Capitalising interest, API article

I'm just done reading the new hottest 100 edition of API and it was the best read I've had in quite a while from any of the big two investment mags.

The article on capitalising interest was of interest to me and got the brain ticking.

It is a story of an investor who has a few rentals with some good equity. He basically got a ruling from the ATO that all rental income and wages went direct to his home loan (PPOR) account and he capitalised equity to fund 100% of his rental properties shortfall. (Which I imagine would be quite a lot)

Apparently the capitalised interest was heavily offset by his savings and tax deductability of the interest bill.

The home loan was paid off within 7 years. I have no idea how big or small this principal and interest loan was unfortunately as it wasn't stated.

To me, this strikes me as tax evasion, but the ATO had ruled that it was not because rental income would one day catch up to the interest bill and become cash-flow positive.

I've heard this before but never thought anything of it as I'd never be game to try it and did not think anyone else would either.
I

Anyway, interesting
 
Hi Investor2009

I have been exploring this (debt recycling) strategy for a while now so found this article very interesting although somewhat confusing the way Julia writes. This has also been discussed at length in this forum but hopefully we are now getting a bit more certainty with this article. This strategy appears to be legal in the eyes of the ATO providing the dominant purpose is to own your own PPOR sooner with the tax benefits being incidental . It would have been good if she could have simplified and explained each step of the strategy in a little more detail. Basically from reading this article and others on the subject am I right in summarising it this way? Maybe some of the SS'ers who have done it could correct me if I am off the mark.
1. An investor has one or more IP's which must have separate loans, not linked in any way however they can share security.
2. A LOC is set up
3. A loan exists on the PPOR
4. Julia says that the rental properties are to be interest only (is this imperative ?)
5. The LOC pays the interest payments for each of the IP's plus all other IP expenses eg. rates, insurance, maintenance etc., but is NOT to be used for any personal expenses.
6. All income including rent, wages etc are to be paid into the PPOR home loan.
7. Living expenses are drawn from the PPOR home loan.
8. Every few years Julia says the loans have to be adjusted. The LOC will need to be increased to cover the growing tax deductible debt. As the PPOR home loan is decreased she says that the banks will be happy to increase the LOC.
9. Julia says interest on the IP is deductible if negatively or positively geared providing that one day the taxpayer will derive a taxable income from it.

My queries are:-

A. So is interest on the individual IP loan/s AND the LOC claimable on your tax return?
B. Can anyone translate this sentence in the article? After Julia goes on to say that of course you CAN do this arrangement she then goes on to say "The question you need to ask (the ATO), is whether, having done this, you need to apportion the interest in the LOC on the basis that the capitalised portion isn't deductible".
C. Does everyone need to get a private tax ruling before entering into such an arrangement even though a reasonable person would see that its purpose (for no doubt the average individual) is to pay off the PPOR sooner and that the tax benefits are secondary? As Julia points out - even if you were not entitled to a tax deduction for the capitalised interest on the LOC, that this strategy would still pay off your home sooner.:):)
 
Sorry folks, I see LOC all the time so what does it stand for? I thought it was Letter of Credit but it seems to be a type of loan. Newbee question
 
Hi Julie, LOC = Line of credit. In this scenario say you have a PPOR valued at $400k, exisiting loan is $200k you can usually set up a LOC you can draw from to top the total loan amount up to 80 - 90% of the $400k so in this case you have around $160k to capitalise interest payments etc.
 
Sorry folks, I see LOC all the time so what does it stand for? I thought it was Letter of Credit but it seems to be a type of loan. Newbee question

You were quite right. Just wrong in the context.
I used to import goods from Asia and for many years, LOC meant Letter of Credit to me.
Now, as a property investor, it has a new meaning :)
 
Thank you everyone. Perhaps we need a sticky note thread that lists all the acronyms. Took me a while to work out PPOR was home lol.


