Paying Non Deductable Debt - Alternatives?

[Coach B]

Good Morning Everyone!

I have been kicking this apple around for some time and haven't really been able to find a definative position.

Scenario A -

PPOR Value $500,000
Mortgage $250,000

IP (in Trust) $300,000
Mortgage $150,000

Q.) How can I get the $150k equity out and apply it against non-deductible?

[Corsa]

Hi Coach B

Could you:

Get a Line of Credit on your IP. Based on a LVR of 80%, you should be able to get a limit of $240,000, so less your current loan of $150,000, this will give you an increased loan of $90,000

Then, assuming you get $250 a week rent on your IP, could you take all this rent and put this into your home loan, or even better an offset account against your PPOR loan in the event that you wish to use this money for another PPOR or purpose down the track. This would result in an extra $13,000 a year off your home loan.

In addition to this, could you capitalise your IP Loan Interest and IP Property costs and use your IP LOC to pay for these property expenses, which would then result in this loan interest being deductible.

Based on a loan of $150,000, your interest repayment will be approximately $880 a month and property costs based on 30% of the rent will be $325 to give a total of $1200 a month or $15,000 a year.

So in broad terms, increasing the loan on your IP LOC by $15,000 a year will mean that it will take approximately 6 years to get to your IP LOC limit. And applying the rent off your home loan will take approximatly 7 years to reduce your home loan by the $90,000.

The only other thing you could do is sell really, realised the capital gain, offset this against your PPOR Home Loan and the get a LOC on your PPOR Home Loan and borrow to fund more IP's purchases.

I would investigate this with your accountant to try and work through a scenario that works for your situation.

Hope this helps

Best Wishes

Corsa

[Coach B]

Get a Line of Credit on your IP. Based on a LVR of 80%, you should be able to get a limit of $240,000, so less your current loan of $150,000, this will give you an increased loan of $90,000

Corsa,

Thanks for the reply. I still have a disconnect that you might help me with?

If my Trust borrows $90,000 and uses it to pay off my mortgage;
1. On what basis is the Trust able to claim that the interest expense was incurred to earn assessable income: and
2. If the money comes out of the Trust is it a gift, a loan or a distribution? Under any of these scenarios is the payment from the Trust to me taxable? For eg if it was by loan and from a corporate entity it could be viewed by the ATO as a deemed dividend.

Once again thanks for you assistance.

Regards


CB

[Corsa]

Hi Coach B

I just re-read your question, sorry I posted the question as if the IP was in your own name.

I dont know the tax treatment for trusts so I will refer this question to someone who specialises in this area.

Good luck

Best Wishes

Corsa

[Mry]

Hmm, I wonder if you could redeem all the units in the trust, cash out your loan and then issue new units for $300,000? Or issue new units in addition to the existing units? I haven't really looked at if it would be allowable, you have to inspect the deed and worry about Part 4A taking effect.

It might be less mucky to sell the house to another HDT which had $300,000 in units but the capital gains and stamp duty would have to be incurred on the transfer. It would then be a cost of transfer vs additional future tax benefits question.

If you want to get a loan in the trust, and use the proceeds to pay off your non-deductible you really should speak to your accountant as I am not sure that you would be able to arrange it.

Typically, making nondeductible debt deductible involves the transfer of capital from one entity to another.

Of course some other accountants may have some ideas on this subject.

[alwayscurious]

I had lunch with my accountant today.

Amongst other things, I floated the idea of selling my house to a trust and renting it back. Short answer: No.

The ATO looks very dimly on this - as the anti-tax avoidance laws state all transactions must be undertaken for a valid commercial reason
- not just to avoid tax.

They would view the sole reason of this is to turn a non deductible debt into deductible, and therefore would classify it as tax avoidance. Essentially they are right, the only reason I would want to do it is to avoid non-deductible debt.

My accountant said - it is like waving a flag to a bull and saying "Audit me!!, Fine me!!" which no one wants.

