Capitalising interest - draft ruling

poppy

poppy

(Note: this thread split from this one)

I've only just read this draft TD:

TD 2008/D12

Apologies if this link has already been posted on somersoft, I did have a look for it...

It seems to me that the ATO is saying if you capitalise interest in order to do "something else" with the money then the purpose of the capitalised interest is considered to be related to that "something else". So if you capitalised interest on your IP loan so you could save up for a holiday, pay off your PPOR etc then you contaminate your IP loan and that part of the loan is not deductible.

Even if for example you don't have any non-deductible debt but have chosen to capitalise IP number one's loan in order to pay off IP number two's loan because IP number two has a higher interest rate, you could potentially create an accounting mess if you later moved into one of the IPs.

Further if my husband capitalises his margin loan so that he can pay all the household bills because I have no money after paying for my IP's, then it seems my husband would then have a partially non-deductible margin loan.
 
Last edited by a moderator:
poppy said:
I've only just read this draft TD:

TD 2008/D12

Apologies if this link has already been posted on somersoft, I did have a look for it...

It seems to me that the ATO is saying if you capitalise interest in order to do "something else" with the money then the purpose of the capitalised interest is considered to be related to that "something else". So if you capitalised interest on your IP loan so you could save up for a holiday, pay off your PPOR etc then you contaminate your IP loan and that part of the loan is not deductible.

Even if for example you don't have any non-deductible debt but have chosen to capitalise IP number one's loan in order to pay off IP number two's loan because IP number two has a higher interest rate, you could potentially create an accounting mess if you later moved into one of the IPs.

Further if my husband capitalises his margin loan so that he can pay all the household bills because I have no money after paying for my IP's, then it seems my husband would then have a partially non-deductible margin loan.
Click to expand...

Yes it featured in this months API mag - nothing new there. Being a draft the ATO have opened it up to discussion.
 
Last edited:
Hey Rixter,

Yes the API article is what prompted me to read the draft TD. It seems the discussion period with the ATO has already closed.

In my opinion this seems to be a big change. Previously, I was of the opinion that capitalising interest was deductible as long as the purpose was not tax avoidance. So, all a taxpayer had to do was prove that the purpose was not tax avoidance. The taxpayer did not have to prove that the purpose of capitalising the interest was related directly to that income producing asset.

In my case, I have no non-deductible debt and only sometimes capitalise interest when I have limited cash flow, and make principal repayments when I can. So I was confident that the capitalised interest was deductible as I am clearly not trying to avoid tax in this situation.

According to this TD, it seems that it is NOT ok if, for example, your spouse is having a baby/sick etc and you need to pay for household expenses so you capitalise your IP repayments.

Further according to this article it would seem that even if, in general, a taxpayer made both principal and interest repayments on an IP loan, but on one occasion was unable to make the repayment and capitalised the interest... they would end up with a contaminated loan.
 
Rixter said:
What does your tax professional in this field advise peastman?
Click to expand...

G'Day Rick,
My "tax professional " I found out last year was in fact not a property tax professional and was giving me wrong information. So I am looking at getting a new accountant. SWMBO used to work for the accountant so she does not want to change, but the time has come.

I think I read here some time ago that there was no legal reason why rent recieved had to be used to pay interest. That means you could use the rent as personal income and capitalise interest. This would make the whole loan tax deductable and make LOE a better proposition.
 
peastman said:
I think I read here some time ago that there was no legal reason why rent recieved had to be used to pay interest. That means you could use the rent as personal income and capitalise interest. This would make the whole loan tax deductable and make LOE a better proposition.
Click to expand...

Yes for those investors concerns, this proposed structure certainly lends itself to keeping things easily separated from an accountancy view point.
 
Although I haven't yet capitalised interest I'd be a bit disappointed if it were ruled against. I was planning to use it as a "debt recycling" strategy to pay down PPOR debt fast.

If this falls down then I'll have to rely on selling properties (either IPs or PPORs as they are "upgraded") in order to access equity to pay down non-deductible debt. I was already planning to do this when upgrading my current PPOR by selling it to my family trust as an IP.

I suppose having to sell to access equity will also mean that "upgrading" PPORs every few years will be more attractive than selling off IPs due to the CGT implications.

I'll be interested to hear whether my strategy will need to be adjusted accordingly depending on any future ruling.
 
What about the people that have private rulings in favour of capitalising interest ? Does the ATO typically give a date that all must comply with if things change?
 
What about the people that have private rulings in favour of capitalising interest ? Does the ATO typically give a date that all must comply with if things change?
Click to expand...

