When to and when not to capitilize interest?

I agree on the point that going to much trouble and cost to setup "asset protection" seems to be a waste for most investors. Furthermore, it would seem that most people would be better off in the long run to purchase in personal names (eg. in partner's name).

I have recently employed a trust structure merely for business income distribution and do not intend to purchase properties using it as I can't see any advantages at this point in time.

However, I disagree that capitalisation of interest is a complex or time-consuming activity. To me it seems to be a very simple way to help me achieve what is ultimately my main goal in purchasing investment properties - to own outright a very nice PPOR (secondly, and less importantly to have some investment properties geared up at a very conservative LVR to invest in shares).

Of course it's important not to lose track of the bigger picture, which for many is to continue to accumulate properties to utilise future capital growth and to pay down debt to improve cashflow and ability to hold these properties. Capitalisation of interest just happens to be one of many useful tools to help one pay down non-deductible debt or improve cashflow.
 
Lukey13 said:
I agree on the point that going to much trouble and cost to setup "asset protection" seems to be a waste for most investors. Furthermore, it would seem that most people would be better off in the long run to purchase in personal names (eg. in partner's name).

I have recently employed a trust structure merely for business income distribution and do not intend to purchase properties using it as I can't see any advantages at this point in time.

However, I disagree that capitalisation of interest is a complex or time-consuming activity. To me it seems to be a very simple way to help me achieve what is ultimately my main goal in purchasing investment properties - to own outright a very nice PPOR (secondly, and less importantly to have some investment properties geared up at a very conservative LVR to invest in shares).

Of course it's important not to lose track of the bigger picture, which for many is to continue to accumulate properties to utilise future capital growth and to pay down debt to improve cashflow and ability to hold these properties. Capitalisation of interest just happens to be one of many useful tools to help one pay down non-deductible debt or improve cashflow.
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Posts with examples, now we're getting somewhere. Good stuff Lukey.

For me, it is all about maximising my tax position as I am on a fairly high wage and I pay a lot of tax. If I have a large tax bill(capitalising interest helps this), I get more back at the end of the year. Providing my investments grow at a higher rate compared to my "loss", I'm in front.

Also agree that overly complex asset protection is a waste of time, but this thread isn't about that stuff, so let's stick to capitalising interest and when it is or isn't a good idea. Thanks.
 
At the end of the day, if your assets are growing faster than your liabilities, and your income is growing faster than the expenses - then I wouldn't have a problem with it. If you have the situation above occuring and can also throw in a more favourable tax result (therefore increasing your income over expenses further) which seems to be your main reason - why not.

If on the other hand you were capitalizing the interest, then blowing your entire wage on holidays, cars etc resulting in an overall reversal of the above scenario - then I'd say your capitalizing would be unhealthy.
 
I think it comes down to how close to the edge you like to sail and what your SANF is. For me capitalizing interest is a fallback position when things get tight but not part of our general strategy. We also haven't done 95% loans, margin loans on shares, no-doc loans etc. which could have got us further than we are now but also could have got us unstuck.

I guess you have to ask yourself what would happen if you lost your well-paid job, got sick, interest rates blew out etc. If you are covered for all those possible events, don't mind that your are increasing debt on investments without increasing their income and are positive your investments will always grow and you will always be able to take out new loans to capitalize interest further when you need to - then go for it.

I think Steve's point is a good one - using the spare income not going into interest payments for other investments is a smart move and would be good risk mitigation.

kaf
 
kaf said:
I think it comes down to how close to the edge you like to sail and what your SANF is. For me capitalizing interest is a fallback position when things get tight but not part of our general strategy. We also haven't done 95% loans, margin loans on shares, no-doc loans etc. which could have got us further than we are now but also could have got us unstuck.

I guess you have to ask yourself what would happen if you lost your well-paid job, got sick, interest rates blew out etc. If you are covered for all those possible events, don't mind that your are increasing debt on investments without increasing their income and are positive your investments will always grow and you will always be able to take out new loans to capitalize interest further when you need to - then go for it.

I think Steve's point is a good one - using the spare income not going into interest payments for other investments is a smart move and would be good risk mitigation.

kaf
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Finished putting a deal to bed this morning that *once again* had all the hallmarks of the book/seminar sucker bet including the 'ol financial time-bomb that is capitalising interest/paying debt with debt.

From zero to $3.2M dollars in property to bankrupt in 5 years.
 
I have come to the view that there is very little to be lost in maximising your credit lines at all times. Capitalising interest is one way of doing this. Provided the offsets are there and growing then it doesn't really matter but you have to have the intestinal fortitude to resist temptation to dip into them. This is more difficult than it sounds for some it seems...

If you get sick etc and NEED credit, that is the worst time to be asking for it. Get the maximum credit in place now as well as the offsets, then sit on them for a rainy day, or top pounce on that perfect CF+ve IP! ;)
 
HiEquity said:
I have come to the view that there is very little to be lost in maximising your credit lines at all times. Capitalising interest is one way of doing this. Provided the offsets are there and growing then it doesn't really matter but you have to have the intestinal fortitude to resist temptation to dip into them. This is more difficult than it sounds for some it seems...