If it was done for a valid reason, like this example:
I am going to move house into another, and sell it to the trust, and then rent it to someone else -

then it would be kosher.

While this is slightly different in approach to what is being proposed here it might be worthwhile REALLY checking this out. It could be a problem if you are audited etc.

Would be interested to see an accountant's view point on this.

Regards
alwayscurious

[Mry]

I had lunch with my accountant today.

Amongst other things, I floated the idea of selling my house to a trust and renting it back. Short answer: No.

If it was your PPOR, I would agree. The question in this thread relates to what you can do with the IP though. Discussion about the sale of the PPOR into a trust for renting back is something I would never contemplate.

The ATO looks very dimly on this - as the anti-tax avoidance laws state all transactions must be undertaken for a valid commercial reason
- not just to avoid tax.

Asset protection and restructure of asset ownership are valid commercial reasons. And Part4A, the law you refer to, states that the predominant reason for an arrangment cannot have as its sole purpose getting tax breaks. The ATO view it as an anti-tax avoidance law, most accountants believe it is a restriction on a taxpayer's previously legal right to arrange their affairs in a tax advantageous way, and a law which is completely open to abuse.

I believe Part 4A is their response to Kerry Packer's legendary remark.

[alwayscurious]

If it was your PPOR, I would agree. The question in this thread relates to what you can do with the IP though. Discussion about the sale of the PPOR into a trust for renting back is something I would never contemplate.



Asset protection and restructure of asset ownership are valid commercial reasons. And Part4A, the law you refer to, states that the predominant reason for an arrangment cannot have as its sole purpose getting tax breaks. The ATO view it as an anti-tax avoidance law, most accountants believe it is a restriction on a taxpayer's previously legal right to arrange their affairs in a tax advantageous way, and a law which is completely open to abuse.

I believe Part 4A is their response to Kerry Packer's legendary remark.


Ooops - you are right about part a). It is about an IP in the trust. Not PPOR... My wrong assumption.
I won't sidetrack this discussion with my bit of thinking about that.


Regarding moving equity around to pay off PPOR however:

Doesn't the ATO treat the final use of the funds as what determines tax deductibility?

No matter how complicated the structure - it's the final use that determines deductibility.

Ie if you took the equity out by cashing out your units, borrowing more from the bank and re issuing special units, then using some of it to pay out your mortgage on your PPOR...

the final use of that money would be to pay out your mortgage on your PPOR not investment purposes.

Therefore not tax deductible right?

[Mry]

Doesn't the ATO treat the final use of the funds as what determines tax deductibility?

The purpose of the borrowed funds is what determines tax deductibility. Where the money flows is a guide, but not the decider. If I borrow money to buy shares off a friend at market value, and he uses the proceeds of the sale to go on an overseas holiday, does that override the original purpose of the loan?

[Simon]

The purpose of the borrowed funds is what determines tax deductibility. Where the money flows is a guide, but not the decider. If I borrow money to buy shares off a friend at market value, and he uses the proceeds of the sale to go on an overseas holiday, does that override the original purpose of the loan?

No - You borrowed to buy shares. That would be deductible. make sure you get a record of the transaction and ownership to substantiate your claim.

Remember that to redraw is the same as a new loan. So if you redraw from a home loan for shares this is now a deductible debt. Conversely if you redraw/borrow against an IP for personal use it will not be deductible.

As far as moving equity I believe there has to be a change of ownership for this to occur. ie the property is sold to a spouse who borrows 100% plus costs to buy it from you. This money then goes into your PPOR. This may trigger CGT and Stamp Duty so may not be financially viable.

Hope this helps but as always I am no accountant just a well meaning chap in an internet room.

[Aceyducey]

Borrow against your PPOR and IP and buy three or more IPs in a Trust.

12 months on, sell your PPOR and move into one of your IPs at market rent.

Your debt is now all deductible.

The ATO is happy because clearly you didn't do this for tax purposes.

