Cup of Tea and Tim Tams needed (calculator optional)
Well, it seems to me that defining ‘capitalizing costs’ is important to this line of argument.
The example I used was primarily based on capitalizing costs of purchase, but of course it can apply to anything.
To use an example of $1,000 then further obscures the argument as $1,000 wouldn’t usually be capitalized but written off in the current tax year.
And is this about:
Writing off the cost eg maintenance or capital expense?
A plumbing repair bill is quite different to installing a new vanity basin.
One is maintenance, one is capital expense which is added to the value of the property and then depreciated over more than one tax year.
The other issue is the tax benefit to the individual paying the bill: Theory and practice can be at odd here as there are so many variables to consider. Assuming that the person’s tax rate was reasonable then sure use borrowed funds to pay the bill. This, of course, can be any form of credit, including the ubiquitous credit card or a loan from Uncle Henry.
However, unless the credit facility was already established it would be hard to rationalize arranging a new mortgage facility for anything less than, say, $5,000 as the establishment costs would result in a disproportionate AAPR (Average Annualized Percentage Rate).
And tax refunds are no excuse for a course of action. At best, this will result in a 47% rebate on costs.
But whichever way the payment is made, ‘tax deductibility’ relates more to the nature of the expense / purchase and not to the way in which payment was made.
So is the expense incurred in the earning of income / maintenance of improvement of an income producing asset / capitalized to the value of an asset which is intended to produce income in te future / intended to be sold for a profit in the future?
Yes?
How was this item paid for? From private funds – then the investment ‘owes’ those funds back to the individual.
From loan funds? Then the loan may be increased by the amount expended and interest charged on those funds may be an allowable taxation expense.
Whether those loan funds are usually for private or domestic use doesn’t matter: What those funds are used for, does.
An extra $1,000 drawn from your home loan to pay for a new hot water heater at your investment property is treated ‘in the books’ no differently than if you paid cash or via your credit card or even used a trade account or deducted the expense from rental income. It is what it is, the method of payment must be clear but that’s it. No magic, no convoluted explanations required.
Over the course of a year I, as an active property investor, pay the bills with whatever funds are to hand. How I post those expenses to the books must be clear and easy to audit. If I ‘hand the expense’ back to a loan account it is up to me to show quite clearly how that happened, even if at first I paid through my personal cheque account or the property manager paid the account from rent collected.
So getting back to the capitalization of expense, sure that’s an OK tactic if the rest of your situation warrants it. But as with everything else in life and investing the whole situation must be considered.
Considering that ‘expense’ can be written off in the usual way and interest just adds to the expense it still detracts from the true cash flow.
The Great God Of Saving Tax Even If It Costs Me Money is a god with feet of clay, and a shrine at which I’ve never bothered worshipping. I appreciate there is a whole industry devoted to ‘saving tax’ but it always seems like reverse logic to me. Why deliberately spend $1 to only get a % of that back? If the $1 needs to be spent, then spend it, in the cheapest way possible and if there are ‘tax benefits’ that’s fine but that’s in the bonus category, not the prime motive or consideration.
However if we didn’t discuss these questions at great length we would never hear anyone else’s point of view, so thanks for raising the subject MJK.
But can I ask regarding your example
…..I wouldnt go out and get a new loan to cpitalise a cost, simply use the undrawn funds in an LOC. Say and expense came up at $1000. I then could capitalise this cost at 6.47%pa or $64.70 pa. I then could claim a deduction on the expense and the interest and get a rebate of say $4-500 in the first year.
If you write the expense off in one year and your top marginal rate is 47% then, yes, you would be eligible to receive a tax refund of $470 on the item.
If you had the expense sitting at 6.5% interest for a full year, sure, add another $32.5 to your tax refund, a total of $500.55.
But there is no denying that your expense still cost you $564.45 and you have now used all your tax concession on that item.
To the best of my knowledge that item has now been fully tax expended and cannot be capitalised to the investment ie added to the capital base and further depreciated or claimed against any future profit on sale.
However, if you are asking ‘Does the debt for the item remain on the credit facility and therefore in future tax years can the interest on the whole debt, including this new amount, be claimed against income…?’
Well that would be the general practice but now we are treading the path of tax opinion so just let me qualify my reply by saying ‘as I understand it, what was the reason for the debt? To pay investment expense” then that is a legitimate reason for incurring the debt in the first place and until the amount is repaid is remains legitimate debt for tax purposes’, or words to that effect.
Whether or not your property has improved in value with or without your further expenditure is a moot point and is a separate and subjective issue with which we may console ourselves as we scrounge around looking for that elusive $1,000 to pay the plumber in the first place.
PS I have certainly in time past paid for things from funds secured against the PPOR ie ‘domestic borrowings’. I have always claimed the appropriate amount of interest incurred in using these loan funds, and produce spreadsheets extrapolating the specific amounts of capital and interest in a pro-rata manner.
Eg if the domestic debt was, say, $40,000 (I wish) and I drew a further $4,000 to pay for installation of air conditioning at an investment property, then I would show that for x number of days in the tax year interest expense was pro-rated at 90.9% for domestic purposes and 9.09% was for investment purposes, and capital repayments to that loan would be apportioned in the same manner.
Keeping good records is the key.
Cheers
Kristine
