Ongoing IP costs into Interest Only Loan - never pay off + claim interest?

[DavidMc]

Hi everyone,

I'm going to ask another cheeky question again.

On my first investment property I had a hot water service fail and had to shell out $1000 to purchase a new one. I paid for this on my credit card and ended up paying $92 interest on the amount, which I claimed as 'sundry expenses' on my tax return. I had read this was OK somewhere. Was it in the ATO's guide? or a property investment book? I can't remember. Either way, it was verified by my accountant.

This got me thinking.

Would it be possible to lump all ongoing costs of running my income producing investment into an interest only loan or LOC with a view to never paying it off and claiming the interest on that amount? I'm talking about landlord insurance, rates, water, those type of expenses. As long as I can increase the limit of the LOC quicker than the expenses come in (which should be the case), then over time I could start to increase my deductable interest.


Regards,

David.

[JPM]

Hi David,

This is exactly what we do for all our properties.It works out very well if you still have a PPOR loan that you are paying off.

I reccomend it to you. IT has made a HUGE difference to us because we have quite a large amount of expenses each year.

Just don't do it with interest ok? The tax department won't have a bar of that!!!

Regards,
Jason

[DavidMc]

Fantastic! :)

Why have I been paying all these things out my personal cashflow for so long rather than 'putting it on the tab'! :eek:

For the time being this is still OK for me as I don't own my PPOR or have any non-deductable debt to 'better use the money'. I have some funds in an account offsetting the deductable IP loan, so when the expenses come out of my offset the interest payable on the IP loan increases anyway. Once I purchase a PPOR then I'll have to set it up.

I'm assuming due to the frequent redraws (or sweeps of your 'IP credit card') that you could only do this with a $nil redraw / LOC loan.

Do you claim these amounts under 'Interest on Loans' or 'Sundry expenses' in you tax return?

[JPM]

David,

The accountant verified it. It's a legitamate business practice. It's claimed under interest.

Our expenses for all our properties last year was probably around the $30K mark so it makes a difference if i can plow that into the ppor loan. as long as youve got a fair chunk of available equity its a strategy that if used wisely can help you a long in your wealth accumulation journey.


We use a LOC. I have a credit card that i put the bills on (get the points up!!) then have it set to clear the debt each month from the LOC.

Talk to your accountant or talk to Dale, just to clarify.

Regards,
Jason

[DavidMc]

Final question :)

Do you use one LOC + CC for all of your properties or do you have a separate one for each?

To account for each property accurately you would need separate ones, right? Or is there no real need to account for each one individually (with the tax office only being interested in 'totals'). Having separate ones would probably attract a lot more fees even within a professional package.

[JPM]

David,

Keep the questions coming if you want. It's no probs.

I actually have a LOC for each property.Really only have 2 cc's for properties. Your right about about the tax office only being interested in totals.

This may not be the best way but it's basically one loan with a sub account for each property. I can change the amonuts of each loc if i want, as long as they dont go over the overall limit.

We use two different banks. ANZ and Macquarie. The CBA wealth product seems to be quite good also. But I'm no broker!!!

Regards,
Jason

[Mry]

I would give a word of caution here. The ATO doesn't like it if people have loans that accumulate deductible interest in order to claim "interest on interest", especially if you have a PPOR loan at the same time. I'd recommend as a bare minimum an interest only loan. If you want to go all the way and claim the interest on the interest, you can do so at your own risk.

The couple who went to court were technically and legally correct in claiming interest on interest, but the ATO with all powerful Part 4A won over them.

You would have to have a valid commercial reason for doing so if the ATO came knocking, not just "I wanted to save on tax".

[DavidMc]

Good point. It does seem a Basic(ish) Interest Only loan with at least 12 free redraws per year would be the best product for this to work (12 being the number of credit card sweeps you'd want).

No doubt you'll pay a slightly higher interest rate to have your free redraws which will reduce the benefit you are trying to achieve.

Other option would be to have a LOC that doesn't capitalise interest although I'm guessing this would be an even higher interest rate again.

[twodogs]

I recently started capitalising expenses to prepare for buying a new ppor with much greater non-deductable debt. I just do a bulk redraw from normal I/O IP loan every month, transfer to a transaction account used just for investment, and pay expenses from there. I record the break up of the redraw so I know what it was for (eg 2x$500 rates + 3x$200 water = $1600 redraw)

The loan I/O payments are met every month per normal from private money, no interest on interest (until I know it is safe to do this...)

Aim is just to move non-deductable debt to deductable, and help personal cash flow a little as well.

[JPM]

Guys,

Agree totally. If you see one of the earlier posts in this thread I mentioned to be carefull about the interest component.

I pay my interest each month out of my 'personal' money. No way would I capitalize interest, just the expenses.

Sorry if I gave that impression.