Cheers,

Aceyducey

(BTW this isn't precisely how we've done it - we have a declared PPOR - which we don't live in).

[quiggles]

Or borrow against your IP and buy a cashbond (a la Steve Navra). Use the income stream to pay down the loan.

[DaleGG]

Hi

I guess the answer will really depend upon:

what type of trust it is; and/or
whether the trust owes you money as well as owing money to the bank

The trust simply be able to borrow money against its equity in the IP and repay the loan to you. You have then replaced one loan (to you) with another loan (from the bank) and the interest should be tax deductible regardless of what you personally do with the funds that the trust pays you.

Dale

[DaleGG]

Hi

I don't entirely agree with your accountant, but, I can see that his/her advice is very good in terms of keeping you out of trouble.

There are a couple of strong court cases that found that having the home inside the trust can be perfectly legal when done for asset protection purposes.

For what it is worth...this is my situation.

Also, if the trust acquires the home on the basis that it is building a portfolio of properties, and, you are merely renting one of those properties for the time being until you move onto bigger and betetr things then you ahve a commercial argument for the house being inside the trust.

A longer term view is important with your plans.

My thoughts are that the tax office should be respected, but, not feared if you plan your affairs well and do everythng in terms of concentrating your focus on the creation and protection of wealth. Tax advantages are then just a pleasant bonus.

Have fun

Dale

I had lunch with my accountant today.

Amongst other things, I floated the idea of selling my house to a trust and renting it back. Short answer: No.

The ATO looks very dimly on this - as the anti-tax avoidance laws state all transactions must be undertaken for a valid commercial reason
- not just to avoid tax.

They would view the sole reason of this is to turn a non deductible debt into deductible, and therefore would classify it as tax avoidance. Essentially they are right, the only reason I would want to do it is to avoid non-deductible debt.

My accountant said - it is like waving a flag to a bull and saying "Audit me!!, Fine me!!" which no one wants.

If it was done for a valid reason, like this example:
I am going to move house into another, and sell it to the trust, and then rent it to someone else -

then it would be kosher.

While this is slightly different in approach to what is being proposed here it might be worthwhile REALLY checking this out. It could be a problem if you are audited etc.

Would be interested to see an accountant's view point on this.

Regards
alwayscurious

[calvin@34]

Originally posted by Aceyducey:
Borrow against your PPOR and IP and buy three or more IPs in a Trust.

12 months on, sell your PPOR and move into one of your IPs at market rent.

Your debt is now all deductible.

The ATO is happy because clearly you didn't do this for tax purposes.


Would this then also be available to convert the PPOR into an investment house? This is what I wanted to know and don't seem to get straight up?
When selling the PPOR, sell it to the trust!? Even if I waited 12 months it would simply convert un-claimable debt into claimable debt, correct? And, after this timeframe, the ATO wont be exessively suspicious? :confused:

[Coach B]

Or borrow against your IP and buy a cashbond (a la Steve Navra). Use the income stream to pay down the loan.

Quiggles,

Thanks for the option. I wonder if you could enlighten me to some of the practical considerations.

Say, I borrow within the Trust to say 90% LVR which gives the Trust $120k in cash. I then buy a Cash Bond over 3 years at $40k (approx) pa in non taxable income.

How do I get the money out of the trust and into my personal name without changing the tax status on the Cash Bond?

Cheers



CB

[Coach B]

Borrow against your PPOR and IP and buy three or more IPs in a Trust.

12 months on, sell your PPOR and move into one of your IPs at market rent.

Your debt is now all deductible.

The ATO is happy because clearly you didn't do this for tax purposes.

Cheers,

Aceyducey

(BTW this isn't precisely how we've done it - we have a declared PPOR - which we don't live in).