I believe the private rulings will normally list the financial years for which they apply.

I guess the ATO will have to take someone to court to test their ruling before they start enforcing it. I wouldn't like to be that person.
 
Plenty of Case Law on allowing capitalised (compound) interest.

However, these have been in a business context where it is easy to see that the money otherwise repaid was used in an ongoing operation of earning assessable income.

This is much more difficult to show for a personal investor, where private outgoings are mixed in.

Cheers,

Rob
 
This is much more difficult to show for a personal investor, where private outgoings are mixed in.
Click to expand...

Agree, but up until now as far as I am aware, the ATO's position was that it's OK to capitalise interest (for an individual) as long as you are not trying to avoid tax and as long as you keep your investment loans seperated from your personal accounts etc.

Now the ATO seems to be saying that individuals cannot capitalise interest even if they have no personal debt, because it can always be argued that the purpose of capitalising the interest was so that the individual could continue to feed themselves whilst keeping their investments. Therefore an individual who has no personal debt and keeps all their investment accounts completely seperate from personal accounts, and uses the rent/dividends to pay down the investment debt, can still be caught out by the ATO because they capitalised their interest on one occasion due to needing to use their salary to pay for personal expenses.
 
has there been any news on this lately?
I'm really interested to find out about this, as it is a structure i was hoping to use after purchasing a PPOR in a couple of years.
 
Witzl

Try Julia's website again. From the home page, go to the right of the page and click on "Free Newsflash" (just below 'Regular Features', which is printed in purple), then when the next screen comes up, click on 'Current Issue' (top right). On the bottom of page 2, you will find a paragraph about it! Voila!!

Cheers
Lynn
 
Bantacs said:
If you use the rent from your investment property to pay off your
own home, in the meantime capitalising interest on the rental property, will the ATO consider your
dominant purpose to be a tax benefit? The counter argument being that the dominant purpose was simply
to pay off your own home sooner which is the logical approach for any home owner. One of the main goals
in your working life is to get your home paid off. Why should the ATO attack such an action?
Click to expand...

I wonder whether if not for the tax benefit, would using income from an IP to pay off a PPOR and use a LOC to pay IP related costs still offer any benefit at all?
 
shady said:
I wonder whether if not for the tax benefit, would using income from an IP to pay off a PPOR and use a LOC to pay IP related costs still offer any benefit at all?
Click to expand...

Increased financial and personal security from paying off your own home ASAP and extracting the title from the Bank?
 
poppy said:
(Note: this thread split from this one)
It seems to me that the ATO is saying if you capitalise interest in order to do "something else" with the money then the purpose of the capitalised interest is considered to be related to that "something else".
Click to expand...

Correct.

poppy said:
So if you capitalised interest on your IP loan so you could save up for a holiday, pay off your PPOR etc then you contaminate your IP loan and that part of the loan is not deductible.
Click to expand...

Sorry Poppy, this is incorrect. If you capilised interest on your IP loan to fund the IP loan or another investment then this will be deductible. This is regardless of what other purpose your "savings" is used for.

poppy said:
Even if for example you don't have any non-deductible debt but have chosen to capitalise IP number one's loan in order to pay off IP number two's loan because IP number two has a higher interest rate, you could potentially create an accounting mess if you later moved into one of the IPs.
Click to expand...

No accounting mess. The capitliased loan interest on IP 1 in relation to IP 2 should be accounted for under IP 2 tax statements. The capilised loan interest in relation to IP 1 should not be accounted for under IP 1.

poppy said:
Further if my husband capitalises his margin loan so that he can pay all the household bills because I have no money after paying for my IP's, then it seems my husband would then have a partially non-deductible margin loan.
Click to expand...

If your hubby capilised his margin loan so he doesnt have to use his cash to pay the margin loan interest so that he can then pay household personal bills does not mean that he has to have a partially non-deductible margin loan.

Margin loan interest capitalised to fund his investment in shares/managed funds is deductible as it is income earning.
 
You must log in or register to reply here.

Similar threads

J
debt recycling and capitalising interest
Replies
1
Views
1K
Terry_w
Terry_w
P
Tax implications of a refinance
Replies
4
Views
2K
perthguy
P
V
Deductibility of deposit interest from offset
Replies
2
Views
2K
vlvh
V
albanga
Loan Contamination
2 3 4
Replies
76
Views
18K
Terry_w
Terry_w
J
No non-deductible loan, where to place savings?
Replies
12
Views
1K
Terry_w
Terry_w
Back
Top