Regards,
Jason

[julia]

All,

You have got me really worried here. I would just like to make some clear guidelines to make this idea work.
Firstly, you are only allowed to claim interest if the money borrowed was used to buy something that was income producing. Accordingly, if you use a line of credit to pay off the credit card you have been living off then that amount was borrowed for non tax deductible purposes. This makes an awful mess of a normally tax deductible loan and can reduce it to 100% non tax deductible within 5 years because any repayments have to be pro rataed between the loan for the IP and the loan for the CC this of course means a larger portion of the repayments pay off the IP and the portion of CC debt increases each month.
Secondly, we now have Domjan's case to contend with, where unless there was a clear connection between the monies borrowed and the expense the interest is not deductible. In Domjan's case the placing of borrowed funds into a personal cheque account to pay IP expenses broke the nexus and the interest on the borrowed funds was not deductible. The ATO is not enforcing Domjan yet but it does give them the precedent if they ever want to.
Thirdly, a substantial part of the ATO argument in Hart's case was the fact the bank marketed the arrangement as a tax minimisation scheme. If you can't afford the interest payment that month because of financial hardship and the bank lets you add it to your loan balance you will not be caught by the precedent in Hart's case.
So how should you run your affairs? As a general rule, there may be better ways looking at individual circumstances:
1) Only use a LOC with a CC for private purposes on a non deductible Loan
2) If other loans for IP are LOC, only draw on them for IP expenses and make sure these expenses are paid direct not mixed with in a private chq account or a credit card used for private purposes as well.
3) Compound interest only when financially necessary.
4) If you do not have a PPOR yet, do not use funds in the offset account to pay IP expenses. Draw them from the LOC keeping the offset amount as high as possible. The net result has no effect on interest but this will increase the amount of deposit you will have in the offset account for you PPOR. When you draw this out the original loan for the IP is still fully tax deductible.
5) An offset arrangement is far better than an LOC as it leaves the funds available for private purposes if needed.
6) Always put the offset account on the non deductible loan.

Julia Hartman
julia@bantacs.com.au
www.bantacs.com.au

[JPM]

Thanks Julia,

I guess I wasnt explaining myself too well. I NEVER capitalize interest whether thats the loan or the credit card. All bills for investment are paid on the card, this is then paid out in full each month. This gives me a record of my expenses.The money to pay the card comes from the LOC which is TOTALLY for the running of my investment property 'business'. The interest payment on the LOC is paid from my personal money (rent) each month.

Two points:
* I never capitalize interest
* I never mix anything to do mith my personal affairs and the running of our investment properties.

Regards,
Jason

[DavidMc]

Time has moved on… LOC has been established.

Any final comments on this arrangement would be appreciated!

My situation – renting PPOR, 3 IP's (IP’s 1-2 in my name, IP 3 held in Trust).

Accounts
Transactional - Personal
Offset (against IP 1 loan) – wages in, personal expenses out
Personal Credit Card – personal expenses out, swept from offset account

Loans - Investment
IP 1 Loan
IP 2 Loan
IP 3 Loan (Trust Loan)

Transactional - Investment
Investment Credit Card – IP 1-2 expenses (water, rates, etc), swept from Investment LOC
Investment LOC – interest on IP 1-3 loans out, investment credit card sweep out, IP 1-2 rents in, tax return in, trust profit distributions in (i.e. IP 3 rent)

Trust Business Account – IP 3 rent in, IP 3 bills out, distribute profits to Investment LOC


The final piece of the puzzle – where should the interest charged on the LOC come from? Should I capitalise this or pay this from my personal account? (I’m leaning towards personal account, so I don’t get into any ‘interest on the interest’ problems).

My main aim of this setup is to have a nice separation of my property investing and my personal affairs. I guess you could say I’d like my investments ‘stand on their own feet’ and run them more like a business rather than dipping into my personal funds to prop them up. Right now my portfolio is CF+ (slightly) however if this ever changed the concept would be to increase this LOC in line with equity/expenses.

[StuartW]

Hi domcc1

My take on this is that its ok to finance property expenses via debt and direct all income to non-deductible debt. However, I would suggest that you use your personal income or rental income to pay for the interest (i.e. don't finance the interest). It doesn't matter what income pays for this. Hope that helps.

[DavidMc]

My take on this is that its ok to finance property expenses via debt and direct all income to non-deductible debt. However, I would suggest that you use your personal income or rental income to pay for the interest (i.e. don't finance the interest). It doesn't matter what income pays for this. Hope that helps.

Thank you Stuart for your comments.

Just to double check :) , 'the interest' you are referring to above is the interest on the LOC?

[GlennM]

Julia,

So if I establish say a second Credit Card that is solely used for Investment purposes only and use this to pay for IP expenses, I can then sweep amounts across each month from my LOC account and claim the interest from this account?

Under this scenario:
1) I effectively free up cash flow as the LOC pays for these expenses
2) The LOC will build up over time and I can claim deductible interest accordingly
3) The second Credit Card that is used exclusively for Investment purposes only will build up reward points

Your thoughts?


GlennM.

[bonecrusher]

Hi all

I spoke to my accountant in regards to paying for IP costs and capitalizing costs.

His response was that:
1) Rent should be paid into the IP LOC account if this has a shortfall
2) the LOC will pick up the shortfall
3) The interest must be paid every month on the LOC

Thats my understanding of it.

Cheers
BC

[DavidMc]

That's what I've deducted from this thread and from talking with a couple of accountants.

One said it was OK to capitalise the LOC interest but agreed it's certainly 'cleaner' to simply pay for this out of personal income/funds. The interest charged on the LOC is tax deductible as long as it's only investment expenses being charged to that account.