Contaminated LOC?

[JohnA]

The situation

Renovating IP. Took out equity loan / LOC against that same IP to fund the reno. LOC came with a cheque book. Tradies we hired were paid by cheque or direct deposit from the LOC account. But the DIY stuff was purchased on our credit card becasue didn't have an access card for the LOC. Keeping a record of these expenses, I reimbursed myself the money from the LOC. But that money was put into home offset and then home offset paid the CC on due date.
I now understand that the LOC is contaminated - accountant says he can sort out - but how this would be done he didn't specifically go into. - I am using a new accountant so early days.

I was advised to get an access card asap to avoid further contamination. In the meantime I have been thinking more about this and

If I keep using the LOC, even with a direct access card, won't the LOC still be contaminated? (I have used/spent 40% of the budget / LOC to date).

Is it possible to see bank manager and reduce the existing LOC to the amout owed, or slightly higher to account for capitalising interest. Then get another separate LOC to cover expenditure from this point on?

In the meantime - how do I purchase the stuff I need?


John

 

[Terry_w]

Sounds messy.

Firstly, you cannot reimburse yourself. Its impossible to borrow from yourself and impossible to pay for something on your behalf.

If your LOC is contaminated then the only solution is to work out the deductible and non deductible portions and to split the loan into 2.

In the meantime you need to work out a way to access your funds. If you pay with cash you may be doing yourself a disservice. If you take from the LOC then you could be compounding the problem.

Could you temporarily borrow the funds from a third party?

 

[matto_]

how long past the "contamination event" before the ATO will no longer look? ie 7 years?

 

[Terry_w]

Life of the loan.

 

[twinkle_star]

Sorry for dumb question, but can someone pls explain to me why the LOC is contaminate since the LOC is being used for all IP expenses?

 

[Terry_w]

Twinle, good question!

It seems John paid for some expenses with his credit card. This is a loan and could be refinanced with the LOC.

But what happened was that John borrowed from the LOC and placed the money in a an offset account. ie he borrowed to put in a savings account. This alone would mean the interest on that part of the LOC would not be deductible. But, if he mixed the borrowed funds with other cash in the account it would be even less likely that the borrowed funds could be attributed to 'investment'.

This would mean that the LOC has become a mixed purpose loan. Part of it would relate to investments and part not.

So now imagine the effect of every deposit into the LOC. A deposit would dilute both parts of the LOC in proportion to the percentage of investment/non investment.

 

[pieman]

Easy to clean up if you have bullet proof evidence of income related expenditure.
If you show a clear nexus between the expense and the purpose, 90% of the time you will be ok unless you are unlucky and get an angry ATO punter. Its simply luck of the draw who you get (in the case of an audit) and how much they are willing to break your balls.
Some are letter to the law types and others are more understanding that your intent was honorable.

 

[JohnA]

Thanks for the feedback.


Mistakes - did not consult accountant before hand. Went with advice of the bank manager. Started reading this forum and found out I did it wrong and yes terry now very messy.

Who is the best person for me to see/ consult to help me work this out?

Who is the best person to discuss whether to

- pay out existing LOC with redraw off PPOR & get new LOC or as I have read may be better to get IP loan with offset)

- can I refinance with another lender


I want to be more aware / educated / informed when I see the bank manager to sort this out. I don't want to make things worse.

 

[Aaron_C]

Refinancing to a new lender won't solve the problem since it is a tax issue, not a bank issue. Paying out the loan from redraw probably won't solve the problem either since it is the purpose that matters. Your accountant is probably best but if it's only a small amount of money it's unlikely the ATO would find out about it unless they do a comprehensive audit on you.

 

[Terry_w]

Yes, best to speak to a tax advisor.

Paying off the LOC with redraw is really only shuffling things around. It is essentially refinancing the LOC with another loan. So if the LOC is contaminated then the redrawn loan amount will be contaminated too.

 

[CHAOS]

Thanks

Awaiting response from accountant.

The lessons we learn!

 

[twinkle_star]

Twinle, good question!

It seems John paid for some expenses with his credit card. This is a loan and could be refinanced with the LOC.