If you get sick etc and NEED credit, that is the worst time to be asking for it. Get the maximum credit in place now as well as the offsets, then sit on them for a rainy day, or top pounce on that perfect CF+ve IP! ;)
Click to expand...

Thanks HiEquity, I think it's all coming together now.

It appears that if my offsets are growing quickly and I am capitalising interest to maximise my tax position, then it's probably a really good strategy.

And if I get sick or if I need large sums of money urgently, the offsets will be bursting at the seams FULL of cash which I can access quickly, so there'd be no issue. When the interest charges get to a point where it does not benefit my tax position any longer, I'll pay the LOC down with cash from an offset so I strike a nice balance. That, coupled with non X-col loans, landlord insurance, life insurance, a working wife, etc, etc, I believe my finances are structured well.

At least that's my take on it anyway, but please put your 2 bob in if you think I'm wrong.
 
The_Bludger said:
but please put your 2 bob in if you think I'm wrong.
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I think you're wrong and yes, you are missing something......

Firstly, as Rolf and Lukey already mentioned, I would say that the main instance where capitalising interest could be worthwhile is if you have PPOR debt, ie. non-deductible debt.

I think when you do the sums, the savings can be quite significant and can really accelerate the elimination of non-deductible debt (admittedly though, by creating a smaller deductible debt in the process).

I know many people who have used this strategy quite successfully, and no Evand, they are not naieve ''mum and dad'' investors.

You, The_Bludger, have no PPOR debt it seems, so I don't see it as being a worthwhile strategy for you.

Personally though, it's not something I have done just yet as I don't have a PPOR, I am a renter and have IP's only.

What you're basically planning to do is capitalise interest on deductible debt on the one hand, and increase that deductible debt further, and at the same time reduce that deductible debt by putting cash into a presumably 100% offset account...???

Fundamentally, it doesn't make any sense.

The only time this would work is if you took the money in the 100% offset account and say invested it in high growth shares or more property.

But then you'd have nothing in your offset account...!

Risky, and quite possibly stupid.

Anyway, that's my 2c!

Hope it makes sense.
 
JIT

Debt recycling still has value without having PPOR debt. It just gives you a bigger pool of funds to use for potential non-deductible purposes (eg sickness, bigger future PPOR etc etc) while maximising your future deductions in the event you need to use the cash. The growing cash in the offset account is ready for deployment for these eventualities in a tax effective manner which wouldn't be available had debt recycling not been pursued.

However, I do agree with evand - this is not the main game and focussing on it is likely to lead to a lack of focus on more profitable pursuits... just my opinion!
 
HiEquity said:
JIT

Debt recycling still has value without having PPOR debt. It just gives you a bigger pool of funds to use for potential non-deductible purposes (eg sickness, bigger future PPOR etc etc)
Click to expand...

Yes, that's true to a degree.

HiEquity said:
while maximising your future deductions in the event you need to use the cash. The growing cash in the offset account is ready for deployment for these eventualities in a tax effective manner which wouldn't be available had debt recycling not been pursued.
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But how tax effective is it really?

You're increasing tax deductible debt and decreasing it at the same time?

I did a thread on this years ago and Simon Macks a poster here did the numbers on it back then and we established that it was ''neither here nor there'', ie. maybe a very marginal benefit.
 
JIT said:
But how tax effective is it really?

You're increasing tax deductible debt and decreasing it at the same time?

I did a thread on this years ago and Simon Macks a poster here did the numbers on it back then and we established that it was ''neither here nor there'', ie. maybe a very marginal benefit.
Click to expand...

That's true - before you use the cash for that unforeseen non-deductible purpose / emergency.

It's after you use the offset cash that the improved tax benefit really kicks in, if you take my meaning... if you never use it the tax benefit never applies! If you want a PPOR that's $100k better than the one you already have and you have debt recycled that $100k into an offset account already then you can trade up and keep everything tax deductible still... for example.
 
JIT said:
I think you're wrong and yes, you are missing something......

Firstly, as Rolf and Lukey already mentioned, I would say that the main instance where capitalising interest could be worthwhile is if you have PPOR debt, ie. non-deductible debt.

I think when you do the sums, the savings can be quite significant and can really accelerate the elimination of non-deductible debt (admittedly though, by creating a smaller deductible debt in the process).

I know many people who have used this strategy quite successfully, and no Evand, they are not naieve ''mum and dad'' investors.

You, The_Bludger, have no PPOR debt it seems, so I don't see it as being a worthwhile strategy for you.

Personally though, it's not something I have done just yet as I don't have a PPOR, I am a renter and have IP's only.

What you're basically planning to do is capitalise interest on deductible debt on the one hand, and increase that deductible debt further, and at the same time reduce that deductible debt by putting cash into a presumably 100% offset account...???

Fundamentally, it doesn't make any sense.

The only time this would work is if you took the money in the 100% offset account and say invested it in high growth shares or more property.

But then you'd have nothing in your offset account...!

Risky, and quite possibly stupid.

Anyway, that's my 2c!

Hope it makes sense.
Click to expand...

