Deductibility of Wifes interest if IP is owned by Husband ?

[NIF]

Does anyone know what the situation is, regarding deductibility of interest, where an investment property is owned by the husband, but the loan used to purchase the property is in the names of both the husband & wife ?

A friend is in this position, & his accountant set up a subsidiary loan agreement which has the effect of the wife loaning her half of the borrowed funds to the husband & charging him interest on it.

He was told this was necessary as the Tax Office would otherwise regard her as gifting her half of the funds to the husband, and her half of the interest would not be tax deductible.

Does anyone know whether the Tax Office does view it that way, & if so, is a subsidiary loan agreement effective in making the wife’s interest tax deductible ?

Thanks

 

[Peter 14.7]

Does anyone know what the situation is, regarding deductibility of interest, where an investment property is owned by the husband, but the loan used to purchase the property is in the names of both the husband & wife ?

A friend is in this position, & his accountant set up a subsidiary loan agreement which has the effect of the wife loaning her half of the borrowed funds to the husband & charging him interest on it.

He was told this was necessary as the Tax Office would otherwise regard her as gifting her half of the funds to the husband, and her half of the interest would not be tax deductible.

Does anyone know whether the Tax Office does view it that way, & if so, is a subsidiary loan agreement effective in making the wife’s interest tax deductible ?

Thanks

Not an accountant but that seems right. Is it title that matters to the ATO.

So if you are tenants in common at say a 90/10% split that is how the deductions and CGT is treated.

Peter 147

 

[Rolf Latham]

Hiya

The acctant is probably being perhaps a little paranoid, however its all part of the documentation process which wont hurt

ta
rolf

 

[DaleGG]

Hi

The issue is quite clearly dealt with by the tax office in its annual booklet for property investors. The interest is claimed by the owner/s of the property in the same proportion of ownership as is shown on the title.

so, if the husband owns 100% of the property he will claim 100% of the interest as a tax deduction regardless of the loan being in joint names.

The booklet is available from here:

http://www.ato.gov.au/individuals/content.asp?doc=/content/42782.htm

have fun

Dale

 

[Garry K]

Hi


so, if the husband owns 100% of the property he will claim 100% of the interest as a tax deduction regardless of the loan being in joint names.


Dale

Hi Dale.

Having said that, the comment by NIF
"A friend is in this position, & his accountant set up a subsidiary loan agreement which has the effect of the wife loaning her half of the borrowed funds to the husband & charging him interest on it. "

Is this a legitimate strategy to obtain an interest tax deduction for the wife?

GarryK

 

[duncan_m]

Hi Dale.

Having said that, the comment by NIF
"A friend is in this position, & his accountant set up a subsidiary loan agreement which has the effect of the wife loaning her half of the borrowed funds to the husband & charging him interest on it. "

Is this a legitimate strategy to obtain an interest tax deduction for the wife?

GarryK

Yes, but it seems pointless as surely she has to show income from her husbands interest payments to her? The two will offset each other.. Unless no loan repayments are being made which kinda makes the "loan" a bit of a sham?

 

[Kristine..]

G'Day

It would seem to me that Nif's friend's accountant is making a simple situation, complicated.

There have been a number of threads on this issue and 'opinion' is divided. However, 'I' own a block of land on which 'we' built a house seven years ago.

The finance for the house is in both names, and we have always split the income and expense for the house 50/50.

The property produces income in excess of expense, that is, the property is cash flow positive and the surplus money is taxable.

During the course of 2004 we enquired with ATO re shifting the whole income / expense to me.

The answer was: The loan is in both names and both are jointly and severally liable. Both share the income and expense equally. No pretence is made that this is 'carrying on a business' (which is the main argument in the examples on the ATO website), this is investment only.

The ATO advised that we were welcome to continue to share income / expense in the established manner, or to change it to myself only, but if we changed it to one party only then all tax returns ie 7 returns would need to be adjusted back to the beginning of the investment to indicate the same position for the life of the investment.

As the idea of adjusting seven tax returns was not appealing, we will continue to declare income and claim expense on a 50/50 basis as we always have.

However, trying to pretend that there is a subordinate loan agreement is, in my opinion, a lot of twaddle. A Memorandum stating the agreed position, yes perhaps, just so the parties clearly remember their intentions at the outset, but this is not a legal document just an internal Heads of Agreement.

As always, applying for a Private Ruling from the ATO is simple and binding. There is no need to reinvent the wheel. Law is all about 'intention'. If it is the 'intention' to avoid tax, then any arrangement can be transparent and the ATO can make application to the Courts to set the arrangement aside.

In our situation, the loan was in both names as I had insufficient income to service the debt myself. The 'intention' was to create and establish the investment on a share basis with full tax declaration from the beginning.

