debt recycling and capitalising interest

There seems to be much confusion about this issue. The consensus seems to be to apply for a private ruling if you are thinking of capitalising interest, particularly where you intend to pay rental income (pre-tax) into a PPOR loan and the PPOR is used as security for an investment LOC. This has been made fairly clear since TD 2012/1.

However, what about the following cases:

  • where you don't 'pay off your home loan sooner' by paying all rent into the LOC, and allow the interest on the IP loan to capitalise and use the LOC to pay for the IP loan interest. You also pay all IP property expenses on the LOC (and claim the interest) but pay the interest on the LOC using the rent (assuming it covers all interest/expense costs). You rely on the view that capitalised interest is deductible if the underlying expense for which it was incurred is deductible.

  • There is also the case where you take the above situation, but DON'T claim for the capitalised interest in respect of the IP loan. You instead pay all rent into the home loan as you are not worried about the Part IVA tax scheme issue applying to the deductibility of the interest. You bear the cost of interest on the LOC without tax deductions, but have the advantage of paying off your non-deductible debt as quickly as possible, assumedly to promote cash flow and ability to build up funds to invest. This seems to be the approach of some firms out there, for example a firm called 'C..... property services'.

    Would this be acceptable on face value? I see this approach being a record keeping nightmare as the interest charge must be apportioned between interest on top of interest and interest on the original borrowings. If one was to adopt this approach, is there a practical way to avoid this nightmare?

Would it matter whether the LOC is secured against the PPOR or IPs in either of the above scenarios? BAN TACS seems to suggest this may be an issue in their advice on their website http://www.bantacs.com.au/capitalising-interest.php I presume because of the unfavourable ATO response to PBR 1011345133229.

Surely in the interest of aiding cash flow this is an issue that should be of concern to investors looking to expand their IP portfolio?
 
I tried to get my head around your second proposal - capitalise but not claim. However I think this would work out the same in the end.

What you pay extra off the home loan you end up with the same amount borrowed from the LOC. Not claiming it means no advantage.
 
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