A tax question

[simonjulie]

Hi Folks
What would the tax implications be if some of the money borrowed for investment purposes was used to pay a shortfall in the mortgage payments on an IP?
Would that be looked at as trying to claim a deduction twice?
Is there a tax ruling on this.
regards
Simon

 

[Rixter]

Simon, My understanding of your question is its esentially the same as capitalising interest on an IP - as such it would be tax deductable.

 

[Cheeks]

My understanding of your question is its esentially the same as capitalising interest on an IP - as such it would be tax deductable

I assume you mean NOT deductable, capitalising interest is only allowed on shares.

 

[simonjulie]

Now I'm confused
Let's toss a coin.
Simon

 

[Rixter]

I assume you mean NOT deductable, capitalising interest is only allowed on shares.

My understanding is interest is deductable as long as its for income producing purposes. ie property & shares etc

But to clarify the matter - CALLING Dale.

 

[DavidMc]

Hi Folks
What would the tax implications be if some of the money borrowed for investment purposes was used to pay a shortfall in the mortgage payments on an IP?
Would that be looked at as trying to claim a deduction twice?
Is there a tax ruling on this.
regards
Simon

That's exactly what I do, it's claimable and Dale does my tax. I use debt to service debt. It's been a great strategy for me.

What you can't do is then claim interest on this interest and it's my view that you should not be seen to be articifically inflating this figure.

 

[simonjulie]

What you can't do is then claim interest on this interest and it's my view that you should not be seen to be articifically inflating this figure.

Thanks domcc1
Can you clarify the above as I am a little confused as to what you mean ?
regards
Simon

 

[The Wild One]

Ok my turn.

lets say my properties cost me approx. $10,000 a year to hold, or $200 a week. I'm running a LOC which means I'm borrowing an extra $200 a week to cover my short fall. The interest on the $200 a week is deductable.
But if I was to borrow the $10,000 before I required it, the interest would not be deductable. Only the borrowed funds that have already bean used are deductable.

Hope that helps.

 

[Mry]

The tax implications would be that you would be unable to claim the interest on the interest payment of the loan but you can claim a deduction for the principal part of that loan repayment. Just as if you had refinanced part of the loan.

TR 98/22
http://law.ato.gov.au/atolaw/view.h.../00001&recStart=1&recnum=1&tot=2&pn=RDB:::RDB

29. Having regard to the advantages the taxpayer obtains under these facilities, the further interest amount can only be properly characterised in these circumstances as a cost incurred for the purpose of enabling a reduction in the principal amount outstanding under the private account. We do not consider the further interest amount is a 'cost of ownership' of the relevant investment asset for the purposes of subsection 110-25(4).
30. We are also of the view the further interest amount cannot be regarded as 'interest on money you borrowed to acquire the asset' for the purposes of paragraph 110-25(4)(a). When interest on an investment account is capitalised, interest incurred on the investment account accrues both in respect of the original principal sum and in respect of the unpaid interest (the 'further interest amount' referred to in paragraph 7 above). All interest accruing retains its character as interest and never becomes part of the principal sum (see Bank of New South Wales v. Brown (As Official Liquidator of Tom the Cheap (WA) Pty Ltd (In Liquidation)) (1983) 151 CLR 514 ('Tom the Cheap'). The further interest amount is not interest on money borrowed but is interest on interest.

31. Interest on the principal sum is a cost of ownership of the asset. Such interest is also 'interest on money you borrowed to acquire the asset' within paragraph 110-25(4)(a).

Emphasis added by me.

So what happened to this person who tried to claim capitalised interest? What could he claim? The answer in paragraph 94 -

Lawrie is only entitled to claim the interest he would have incurred if he had not redirected payments and capitalised interest, i.e., equal to that he would have incurred under an interest only investment loan.

Very complicated, but there you go. If you have a monthly interest charge and a weekly loan repayment, I would hate to be responsible for calculating that out.

Now of course, this is the ATO position, and as I have said before, you go with the ATO position unless you have deep pockets for lawyers. And I disclaim responsibility for reliance on this.

