Can this still be done?

[Jess Peletier]

Hi all,

I remember ages ago it used to be okay to use a LOC to pay interest, all prop expenses etc, while having all rent going into offset against PPoR.

I'm assuming this is no longer allowed, but can someone please confirm?

Thank you!

 

[perthguy]

BANTACS have an article about it http://www.bantacs.com.au/capitalising-interest.php

 

[Peter_Tersteeg]

Very shaky ground here. Some do it and have private rulings to make it work, for other's it's seen as tax avoidance and the ATO has come down hard on them.

One client attempted to do just this and engaged BANTACS. They were advised that it was all okay and they'd get a private ruling so the client proceeded on that basis. The private ruling was denied, they copped a fine and had to restructure all their lending. In the end they got fewer tax deductions than if they hadn't tried to be so aggressive.

As a broker we can't advise on tax issues (obviously), but I would insist the clients do get appropriate advice on this before commencing at a minimum. In the absence of proper taxation advice I'd recommend they structure things 'normally', then restructure everything when the appropriate advice and rulings are in place.

If the clients do proceed, I'd suggest you put in writing the structure you're setting up and get them to acknowledge this. Don't include any advice outside of your credit license, write it to confirm the instructions you've been given by the client. You basically need your backside covered in case the brown stuff hits the fan.

 

[Terry_w]

Hi all,

I remember ages ago it used to be okay to use a LOC to pay interest, all prop expenses etc, while having all rent going into offset against PPoR.

I'm assuming this is no longer allowed, but can someone please confirm?

Thank you!

Yes it is allowed. But whether you can claim the interest on the LOC or not is a different question. This is still possible depending on the circumstances.

 

[coastymike]

Every circumstance is different. Just be cautious of Part IVA

http://law.ato.gov.au/atolaw/view.htm?docid="DXT/TD2011D8/NAT/ATO/00001"

 

[Paul@PFI]

I'm with Terry on this but the reality is that the LOC is not an never ending tree of money. There are strategies to maximise the deductible. The careful issue is doing it in a way that isn't a scheme.

eg : Crediting rent to your PPOR through an offset and maxing the IP loan would fail the Part IVA test and constitutes a scheme. This may be a split loan facility and prohibited under numerous rulings etc. Even some banks tried to flog this same product.

However that doesn't mean you can increase the IP loan by paying some rental outgoings. The mischief is in the second limb...Crediting rent to the PPOR. That too isn't an issue. But it is when the lender or you create a pooled facility so that the increased limit on the IP effectively arises from growing equity in the PPOR.

In your example if the bank provides a pooled facility that considers both property values then its likely to be considered a split loan scheme (ie total loan is split between deductible and PPOR). Your scheme artificially creates a tax benefit. You run risk that apportionment of interest may need to occur and if you don't the ATO response is to just deny 100% of all interest deductions. Ouch. Seen it plenty of times. Costly to fight too. Once it looks like a scheme and smells like a scheme you struggle to convince anyone it wasn't a scheme. Onus of proof is on you.

I wouldn't touch your proposal without a private ruling

 

[Jess Peletier]

Great replies, thanks so much everyone, I really appreciate it.

Terry - can you please explain an eg - of the circumstances in which you potentially could claim the LOC as deductible?

Peter - Absolutely. It can be a fine line between thinking outside the box with creative ideas, and totally screwing things up for everyone, myself included! Hence the post - I'm not an accountant but the tax side of things is so relevant and so important to get right!

Paul - can you please explain a 'pooled facility' to me?

 

[Terry_w]

Great replies, thanks so much everyone, I really appreciate it.

Terry - can you please explain an eg - of the circumstances in which you potentially could claim the LOC as deductible?

Peter - Absolutely. It can be a fine line between thinking outside the box with creative ideas, and totally screwing things up for everyone, myself included! Hence the post - I'm not an accountant but the tax side of things is so relevant and so important to get right!

Paul - can you please explain a 'pooled facility' to me?

An example may be when suffering cashflow issues.

 

[Paul@PFI]

Great replies, thanks so much everyone, I really appreciate it.

Terry - can you please explain an eg - of the circumstances in which you potentially could claim the LOC as deductible?

Peter - Absolutely. It can be a fine line between thinking outside the box with creative ideas, and totally screwing things up for everyone, myself included! Hence the post - I'm not an accountant but the tax side of things is so relevant and so important to get right!

Paul - can you please explain a 'pooled facility' to me?

Pooled facility is my words for a loan facility that you or others create. You use all the land as security and the lender allows a limit based on value of all property. You draw down funds to use for one or other purpose.

St George had a facility called "portfolio" once. Other lenders have tried other products. ATO called them split loans and you can search that expression. STG tried to flog it in the manner asked in the original post. ATO views were that the intent to use all property as loan security then treat a loan repayment for PPOR (only) and this allowed capitalisation of the deductible was a scheme covered by Part IVA. Disallow 100% interest may be the outcome.

