Oh No !! Not capitalised interest again.

To offset CG this year, I will prepay some interest on some IP's. I may be able to pay for this from savings (offset a/c), but don't want as this money is for new PPOR. If I re-draw from a I/P LOC, what's the general opinion from formites on the deducability of this type of interest on interest.

Now, this is not the same arrangement as 'Harts" and not a scheme, just the best and prefered method of arranging finances. I should get the prepaid interest at a better rate, so there is a commercial reason to do so. Is that enough ammunition to keep Mr ATO happy ?

For the last 10 years, I have been (partly) living off the increasing equity in my proeprty portfolio.

I have been regularly increasing my borrowings to pay for (amongst other things) interest payments. And these borrowings are tax deductible.

Once you have sufficient equity in your properties, its the only way to go.

HI,
My shortfall of interest for my property portfolio is covered by borrowing the interest through my Line of Credit facility.

Yes the initial interest is tax deductible, but then the interest charged on the
interest borrowed is not tax deductible.

So I always make sure every month when interest is charged that I segregate the deductible and non- deductible part and calculate accordingly.

Example, on one of my properties that I just finished developing I have capitlized 20K worth of interest. Interest being charged on this is roughly 1400 Per annum. This $1400 is not tax deductible as it is interest being charged on the interest. .


Hope this helps.

Kind regards
Marina.

Michael Yardney said:

For the last 10 years, I have been (partly) living off the increasing equity in my proeprty portfolio.

I have been regularly increasing my borrowings to pay for (amongst other things) interest payments. And these borrowings are tax deductible.

Once you have sufficient equity in your properties, its the only way to go.

Click to expand...

Hi Michael,
Do you pay the monthly interest on the increased borrowings
or are you letting the 2nd loan increase?
If the interest on the increased borrowings is not paid off
every month isn't it an indirect capitalising?
cheers

How about this idea.

1. You open up a LOC-1 of lets say $100K
to use exclusively to pay the interest and other expenses
for your IP's.

2. You open up up a 2nd LOC of lets say $10K to use exclusively
for paying the interest on LOC-1 and at the end of each month you pay
back FROM YOUR OWN MONEY the interest on LOC-2.

Using this method you pay approx 0.07% interest on your monthly shortfall.

Example:
for your IP's you have a $5K shortfall every month
so you pull $5K out of LOC-1.
A month later you will be asked to pay interest on the 5K you borrowed
i.e $30.00.
This time you pull the $30.00 from the 2nd LOC
A month later you will need to pay interest on the $30.00
So you go online and pay the monthly interest of $0.20
from your PPOR loan this time.
Now you can either consider the 20c lost forever
or you can claim it as a shortfall and get half of it back from the ATO.

Isn't $0.20 better than paying $5,000.00 per month?
Ofcourse next month you will need to pay back $0.20 + 0.20 etc
but it will take many years before it will affect your cash flow.
The above is based on the right of every business to borrow and pay
for their financial loss so that they can keep on trading (check with your accountant).

Now that the interest rates are increasing some investors
with enough equity might need to consider similar methods.

Any other ideas, suggections, objections?

Cheers

Michael Yardney said:

Once you have sufficient equity in your properties, its the only way to go.

Click to expand...

Hi Michael.

This is something I am aiming for (partly living off equity, that is). How much equity do you suggest someone have before contemplating such a move, and do you do it by just drawing down from a line of credit?

Regards
Marty

kissfan said:

Hi Michael.

This is something I am aiming for (partly living off equity, that is). How much equity do you suggest someone have before contemplating such a move, and do you do it by just drawing down from a line of credit?

Regards
Marty

Click to expand...

Marty

To do it comfortably I feel you should have $1,000,000 nett equity.

Borrowing to pay for debt is definately not a sensible stratgey for beginning investors. Its how a lot of people go broke.

Your properties need to be going up in value considerably more ( double to be safe) than your increase in borrowings each year, so that at the end of the year you are left with more equity than your started with

Hart lost his case because the court found that the arrangement was a scheme to reduce tax. Most of this argument centered around the fact the banks had marketed the arrangement that way.
This case did not change the deductible nature of interest or interest on interest. Both Gleeson & McHugh stated that the question of the deductiblity of interest upon interest does not need to be addressed becasue the issue was already decided on the basis that there was a scheme to gain a tax benefit.
THe judges also said; "If such a taxpayer took out two separate loans, and the terms of the loan for the investment property were different from the terms of the loan for the residental property in that they provided a higher ratio of debt to equity, and for payments of interst only, rather than interst and principal, during a lengthy term, then ordinarily that would give rise to no adverse conclusion under Part IVA. It may mean no more than that, in considering the terms of the borrowing for investment purposes, the taxpayer took into account the deductibility of interest in negoitating the terms of the loan. How could a borrower, acting rationally, fail to take it into account?"
In other words the judges are saying there is nothing wrong in chosing the best tax outcome it is only logical that you should. The ATO can't make you arrange your affairs for the best outcome for them.

The ATO in IT2330 even states they will not attack your right to simply choose a more tax effective option. Don't let them bluff you. Harts was the ATO's clay pigeon. You do not have to change the way you do things just so you will pay more tax. If there is a need to borrow money and the nexus to the income producing purpose exists go for it. It was the linking of the loans and the advertising material, not paying interest on interest that sunk Hart.

To be caught under Part IVA there must be a scheme that has a dominant purpose of a tax benefit. You are not talking about a scheme simply a choice.

Julia Hartman
[email protected]
www.bantacs.com.au

Thanks for that interesting post Julia.

Hi Julia

A not unusual interpretation once one reads behind the details.

