Can I claim the interest as a deduction?

[cassidy]

Hi all.. long time lurker (finally signed up) and first time poster here!

Firstly, thanks for a great site!

I am new to the property game and have a question about whether interest in the following situation is fully tax deductible.

If I have a property worth 600k (no mortgage), I want to borrow 80% of the value (480k) to raise cash. I'll draw out 200k to pay a family member which I owe and then draw out the residual 240k and move to my offset account. By doing this I have cleared my debt with my family member and have obtained 240K 'cash' for which I can do as I please with. For my Q, let's assume I spend it all and don't invest (buying cars/boats/holidays etc..).

If this is a IP, is the full 480k mortgage a tax deduction??

 

[Rixter]

No in your situation.

Interest is only tax deductible when the funds are used to acquire "income producing" assets.

Hope this helps

 

[cassidy]

Ok I understand.

but let me just ask it this way:

I've got 600k cash. In a normal situation, I would purchase an IP and borrow 80-100% and put my cash in the offset account. Over time I then use the 600k for investments / buying a PPOR / normal discretionary spending etc.. As I spend this 600k, my debt increases and is fully tax deductible regardless of how I spend it.

If I was in a situation where I had to purchase the IP with the 600k cash (don't ask lol), I've got no way of recovering my money so that I would be in the same situation as above?? Apart from acquire 'income producing assets'

 

[Rixter]

I've got 600k cash. In a normal situation, I would purchase an IP and borrow 80-100% and put my cash in the offset account. Over time I then use the 600k for investments / buying a PPOR / normal discretionary spending etc.. As I spend this 600k, my debt increases and is fully tax deductible regardless of how I spend it.

No.

The security used for the loan (in your case the IP) does not determine deductibility.

What the funds are used for is what determines deductibility.

In your case only the portion thats used for purchasing income producing assets will be tax deductible.

Funds used for lifestyle / personal spending (in your case ppor & normal discretionary spending etc) is not deductible.

Hope this helps.

 

[cassidy]

I now understand that only the portion thats used for purchasing income producing assets will be tax deductible if I draw down on the equity that's in the IP and that's why in my 2nd eg. (ie. paying cash upfront then drawing on equity) this is the case.

However, in the 1st eg. borrowing let's say 100% and then putting all my money in an offset, when I draw out of the offset, my understanding is the interest is deductible regardless of how I spend the money



Thanks for clearing up my original question!

 

[Rixter]

However, in the 1st eg. borrowing let's say 100% and then putting all my money in an offset, when I draw out of the offset, my understanding is the interest is deductible regardless of how I spend the money

No it is not.

 

[cassidy]

No it is not.

Now i'm confused

Interest on borrowed money (the 600k) should be deductible as the monies are used to acquire the income producing asset (IP)?? regardless of what has/is happening in my offset a/c

 

[Rixter]

Now i'm confused

Interest on borrowed money (the 600k) should be deductible as the monies are used to acquire the income producing asset (IP)?? regardless of what has/is happening in my offset a/c

Using your example you paid cash for the IP then borrowed against the IP and placed those borrowing into an offset account.. Its what you do from there on, with those borrowings, that determines deductibility or not.

Does this make sense?

 

[Pushka]

You have already acquired the property, so the money you borrowed had nothing to do with its acquisition.

 

[s_t]

Ok I understand.

but let me just ask it this way:

I've got 600k cash. In a normal situation, I would purchase an IP and borrow 80-100% and put my cash in the offset account. Over time I then use the 600k for investments / buying a PPOR / normal discretionary spending etc.. As I spend this 600k, my debt increases and is fully tax deductible regardless of how I spend it.

If I was in a situation where I had to purchase the IP with the 600k cash (don't ask lol), I've got no way of recovering my money so that I would be in the same situation as above?? Apart from acquire 'income producing assets'

I understand the above to be correct, but I'm not expert. I understand what you are getting at - why should a simple mistake of buying with no loan, and then trying to get money back for living via loan, be different from buying the property via a loan (and small deposit), and living/spending your leftover cash? One is tax deductible, and one isn't.

Reality is that it is all 'intentions' based, which is interpreted based on 'typical' money/ borrowing habits.

 

[alexlee]

why should a simple mistake of buying with no loan, and then trying to get money back for living via loan, be different from buying the property via a loan (and small deposit), and living/spending your leftover cash?

Because the law says so, that's why.

 

[s_t]

Because the law says so, that's why.

Well, thats what the ato says anyway (I wouln't have clue what the actual law says). And as I said, intentions (which might be nothing more than thoughts) can't be proven so they (ato) have to use rules that go by typical money/borrowing habits (ie. most people don't buy a house with cash, and then take out a loan to live off.....).

To get around the problem, I imagine you could sell the place to your wife/trust or something (and they buy it with borrowed money), but that would involve lots of additional costs so you would have to do the sums.

 

[Pushka]

Well, thats what the ato says anyway.

Well, for the most (but not always) part, the ATO is the law. Actually I can see both sides.

 

[Martin_2F]

Ok I understand.

but let me just ask it this way:

I've got 600k cash. In a normal situation, I would purchase an IP and borrow 80-100% and put my cash in the offset account. Over time I then use the 600k for investments / buying a PPOR / normal discretionary spending etc.. As I spend this 600k, my debt increases and is fully tax deductible regardless of how I spend it.

If I was in a situation where I had to purchase the IP with the 600k cash (don't ask lol), I've got no way of recovering my money so that I would be in the same situation as above?? Apart from acquire 'income producing assets'

Using your example you paid cash for the IP then borrowed against the IP and placed those borrowing into an offset account.. Its what you do from there on, with those borrowings, that determines deductibility or not.

Does this make sense?

Well, I dont't think cassidy meant to buy the IP with his cash upfront. He just buy the IP with an 80%-100% I/O investment loan featured with an offset account first. Then, he put his own cash into that offset account to minimize the interest payable. In this case, how he dispose his money later in his offset account won't affect the deductibility of the interest generated from his investment loan.

 

[s_t]

Agreed Martin. But that is a different setup to his first post.

different situation but similar solution (to the first post) in this thread:

http://www.somersoft.com/forums/showthread.php?t=40430

 

[cassidy]

thanks guys

yeah i had asked 2 different q's in the end. 1 situation buying outright (deductibility depends on use of funds) and then borrowing and using the offset (doesnt matter how I use the funds)

thanks to all

 

[Perp]

I agree, cassidy, it's crazy that because you set up the thing in one way rather than another, you can really screw yourself so hugely with regards to tax deductibility. I understand, from the ATO's perspective, that it can be complicated to prove what specific dollars were used for, or what the intent of each transaction was.

My proposed solution: all borrowings up to 100% of the purchase price of investments should be deductible. If the investor has several loan facilities - several mortgages and credit cards etc - the lowest interest products should be deductible first.

Examples: if you have 2 x $300K mortgages and $20K on credit cards - total $620K - but have investments that cost you $700K, the interest on the entire $620K of borrowings should be deductible. If you only paid $600K for your investments, the mortgage interest would be deductible but not the credit cards. (Assuming credit cards have higher interest rate than mortgages.)

I think this is reasonable because it assumes that everybody pays for their private purchases out of their own cash, and borrows for investing. I can't foresee this producing any inequitable outcomes. And it eliminates the need for complex juggling (eg using offsets rather than redraws etc) to get things "right" by the ATO rules; I think it would be simpler overall than the current system.