hi guys,
I have an investment property and an interest offset account on my interest only loan. I have a huge redraw buffer oh my loan, so what I tend to do is redraw from the loan and repay the monthly interest payment with redrawn money.
This allows me to keep more money in my offset account, incase something were to happen, as redrawing takes at least 24 hours to be processed.
Q1. Is the interest charged on my loan still fully tax deductable? I do not redraw the loan for anything else. I do earn some rent from property, but its lower than what the interest charged on the loan is.
Q2. I made the common mistake of paying too much principal off my investment property and afaik this is not recoverable. I am now looking to buy a principal place of residence. If I let the loan redraw on itself to repay itself and I take out all the money from my offset account to buy a PPR, is all of the interest on my investment loan fully tax deductable? Again I do not redraw the loan for anything else.
thanks guys
1. This is dangerous. Technically you would be borrowing money and placing it into a savings account. If you have no money in this offset account other than the borrowed money, then the ATO could allow it as the funds are traceable. But you are also borrowing to pay interest, and the ATO may not be so happy with this, although it is technically allowable.
If the offset account contains any other funds, such as savings, wages, etc, then this is even more dangerous. Especially if you withdraw funds later for personal use.
2. You want to stop paying and then let the loan interest accumulate up to the original limit. This is a good idea, but also risky as the ATO could also disallow this if it is a scheme to just make a tax deduction.
Unless the loan is a LOC you may also find the bank will consider this a missed repayment and a default, even if you are ahead.
I would suggest you get a private ruling before doing either.
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
1. I only place money into my offset account from the loan, which then I pay back to the loan as part of the mandatory interest payment. No money sits in my account from the loan (only momentarily until the interest payment is taken). I do have personal funds in this account. I never redraw the loan for personal use.
2. I do not default on the loan, as the interest payment is paid from my offset account with the redrawn funds.
This thread is totally confusing.
Maybe some terminology is incorrect, however I still cannot see the fund flows and purpose.
Maybe some hypothetical accounts & transactions as examples ?
Cheers,
Rob
Sorry for the confusion, here is how I manage my loan:
Current balance $185k, Total loan amount: $250k
The loan is an interest only loan, I have an interest offset account linked. Currently I have $10000 in my offset account, which I use for day to day purchases.
Once a month interest is charged on my loan, last month it was ~$1100. I redraw $1100 from the loan the day before interest is charged into my offset account. The loan sucks that payment up automatically from my offset account.
Apart the night before, there is no money from my loan in my offset account ever.
Sounds like a less than ideal setup.
You will be mixing borrowings with savings.
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
It enables me to keep maximum funds in my offset account readily available at any time. There is no mix between borrowing and savings as anything that comes off my loan goes straight back on.
I am increasing the principal on the loan though by doing this… If I eventually buy my PPR and use funds in my offset account to purchase that, is the interest charged on this increased principal amount on my investment property still tax deductable?
What about the $10k. Is that savings?
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
P.S. is there any way to increase the principal owing on my investment property and still claim full tax deduction on the interest charged on the new loan amount, without redrawing it all and having to utilise that money for investment purposes? (ie. renovation)
The $10k is savings, but its offsetting the loan interest…
So you will be borrowing money and investing it in a savings account and mixing it with savings.
I would say the interest wouldn't be fully deductible. If you had no other funds in the offset then you could show the direct link and the funds would be uncontaminated.
Even assuming there was no savings in the offset then ATO could disallow it if it is a scheme just to increase tax deductions.
Later on if you take money out of the offset to pay for a private residence then this will make it even more mixed up as you will have borrowed money to buy a private asset.
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
Let's get back to fundamentals. To determine the deductibility of interest we must look at the use to which the loaned funds were put.
In the case of a re-draw, this is technically a new borrowing. This borrowing is not put towards the acquisition of an asset that will produce assessable income. Ie using it to pay the monthly repayment is not the same as using it to buy a property.
This being the case, the interest relating to the re-draw amounts will not be tax deductible. You need to do an apportionment calculation to determine how much of the interest can be claimed and this is going to be messy.
What you propose at Q2 will exacerbate this problem.
I see your points, thank you for the advice. But it’s quite obvious from the transaction history that I re-credit the loan for the entire original redrawn amount.
If I were to pay the interest every month out of my own pocket, the interest charged on my loan would be the same. For example:
Outstanding loan balance: $200k, interest charged 7%*(200k-offset_balance) = $1.108k; (assume offset_balance=$10k)
If I redraw the loan for this payment:
Redraw loan: $1k, Re-credit loan $1k, New loan balance: $201k, Interest charged 7%*(201k-offset_balance) = $1.114k (assume offset_balance = $10k)If I pay the interest out of my own pocket, without redrawing:
Outstanding loan balance: $200k, interest charged 7%*(200k-offset_balance) = $1.108k; (assume offset_balance=$10k)
Credit loan $1k from offset account, new interest charged = 7%*(200k – offset_balance) = $1.114k (assume offset_balance is now $8.886k)You’re saying the ATO will not allow me to deduct full interest at tax time if I take the first approach? I keep a log of what I redraw the loan for and it is quite obvious on the transaction history where the money is going.