If one of your clients came to you with this proposal

A Home Loan, 300 k at 3.63 % P&I variable, crossed with a $ 300 k IP loan at 10.88 % IO Variable (for an ip that cost 285 + costs), what would your advice be ?

ta

rolf

BV

That is a very interesting concept. Thanks for sharing it. I am going to ponder over it for a while and send off to my accountant for his opinion.

MI

Michael Yardney said:

For the last 10 years, I have been (partly) living off the increasing equity in my proeprty portfolio.

I have been regularly increasing my borrowings to pay for (amongst other things) interest payments. And these borrowings are tax deductible.

Once you have sufficient equity in your properties, its the only way to go.

Click to expand...

Michael, whats your definition of sufficient equity in your properties?
and what sort of buffer do you allow?

Is it legal to do something like the following:

Say you have a PPOR home loan (non-deductable) and a LOC (deductable) with undrawn equity and a number of IP loans. Can you credit the rents to the home loan and pay the interest for the IPs from the LOC (Interest on the LOC would need to come from the home loan though).

An example: say you have to pay $50k in interest on your IPs and receive $40k in rent for the year. At the end of the year you would have around $38.5k (allowing for the LOC interest) extra paid off on your home loan and effectively swapping non-deductable for deductable interest.

Michael

mjanos said:

Is it legal to do something like the following:

Say you have a PPOR home loan (non-deductable) and a LOC (deductable) with undrawn equity and a number of IP loans. Can you credit the rents to the home loan and pay the interest for the IPs from the LOC (Interest on the LOC would need to come from the home loan though).

An example: say you have to pay $50k in interest on your IPs and receive $40k in rent for the year. At the end of the year you would have around $38.5k (allowing for the LOC interest) extra paid off on your home loan and effectively swapping non-deductable for deductable interest.

Michael

Click to expand...

Michael,
If I understand you correctly you use the LOC to pay the interest
on your IP loans and you pay the interest on the LOC from your own money
As long as the LOC is separate to the IP loans it would be legit.
I don't know if the ATO would care where the rents go.
cheers

BV,

Thanks, yes you have read it correctly.

Michael

Michael,

Just another question on when you use the LOC to pay the interest
on your IP loans and you pay the interest on the LOC from your own money
You said its OK if the LOC is separate to the IP loans it would be legit.
So can you claim the interest on the LOC to service the IP Loans.?
Then claim the interest payments on the IPs as a Tax deduction.?

Thanks

Michael,

Just another question on when you use the LOC to pay the interest
on your IP loans and you pay the interest on the LOC from your own money
You said its OK if the LOC is separate to the IP loans it would be legit.
So can you claim the interest on the LOC to service the IP Loans.?
Then claim the interest payments on the IPs as a Tax deduction.?

Thanks

Click to expand...

madmurf,

If the LOC is used only for property and share expenses I can't see why I can't claim the interest on it. (I'm still going to check with an accountant as logic and the ATO don't always see eye to eye).

Michael

madmurf said:

Michael,

Just another question on when you use the LOC to pay the interest
on your IP loans and you pay the interest on the LOC from your own money
You said its OK if the LOC is separate to the IP loans it would be legit.
So can you claim the interest on the LOC to service the IP Loans.?
Then claim the interest payments on the IPs as a Tax deduction.?

Thanks

Click to expand...

What you've described is my understanding of the situation (and happens to be something I do and that my accountant is comfortable with).

The logic is that this is what business do all the time with an overdraft a/c. Such an account is designed to cover shortfalls. Interest on a business overdraft account is tax deductable.

I think of my property investment as a business, and the "extra" LOC as an overdraft account to cover the monthly shortfall. But because I treat it this way, I would not be comfortable doing what I have seen suggested before which is banking rent into my personal accounts and therefore artifically increasing the shortfall. I think that kind of action breaks any kind of wall that you are trying to create for tax deductability purposes between your IP "business" and your personal affairs. Take what I say with a grain of salt of course; I'm not an accountant, and I don't believe the scenario has ever been tested in the courts.

Wow,

this is a really interesting concept for dealing with shortfall for the asset rich / cash flow poor!
It seems the idea hinges on having two seperate loan accounts so the non IP loan ( A ) interest ( used to pay for business shortfall ) can be seperated from the IP interest loan ( B ) ? Interest on both accounts can be claimed as a tax deduction.

Question:Am I on the right track? This is a way of getting around the non deductable issue of capitalising interest ?

Question: Can the ( A ) & (B ) loan accounts be sub accounts within a portfolio loan using the same security?

MJK

There is a risk that the ATO/courts/whatever may one day rule that property investors capitalising interest is not kosher for tax deductability (this has not happened yet, there is no issue despite what has been posted higher up in the thread!). They would have to define what capitalising interest is, and the simplest definition is where the interest is not paid on a loan and instead the loan balance grows by the amount of the interest each month. Now, 2 sub accounts are part of a single loan so could potentially fall under such a definition of interest capitalisation. Conclusion: why risk it, the risk is small but it can be managed away with zero cost, just have a separate LOC (not a sub account) for your holding costs.

Of course this structure has to be used carefully. Much like investing you need to have a clear reason for such a structure, understand the risks, and have an exit plan. An example of a clear reason could be that you still have non tax deductable debt to pay off, so rather than committing after-tax funds to holding costs of your IP business, commit them instead to paying off that non-deductble debt. An exit strategy could be that once the non-deductable debt is paid off the spare funds are committed to paying off the holding costs LOC. So you would need to ensure then that the limit on the holding costs LOC is sufficient for the period until the non-deductable debt is paid off.