As I have said, this arrangement has been running for seven tax years. In that time we have had at least two ATO opinions on the arrangement. Provided we do not change the balance of liability / benefit the arrangement will continue to stand.

Cheers

Kristine

 

[duncan_m]

There have been a number of threads on this issue and 'opinion' is divided. However, 'I' own a block of land on which 'we' built a house seven years ago.

This seems quite at odds with the ATO's Rental Property Guidelines that suggest all expenses/income MUST be apportioned in accordance with the Legal Ownership of the Property.. Obviously your Private Ruling gives you confidence, but it fills the rest of us with despair at their fickleness.

To quote from their site

Rental income and expenses must be attributed to each co-owner according to their legal interest in the property, despite any agreement between co-owners, either oral or in writing, stating otherwise.

 

[Kristine..]

G'Day Duncan

Yes, I hear all the arguments as to why this should not be so, but precedent in this situation is well established.

Perhaps this is because I owned the land outright before the house was built, and the finance was organised to build the house, that is, the income producing improvements.

No, I do not have private ruling, as I stated we have sought opinion and the last time we sought opinion it was to the eligibility of changing the arrangement to me only. We can only do that if the change is retrospective to the commencement of the investment.

So I do not see this as 'fickleness' on the part of the ATO. Rather, I see this as their ability to view each situation on a case by case basis. We are not trying to pass expense off to the higher earner and we do not have some whimsical 'private agreement'. The arrangement is based solely on our benefit and liability according to the arrangement of finance to improve the property to produce income.

There is a significant body of case law regarding ownership of improvements. In this instance we both own the improvements, and we both own the debt and all expenses incurred in the normal operation of the property.

Perhaps it would have been different if the property was improved ie the house was already there when I bought it, but certainly in this situation this is how it (apportionment for tax purposes) applies.

Cheers

Kristine

 

[duncan_m]

There is a significant body of case law regarding ownership of improvements. In this instance we both own the improvements, and we both own the debt and all expenses incurred in the normal operation of the property.

Yes I can see the subtle difference here, thanks.

It would seem if the IP in question (for the original poster) was an established residence when purchased that the apportionment of income and expenses would be subject to difference precedents/caselaw from those which you've relied on.

 

[quiggles]

Duncan,

Kristine's post missed an important piece of data. Who has the legal interest in the property? If it is 50/50 then ATO's position is consistent, otherwise I agree with your last despairing comment. K owned the land but both built the house (the income producing part).

I am interpreting the comment that K was welcome to move expenses/income to one partner as meaning the ownership could also be moved although why this would require retroactive adjustment of the taxes (unless the property shift were retroactive) I have no idea.

 

[duncan_m]

Hi Quiggles,

I agree, the ATO position is crystal clear on the matter.. an established property MUST have its Income/Expenses apportioned according to the legal ownership. The only way around this is if the Husband/Wife have so much property that they could be classified as being "in business". The ATO's website provides SOME guidelines on where this line can be drawn..

It would seem from Kristine's post that ownership of subsequent improvements built on a vacant block of land could result in the apportionment being varied according to some other measure than legal ownership on the title for the land.

I do still despair at the fickleness of the ATO, I often see Private Rulings that seem quite at odds with the general advice on their website.

Incidentally, don't you love how they dont allow you to SEARCH Private Rulings? All you can do is browse the 30,000 odd that are in the registry, 1 by 1. I'm sure this is because they must have a host of great ideas contained within them. But it could be the cynic in me coming out. I havent tried Google, if its indexed them it should now be possible.

I wrote some software to download EVERY single Ruling to my Hard Drive to enable me to search by Keyword.. its a great resource, I wish I could sell it but their copyright prohibits me doing this.


EDIT: Hmm, even the online register of binding rulings now seems to have disappeared from the ATO's site!

This register was established after the much publicized incident where a Deputy Tax Comissioner was giving positive rulings to Mates.. the register was meant to increase our confidence/trust in the system.. now its gone! A search of their site showed up one link that doesnt work anymore..

 

[XBenX]

Did you archive them Dunc?

 

[duncan_m]

Did you archive them Dunc?

I'm pretty sure I did.. it was about 8 months ago, will check when I get home.. my legal position in doing anything with them is somewhat constrained, which is just fascist of them.

 

[Mry]

I agree with DaleGG.

The house is owned by the husband so the husband is the only one entitled to claim the interest, and 100% of the interest if 100% of the loan funds were used to acquire the house. The wife can claim nothing.

Certainly the idea that the wife's name on the loan account has some merit but the overriding question with loans is - what is the purpose of the loan?

Also remember one of my favorite sayings - You can only claim deductions against income (it has some exceptions but overall it works ). If the wife has no legal ownership of the property she has no right to the rental income. If she has no income, she cannot claim deductions against that property.