Just to complicate the situation a little further, my minimum redraw amount from my loan is $2000. I have to redraw $2000 everytime I want money off the loan. Aside from redrawing the loan for interest payments every month, I also redraw it for the propertys bills, rates and repairs. I’ve just received a $1000 bill for installing a new air conditioner, if I redraw $2000 from the loan, pay the air conditioner repair man $1000 from this $2000 redraw then re-credit the loan with the remaining $1000 from the redraw, is the interest charged on this $1000 tax deductible?
I’m sorry guys, I’m really lost as to how to best deal with my situation and my appointment with my accountant isnt until November. Any advice provided will allow me to sleep at night until then.
Money borrowed to pay interest on your investment loan would usually be an allowable deduction.
The problem is the temporary redraw and parking with private funds (in the offset account) causes loss of traceability.
e.g.
$10k private funds in offset account.
$10k interest payment is due. Redraw the day before and park in offset account.
When you take the $10k out of your offset to pay your interest, this will consist of $5k private funds already in the offset plus $5k sourced from you IP loan. You CANNOT CHOOSE which portion you withdraw.
So your IP loan has increased by $10k (redraw), but only $5k of that principle is related to an income producing purpose. The other $5k remains in your offset account to replace the savings used from the latter account.
Over time, your IP loan will increasingly become mixed up with private purpose funds.
Regards,
Rob
Rob G. wrote:Money borrowed to pay interest on your investment loan would usually be an allowable deduction.
The problem is the temporary redraw and parking with private funds (in the offset account) causes loss of traceability.
e.g.
$10k private funds in offset account.
$10k interest payment is due. Redraw the day before and park in offset account.
When you take the $10k out of your offset to pay your interest, this will consist of $5k private funds already in the offset plus $5k sourced from you IP loan. You CANNOT CHOOSE which portion you withdraw.
So your IP loan has increased by $10k (redraw), but only $5k of that principle is related to an income producing purpose. The other $5k remains in your offset account to replace the savings used from the latter account.
Over time, your IP loan will increasingly become mixed up with private purpose funds.
Regards,
Rob
How will it consist of $5k private funds and $5k sourced form the loan? I am redrawing the entire $10k from the loan and paying the loan interest payment with that redrawn $10k. The balance left in my offset account is as it was before I made the redraw.
Here is an analogy.
Place 500ml of water into a jar.
Now place 500ml of urine into the same jar.
Then take out the 500ml of Urine.
Would you drink the water?
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
hahaha nice analogy…
At the end of the day, interest will be calculated annually and deducted at tax time. The total interest charged on my loan will be some interest $x. The rental income will be $y.
The tax deduction will be based on $x – $y – expenses. I can show by way of transaction history on both my offset and home loan accounts where the money is going once redrawn off the loan. I’m sure $x charged on the loan will still be fully tax deductable.
The ATO are currently attacking scenarios where people are seeking to claim deductions for money borrowed to pay interest on investment loans.
Need to be careful on this front.
Refer:
http://law.ato.gov.au/atolaw/view.htm?rank=find&criteria=AND~tr~basic~exact:::AND~2011%2Fd8~basic~exact&target=FA&style=java&sdocid=DXT/TD2011D8/NAT/ATO/00001&recStart=1&PiT=99991231235958&recnum=2&tot=2&pn=ALL:::ALLIf you can demonstrate that the interest is the same either way then you would appear to have a good argument that you are not engineering tax benefits.
However, it seems that if you are able to avoid the withdrawal and repayment scenario it would be better for your position. Can you just let the interest hit the account and eat up the re-draw without having a problem with your lender?
I think there are 2 issues here.
1. The mixing of borrowed funds and savings = no full deduction.
2. Capitalising interest = generally deductible if the underlying interest is deductible, but the ATO can still disallow it under Part IVA.
If you want to go ahead:
1. Change the loan structure. t make it more likely you will get a full deduction.
eg split the loan. Have an IO loan with $10k in the offset against this. Then have a separate LOC to pay the interest. Put all cash into the offset, but no borrowings.2. Have a good reason for not paying the interest on the IO loan each month. If this reason is to build up cash to pay for your PPOR down the track then the ATO will likely disallow the 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
Terryw, how would they calculate the tax deduction available on borrowed funds vs savings?
If you have pulled the interest payment from the loan the night before and placed it back on the loan the day after, the interest charged on the loan will not be any different to what would have been charged if you paid the interest payment without redrawing.
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