But what happened was that John borrowed from the LOC and placed the money in a an offset account. ie he borrowed to put in a savings account. This alone would mean the interest on that part of the LOC would not be deductible. But, if he mixed the borrowed funds with other cash in the account it would be even less likely that the borrowed funds could be attributed to 'investment'.

This would mean that the LOC has become a mixed purpose loan. Part of it would relate to investments and part not.

So now imagine the effect of every deposit into the LOC. A deposit would dilute both parts of the LOC in proportion to the percentage of investment/non investment.

Terry, thanks for the explanation but I think I'm having a slow day!

I thought that even though John put money into the offset account it was to repay his credit card expenses related to the IP and therefore it would still be deductible?

Does this mean that how the funds are accessed is as important as the purpose of the expenditure to determine tax deductibility?

 

[Terry_w]

I thought that even though John put money into the offset account it was to repay his credit card expenses related to the IP and therefore it would still be deductible?

Does this mean that how the funds are accessed is as important as the purpose of the expenditure to determine tax deductibility?

The offset account is not a loan account. Therefore any money borrowed and placed in the account would not be used for investment purposes - so the interest couldn't be deductible. One could argue that the end use of the money was for investment purposes, but once it hits the savings account it is no longer borrowed money but just funds in a savings account so any subsequent usage would be simply paying cash.

 

[ShellTee]

WHOLEY %#@* Batman!

oh no. I think I have been caught out with this problem.

Set up loan structure with LOC Dec 11. No way off accessing funds without transferring via internet into another account (ie credit card or savings account)

So EVERYTHING including all purchase costs, reno and main mortgage of IP repayments (prior to tenant revenue) were paid for from savings account or credit card and reimbursed from LOC.

Does this mean I have NO deductable interest? It is about $50k drawn down.

OUCH!

 

[Terry_w]

Shell

Credit card is a loan so refinancing this debt with LOC borrowings would be ok. But if you have put money from a loan into an offset account or savings/cheque account the chances of claiming a deduction legitimately are low. if there was cash in the account then this makes it even less likely - how do you trace the funds.

 

[ShellTee]

Sorry - no intention of hijacking thread.



I trace the funds from legitimate receipts.

Ie If I paid kitchen installer $6125, then there is a $6125 charge on credit card or savings account one day and a $6125 transfer out of LOC into credit card or savings account the next. MOST of the expenses went via the credit card.

EVERY single expense was transferred out of LOC to exact cent individually so it is transaparant and easy to see that it was a direct expense with receipts.

Is this still not good enough for the ATO?

 

[Terry_w]

Sorry - no intention of hijacking thread.



I trace the funds from legitimate receipts.

Ie If I paid kitchen installer $6125, then there is a $6125 charge on credit card or savings account one day and a $6125 transfer out of LOC into credit card or savings account the next. MOST of the expenses went via the credit card.

EVERY single expense was transferred out of LOC to exact cent individually so it is transaparant and easy to see that it was a direct expense with receipts.

Is this still not good enough for the ATO?

Say you paid $6,125 on credit card and then reimbursed this from a savings account - how could the interest on this be deductible? It is no longer borrowed money once in the savings account.

If you reimbursed from a LOC you are not reimbursing but refinancing one loan (credit card) with another (LOC) so the interest could be deductible.

 

[BMan]

this is interesting
terry could you show us how do others with LOC work it so there not getting contaminated then?
pay with credit card and then transfer from LOC to CC?
what about items you cant pay for with a CC?
can you get a debt card for the LOC?
do you recommend a debt card for the LOC?

 

[Terry_w]

this is interesting
terry could you show us how do others with LOC work it so there not getting contaminated then?
pay with credit card and then transfer from LOC to CC?
what about items you cant pay for with a CC?
can you get a debt card for the LOC?
do you recommend a debt card for the LOC?

If you want to pay expenses with money from the LOC - ie borrow to pay - then you must transfer directly from the loan account to the provider of the service. ie write a cheque, electronic transfer etc from the actual LOC.

If you want to use a credit card to do so then don't have any other expenses on the card other than investment or business expenses. Then transfer money from the LOC directly to the credit card each month to pay this off.

 

[pieman]

I have a CC that is strictly investment related and is paid by a loan account. In that way there is a clear link between the expense and the loan funds with zero personal expenditure.