 

[Jess Peletier]

Right. So I'm assuming with this 'pooled facility' it makes no difference whether the loans are completely seperate, different lenders and not joined in any way. It's the scheme which is the issue. So the trick is to have a legitimate reason for the structure that doesn't focus on tax in any way.

Are there any other reasons other than cashflow? I'm trying to think of a good reason and the only thing I can think of is accessable cash - but I'm struggling to think of a worthwhile reason for holding the cash.

Ate there any other ways to fix a poor structure that I'm not yet aware of? Typical situation where IP is fully paid off but PPOR is mortgaged. PPOR may become iP in future though.

 

[Paul@PFI]

Basically - Yes. If the outcome is a tax benefit then it likely fails. That was what the original post sought wasn't it ??

Alternatives ?? Spouse refinance with change of TIC % etc...Some states it can be exempt from duty.

 

[Terry_w]

A non working spouse may have cashflow issues and this person's loan may be able to be legitimately capitalised in some instances. Th may work for maternity or paternity leave.

also as Paul mentioned a spousal sale. Paul and I just did one jointly (and no we are not married) for a client.

And finally consider whether it is worthwhile just to sell the investment property and to consolidate finances, pay off non deductible debt (or offset) and buy a new better performing property properly structured from the start.

 

[neK]

eg : Crediting rent to your PPOR through an offset and maxing the IP loan would fail the Part IVA test and constitutes a scheme. This may be a split loan facility and prohibited under numerous rulings etc. Even some banks tried to flog this same product.

However that doesn't mean you can increase the IP loan by paying some rental outgoings. The mischief is in the second limb...Crediting rent to the PPOR. That too isn't an issue.

Sorry, but I'm a bit confused here. If the interest is being paid through an income source (whether it be rent or employment income), wouldn't a person be free to do with whatever they want with the rental income (including placing it in the offset PPR account or spending it on booze).

 

[Paul@PFI]

Sorry, but I'm a bit confused here. If the interest is being paid through an income source (whether it be rent or employment income), wouldn't a person be free to do with whatever they want with the rental income (including placing it in the offset PPR account or spending it on booze).

LOL

That's a very simplistic view. It doesn't matter where its paid from, banked or used. The Income Tax Assessment Act 1997 clearly says if the interest was necessarily incurred in earning assessable income its deductible right ?. The issue is did the additional deduction incur additional income ? Was the additional deduction a scheme to derive a tax benefit?. Part IVA is also within same tax law and denies some or all the interest....If its hard to work out the ATO deny 100%. You have to argue the point as an objection and then an appeal.

 

[Terry_w]

Sorry, but I'm a bit confused here. If the interest is being paid through an income source (whether it be rent or employment income), wouldn't a person be free to do with whatever they want with the rental income (including placing it in the offset PPR account or spending it on booze).

But the interest isn't being paid from an income source but borrowed. It is an artificial scheme to increase deductions.

 

[neK]

But the interest isn't being paid from an income source but borrowed. It is an artificial scheme to increase deductions.

This part I agree with. This one falls into PartIVA.... but what about the example below? The interest costs aren't be capitalised, no additional money is borrowed etc.

Have i missed something here?

LOL

That's a very simplistic view. It doesn't matter where its paid from, banked or used. The Income Tax Assessment Act 1997 clearly says if the interest was necessarily incurred in earning assessable income its deductible right ?. The issue is did the additional deduction incur additional income ? Was the additional deduction a scheme to derive a tax benefit?. Part IVA is also within same tax law and denies some or all the interest....If its hard to work out the ATO deny 100%. You have to argue the point as an objection and then an appeal.

Sorry, I am still confused. Can you explain what would happen in the following scenario:

Person buys a property. Purchase price is $200,000. Interest rate at 5%, paying interest only. Interest cost per year is $10,000. The property is being rented out at $500 per week, so $26,000 per annum. Assume there are no other expenses.

Person uses rental income to cover the interest cost and the rates. Therefore they are left with $16,000 in rental income. This $16,000 is declared on their tax return and they pay tax on it at their marginal rates.

There is no capitalisation of interest going on, the loan remains at $200,000 and they are only deducting interest charged based on the $200,000.

Question, MUST the $16,000 be retained in an offset account (or alternatively paid into the loan account) in order for them to maintain a tax deduction on the property (assuming they do not have any private ruling in place).

I would have thought the $16,000 could be used for any purpose, whether it be paying down an existing PPR, buying a car, going on holiday etc. Is this not correct?

 

[Terry_w]

T
I would have thought the $15,000 could be used for any purpose, whether it be paying down an existing PPR, buying a car, going on holiday etc. Is this not correct?

Yes. but isn' it $16k

 

[neK]

Yes. but isn' it $16k

Yes.
I can't add
Fixing it up

So Paul was only referring to the situation where someone borrows money to pay the interest, then puts the rental income into the PPR offset ? Or was the tipping point where they attempted to claim the interest on interest?