Thanks Acey,

I like this approach but can see two matters that need further consideration;

1. Telling my wife that we have to move.
2. CGT issues if I ever decide to sell my PPOR in a trust.

Cheers


CB

[Coach B]

Hi

I guess the answer will really depend upon:

what type of trust it is; and/or
whether the trust owes you money as well as owing money to the bank

The trust simply be able to borrow money against its equity in the IP and repay the loan to you. You have then replaced one loan (to you) with another loan (from the bank) and the interest should be tax deductible regardless of what you personally do with the funds that the trust pays you.

Dale

Thanks Dale,

This shows one of the key advantages of a HDT.

However, had I borrowed the $150k IO (deductible) to buy units in the Trust I still can only get back the $150k. I pressume that I would have to pay down any deductible debt not non deductible debt with the redemption of units.

In a normal discretionary trust if the $150k was in as a loan the interest on the loan would be deductible, however, same scenario on repaying the loan, it goes against deductible debt.

Cheers


CB

[alwayscurious]

Hi

I don't entirely agree with your accountant, but, I can see that his/her advice is very good in terms of keeping you out of trouble.

There are a couple of strong court cases that found that having the home inside the trust can be perfectly legal when done for asset protection purposes.

For what it is worth...this is my situation.

Also, if the trust acquires the home on the basis that it is building a portfolio of properties, and, you are merely renting one of those properties for the time being until you move onto bigger and betetr things then you ahve a commercial argument for the house being inside the trust.

A longer term view is important with your plans.

My thoughts are that the tax office should be respected, but, not feared if you plan your affairs well and do everythng in terms of concentrating your focus on the creation and protection of wealth. Tax advantages are then just a pleasant bonus.

Have fun

Dale

Dale,
Thank you for your reply.

I agree that if a valid commercial reason can be shown that is not just "tax avoidance" then it will be OK. This has to be documented and proved.

To be fair on my accountant - I probably didn't phrase the question as neatly as I could have.

My accountant was giving me advice that if I set up a trust, immediately moved my PPOR into it, and stopped there - this would be a flag to the ATO that I am deliberatly avoiding tax as there is no obvious commercial reason to do so.

However:
I understand your point about the trust building a portfolio of assets, and the PPOR being one of those assets.

I think in my situation I would be comfortable if I started the trust, putting the first of a portfolio of assets as an Investment Property.

At a later stage I could consider moving the PPOR into the trust for the following commercial, well documented reasons:

a) asset protection purposes

b) I trade as a sole trader in a seperate business and as such have a risk of being liable, and my assets are at risk.

c)the trust is building assets and the PPOR is one of those

d) we are going to be moving on from our PPOR within a planned timeframe (documented, planned) and it will turn into an IP at that time.

I guess the mechanics of this scenario would mean I would then be renting a property off the trust. I would no longer personally own any assets.

I will discuss this point of view with my accountant.

I guess the key here is Documenting and Proving that my actions have a valid commercial reason.

Kind Regards
ac

[alwayscurious]

Borrow against your PPOR and IP and buy three or more IPs in a Trust.


12 months on, sell your PPOR and move into one of your IPs at market rent.

Your debt is now all deductible.

The ATO is happy because clearly you didn't do this for tax purposes.

Cheers,

Aceyducey

(BTW this isn't precisely how we've done it - we have a declared PPOR - which we don't live in).

Aceyducy - Bingo.

Why 3 or more? :) Is this the magic number or just pulled out of a hat?

Cheers
alwayscurious

[MasterInvestor]

Acey, why not just make one of those properties in personal names, the other two in trusts. That way they could move into the personal one and claim that as their PPOR and get CGT free status (except for the first period when it was rented).

MI

[redwing]

good ideas Acey..

But why do you still have a 'declared' PPoR?

We are looking at buying the next Ipin the HDT and renting it 'at market rent', we will obviously value add to the property and will most likely move out in 2-3yrs and new tenants will move in..we will thenmove onto the next IP..

Currently we have 3 IP's though this will be number 1 in the HDT

we will also buy/sell shares through the trust, i believe this will also assist in showing it is a business venture