What JIT said but in less words ;)
 
HiEquity said:
That's true - before you use the cash for that unforeseen non-deductible purpose / emergency.

It's after you use the offset cash that the improved tax benefit really kicks in, if you take my meaning... if you never use it the tax benefit never applies! If you want a PPOR that's $100k better than the one you already have and you have debt recycled that $100k into an offset account already then you can trade up and keep everything tax deductible still... for example.
Click to expand...

Yes, I understand what you're saying.

Depends on what The_Bludger plans to do re. his "possible future upgraded PPOR/other non-deductible debt".
 
The_Bludger said:
Are there any general rules to when to and when not to capitilize interest? .
Click to expand...

My own specific rule is not to use capitalization of interest as a long term strategy to hold property. I do however use my LOC's to:

1) Pre-pay all Ip outgoing costs (rates, water, etc, etc) a year in advance, and then pay out the LOC when I receive my tax return.

2) With one of our loans pre-pay interest a year in advance, using a LOC, but then pay off the LOC with rent received during the course of the year.

So each of my LOC's is effectively cleared each year, and then the process starts afresh the next year.

I find that LOC's are a helpful tool in managing the running costs of the portfolio and they allow me to pre-pay bills in advance (interest on one loan) which helps my overall tax situation.

Regards Jason.
 
JIT said:
Depends on what The_Bludger plans to do re. his "possible future upgraded PPOR/other non-deductible debt".
Click to expand...

Not really planning on upgrading the PPOR, currently renovating and we'll be here for another 10 years at least, probably forever actually.

Might upgrade the boat, but that won't happen for a while, the car is still ok and not planning any extravagant holidays to Europe, so probably won't need bagfulls of cash for a while. Kids are still young, so private school fees are years off.

Thanks for everybody's feedback. The haze in my head is starting to clear somewhat.
 
The_Bludger said:
Not really planning on upgrading the PPOR, currently renovating and we'll be here for another 10 years at least, probably forever actually.

Might upgrade the boat, but that won't happen for a while, the car is still ok and not planning any extravagant holidays to Europe, so probably won't need bagfulls of cash for a while. Kids are still young, so private school fees are years off.

Thanks for everybody's feedback. The haze in my head is starting to clear somewhat.
Click to expand...

If that's the case then I would think that for you the overall $ benefit of this strategy wouldn't be that great, but you'd have to do the numbers yourself for your particular situation to establish exactly what that $ benefit is, and whether it is worthwhile.

LOC's eventually run out, so it will need a continual top-up for the strategy to work indefinitely.
 
jingo said:
My own specific rule is not to use capitalization of interest as a long term strategy to hold property. I do however use my LOC's to:

1) Pre-pay all Ip outgoing costs (rates, water, etc, etc) a year in advance, and then pay out the LOC when I receive my tax return.

2) With one of our loans pre-pay interest a year in advance, using a LOC, but then pay off the LOC with rent received during the course of the year.

So each of my LOC's is effectively cleared each year, and then the process starts afresh the next year.

I find that LOC's are a helpful tool in managing the running costs of the portfolio and they allow me to pre-pay bills in advance (interest on one loan) which helps my overall tax situation.

Regards Jason.
Click to expand...

Yeah, I can see some merit in that. I can also see that having a LOC setup specifically for investment purposes helps book keeping come tax time, as all of the interest payments and expenses relating to income producing assets are easily tracked and managed in the one account. Providing you split this between all of your IP's, I doubt the Tax office would be too hung up about it unless you got audited, for which you then would have to break down items individually. Only guessing.

So even though what JIT and others have said makes perfect sense, there still are some advantages(Ie. tax - maybe, but more importantly keeping the accounting side of things clean), providing of course the LOC is paid down entirely every year.

Stay with me on this one guys...
 
Eating beans..... Some investors eat beans, or cut back on their lifestyle, because their income to expenses ratio may be diferent to yours or their goals and timeframes may be diferent. This has no bearing directly on their overall risk strategy necessarily. (most lenders base their living expenses calculation on the henderson poverty index, not what the average family spends each month)
Many investors choose to do this early on in the journey while they built up a portfolio.
Capitalising the diference between rental income and rental expenses means that investors may use their earned income as they wish, either to pay down debt, or for lifestyle. Although many have the opinion this is a risky strategy, the real question is what the investors do with the surplus income they have access to after the capitalised interest.
If they use it for lifestyle expenses, then this could be seen as risky, if they use it to further their buffer against bad times, then this might be less risky than a normal set up.
There is always a balance between living for the now, and saving/investing for later. I have been savings hard, eating beans for quite a while, capitalising interest lets me have more of a balance for the timebeing, without reducing my gross exposure to growth assets.
 
great thread i was wondering if i have a loan & revalue in 2 years time get say a 50 g line of credit if i were to use this with some funds to buy a ip with another bank how could i structure it to minimise interest on my ppor? a little confused. The struture of the line of credit sounds interesting??

Jaime.:)
 
If you are not going to get an immediate benefit from capitalizing the interest (because you have no PPOR debt), why not acquire a few more IPs to reduce your tax bill?
 
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