If you wanted to be really pedantic about it, you could say that half of the interest claim is a reimbursement of interest incurred by the wife for the use of the loaned funds given to the husband but lets not go there.

 

[NIF]

Thank you everyone for your help !

 

[julia]

I stirred up the ATO after getting some documentation saying that the interest must be apportioned according to ownership. I said my bother and I owned a property and he borrowed for his share yet I paid cash for mine. I am in a higher tax bracket than him so can I claim half his interest? Well I got cut off 3 times and spent most of the day nailling this one. In the end they said the running costs are apportioned according to ownership but the ownership costs ie interest are apportioned according to the individual's circumstances.

Then you have Domjan's case where the ATO successfully argued
• the net income or loss from investments should be shared according to the legal interest of the owners except in the very limited circumstances where there was sufficient evidence to establish that the equitable interest was different from the legal title

61. As the Tribunal noted in Case 63/96 the test for deductibility of interest is the purpose of the borrowing and the use to which the borrowed funds are put. Accordingly in the matter before me I adopt the conclusion reached by the Commissioner
At the time the Applicant's husband made the payment of $78,505.97 to the loan account, the loan was being used to fund the purchase of partnership assets ie assets purchased in the name of the Applicant and her husband as well as assets purchased in the Applicant's name only. The balance of the loan outstanding that relates to the purchase of partnership assets clearly belongs to the deemed partnership and as such the interest incurred on this part of loan should be used to calculate the net income of the Applicant and her husband in accordance with subsection 92(1) of the ITAA 36.

Then there is the results of internal checks on ATO written advice a couple of years ago that showed it was wrong 22% of the time.

I wouldn't say your Accountant is over reacting, it is better to do everything you can to support your position. Best of all get a ruling from them.

Julia Hartman
[email protected]
www.bantacs.com.au

 

[duncan_m]

Did you archive them Dunc?

Yes I have them archived, all 27796 of them Some of them are better than novels for entertainment..

 

[duncan_m]

I stirred up the ATO after getting some documentation saying that the interest must be apportioned according to ownership. I said my bother and I owned a property and he borrowed for his share yet I paid cash for mine. I am in a higher tax bracket than him so can I claim half his interest? Well I got cut off 3 times and spent most of the day nailling this one. In the end they said the running costs are apportioned according to ownership but the ownership costs ie interest are apportioned according to the individual's circumstances

Love your work Julia

 

[Kristine..]

I stirred up the ATO after getting some documentation saying that the interest must be apportioned according to ownership. I said my bother and I owned a property and he borrowed for his share yet I paid cash for mine. I am in a higher tax bracket than him so can I claim half his interest? Well I got cut off 3 times and spent most of the day nailling this one. In the end they said the running costs are apportioned according to ownership but the ownership costs ie interest are apportioned according to the individual's circumstances.

Then you have Domjan's case where the ATO successfully argued
• the net income or loss from investments should be shared according to the legal interest of the owners except in the very limited circumstances where there was sufficient evidence to establish that the equitable interest was different from the legal title

61. As the Tribunal noted in Case 63/96 the test for deductibility of interest is the purpose of the borrowing and the use to which the borrowed funds are put. Accordingly in the matter before me I adopt the conclusion reached by the Commissioner
At the time the Applicant's husband made the payment of $78,505.97 to the loan account, the loan was being used to fund the purchase of partnership assets ie assets purchased in the name of the Applicant and her husband as well as assets purchased in the Applicant's name only. The balance of the loan outstanding that relates to the purchase of partnership assets clearly belongs to the deemed partnership and as such the interest incurred on this part of loan should be used to calculate the net income of the Applicant and her husband in accordance with subsection 92(1) of the ITAA 36.

Then there is the results of internal checks on ATO written advice a couple of years ago that showed it was wrong 22% of the time.

I wouldn't say your Accountant is over reacting, it is better to do everything you can to support your position. Best of all get a ruling from them.

Julia Hartman
[email protected]
www.bantacs.com.au

Hello Julia

I rest my case.

Thank you.

This issue has been debated at length at least three times on this forum and every time I mention the circumstances relating to my specific and particular property I am criticised because 'it's against the rules'.

However, the ATO is fully aware of what we are doing and why and the situation continues without comment other than that the investment must continue in the way it was started. I suppose if one of us 'bought out' the other one's interest we could change the reporting method without adjusting the historic tax returns, but just changing the balance for the sake of tax benefit is not acceptable.

I appreciate your comments, your anecdote and your quotes.

Thanks again

Kristine

PS This is one reason why my beloved cardigan wearing fuddy duddy CPA is firmly entrenched on my Christmas Card list - he's not just a pretty face, after all!!

PPS Love your website