Now can someone please explain this bit :

" a ruling from the ATO that all rental income and wages went direct to his home loan (PPOR) account and he capitalised equity to fund 100% of his rental properties shortfall. (Which I imagine would be quite a lot)"

(what does 'capitalised equity' mean?)
 
Capitalised interest or on this occasion "equity" (same thing really) means you borrowed against your existing debt (equity) and are using those borrowed funds to service your debt (repayments) increasing your tax deductible debt.
 
Capitalised interest or on this occasion "equity" (same thing really) means you borrowed against your existing debt (equity) and are using those borrowed funds to service your debt (repayments) increasing your tax deductible debt.

So for instance. Borrowed 120k used 100k to buy a property. Left 20k in the loan account and use this 20k to pay the interest on the 100k+(interest on each payment you make out of the 20k account) yes?

and you top up the 20k account so it never goes to negative yes?
 
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Yes, thats right Jules. Sounds like you've got it all sorted :)

So for instance. Borrowed 120k used 100k to buy a property. Left 20k in the loan account and use this 20k to pay the interest on the 100k+(interest on each payment you make out of the 20k account) yes?

and you top up the 20k account so it never goes to negative yes?
 
You'd need a pretty good spreadsheet to see if it was worthwhile I'd think otherwise it could be a case of a lot of work to get a small return - if they'd let you get the tax advantage. I'm trying to base my decisions on understanding the implicatiions so I'll leave this one alone - like that delightful catchphrase from someone here: coulda shoulda didn't? lol.
 
My thoughts exactly.

You'd need a pretty good spreadsheet to see if it was worthwhile I'd think otherwise it could be a case of a lot of work to get a small return - if they'd let you get the tax advantage. I'm trying to base my decisions on understanding the implicatiions so I'll leave this one alone - like that delightful catchphrase from someone here: coulda shoulda didn't? lol.
 
I can see how the strategy would work without getting into more debt ... put all your rental income into one loan (ie, PPoR) and just pay minimum on the IP loans. Rinse and repeat until they are all paid off.
 
Contrary to some opinions, I think the setting up of "debt recycling" or "capitalisation of interest" is really simple.

I have set it up just recently, simply by getting a LOC which will be used exclusively for all IP expenses. I receive the rental income as before in one of my accounts but from now I will not use it to repay IP expenses. I can just pump it into repaying non-deductible debt.

From here I could have properties revalued each year or so in order to increase the LOC to continue paying for IP expenses and effectively swapping non-deductible debt for deductible debt.

Another "side effect" of this would be that since your deductible debt against your IPs would be increasing, so would your amount of negative gearing and tax benefits. This would certainly only be secondary to the main goal of paying down PPOR or other non-deductible debt.
 
Contrary to some opinions, I think the setting up of "debt recycling" or "capitalisation of interest" is really simple.

I have set it up just recently, simply by getting a LOC which will be used exclusively for all IP expenses. I receive the rental income as before in one of my accounts but from now I will not use it to repay IP expenses. I can just pump it into repaying non-deductible debt.

That was my thinking as well. Wondering why they're making it sound so difficult with ATO exemptions and personal rulings etc? :confused:

You use an LOC to pay all IP expenses, and all rent coming into you accounts you do what you want with - whether it be paying down PPOR loan or blowing it all at the track. Not sure why you'd have to get a private ruling from the ATO?

Once I get my PPOR down the track, I'm actually contemplating doing this with my business income as well if I have enough equity (if it's not too messy, will check with my accountant when the time comes). Would have my PPOR loan fully paid off in 2-3yrs.
 
Good points above, I did the math on pumping all rents and half my wage to my PPOR and it would still take 9 YEARS to repay.. !!

Thats 3 investment rents, plus half a wage, for a median priced property.. I had no plans on paying off my interest only PPOR and now certainly don't. I may however pay one off once I'm absolutely loaded :D

I figure once just one property doubles in value I can sell it and pretty well rid the home loan if need be.
 
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