 

[simonjulie]

Oh my. Why did I ask the question?
Let me get my head around it.
If I had a shortfall in holdong costs for my portfolio I could borrow to pay it but the interest on the borrowings is not deductable because the money borrowed is not part of the original ownership of the IP? Is that close.
Simon

 

[The Wild One]

Ah, but moment please !

Correct me if I'm wrong. Simon and julie, and me too, are talking about the short fall that happens from time to time. Things like when there's a loss of rent from vacancies, rates, insurance, repairs, ect. We all pay for these and are part of maintaining a portfolio. If we have to borrow extra for these expences ( and I do ) the interest on these expences are tax deductable.

 

[simonjulie]

I like that
Simon

 

[The Wild One]

While on the subject of tax.

I reckon one of the best books that I've read on property investing is Tony Cromton's book, Rental Property and Taxation. It's brilliantly written, easy to understand and fun to read.
Sounds hard to beleave, a tax book that's fun to read ?
I beleave it's differently a must read for property investors..

 

[Mry]

simonjulie - Well, I probably went off on a tangent but usually people who ask that question are trying to ask if they can use a LOC to pay for their IP loan repayments and capitalise them. Sorry. It still applies partially to your situation. The loan for the IP is still fully deductible (as long as the entirety of it was used to acquire the property), but the loan for the investments is partially for the IP and the rest is allocated towards its original purpose. It is as if you partially refinanced the non-IP loan by the amount of the payment.

The Wild One - The interest in the loan is deductible as long as the interest is not capitalised. That portion is not deductible.

 

[markp]

Simonjulie
Ah, can you repeat the question please.

 

[simonjulie]

The reason I came to ask the question in the first place was to see if it were possible to expand on a strategy that I have been exploring.
Example of a neutral/slightly negative cashlfow.
$10ml portfolio,60% lvr,income 560kpa, loan payments 460Kpa,other costs @20% of rental income = 112K, historical growth @8%pa=800kpa compounding.
My question
If I were to borrow to service the holding costs,renovations, and new purchases of the portfolio, is the interest on the borrowings from my equity growth classed as a tax deductable amount against the current portfolio.
If this is allowed then the rental income should be mine to do with what I want as long as my equity borrowings do not blow out my LVR to unmanageable proportions.
Up until now I have tried to keep the rents covering the interest payments but if one had a machine like the above example working for them the possibilities would appear endless as long as the growth continued.

Simon

 

[markp]

That seems fair to me, but I thought that is what you were doing.

 

[DavidMc]

Up until now I have tried to keep the rents covering the interest payments but if one had a machine like the above example working for them the possibilities would appear endless as long as the growth continued.

Spot on! I've been doing this for a little while now (but still miles behind you! - but I'll get there!).

I believe the 'can't claim the interest on the interest' part of my statement was clarified for you earlier.

Those rental payments are your income for you to do with what you like. You don't have to use it to pay off otherwise deductable debt - it can be cocaine and Ferrari's all round as far as the tax department is concerned.

What I was saying before about how I think one should 'not be seen to artificially increase the size of this deduction' is sort of where you are getting at above. I'm no accountant, so I'd seek advice of someone more knowledgable, but that catch all 'part IV' tax avoidance (or whatever) of the tax act might catch you if you get a bit too greedy with this strategy.

I think the key might be to have some sort of 'business reason' for letting this debt stack up. Maybe Mry or someone can help?

 

[markp]

I think I use a similar strategy in my business.

Where I take the income from my business as I please, then use the increased equity from my IP's to pay the business expenses.

What are your thoughts on this strategy?

 

[geoffw]

I think I use a similar strategy in my business.

Where I take the income from my business as I please, then use the increased equity from my IP's to pay the business expenses.

What are your thoughts on this strategy?

My thoughts

.Make sure the business is making a profit (or has the potential)- so that you're not propping up a falling structure

.Make sure that you're not mixing up drawings from your IPs with private expenses