divorce/messy tax situation

[poppy]

Situation is we have five loans, all in joint names.

4 of the loans are for 4 IPs, all in my name.

The 5th loan, secured against my PPOR, was used for deposits on the IPs as well as for numerous other expenses related to the IPs, obviously never used for private purpose.

So, when I did my tax return when it came to splitting the interest on the 5th loan, I realised the messy situation I had caused, and just used a reasonable approximation as it made no difference to my tax liability. A bit naughty but would the ATO really be that interested in working out the exact numbers to try to punish me for something that makes no difference to my liability.

Anyway, now we are getting a divorce and we want to keep the IPs, shared amongst us, but will need to refinance all the loans (into the name of the person keeping that IP). There should be enough equity for us to end up with only four loans and still 80% LVR. However, as transfer of property due to divorce is not a normal CGT event, in order to keep the loans fully tax deductible the amount being refinanced will presumably need to be only the balance of the previous loan + the share of the 5th loan related to that property. There lies the nightmare in calculating that.

So I'm wondering:
Is there somewhere some software that I can just type in the last 6 years or so of transactions and have it spit out the numbers (a nightmare in itself, but better than calculating manually)?

If no, is there any possibility whatsoever that the ATO might have some kind of hardship provision for allowing an approximation and still maintaining tax deductibility?

Or perhaps I have totally misunderstood what I need to do?

Thanks

 

[jrc77]

Surely if you have all the transactions and which IP they relate to it wouldn't be that difficult to do a spreadsheet calculating the percentage for each?

Regards,

Jason

 

[poppy]

Surely if you have all the transactions and which IP they relate to it wouldn't be that difficult to do a spreadsheet calculating the percentage for each?

Regards,

Jason

Don't mean to be rude, but are you serious?

Interest is calculated daily. The calculations are complex when the balance changes every day.
Interest rate changes frequently. I'll have to plug in all the interest rate changes for each IP.
All transactions have to be assigned to the correct IP. Yes I have all this documentation but 6 odd years of 4 IPs, going through each transaction and matching it up to the related expense for the correct IP is a nightmare. I'm not going to remember whether a transaction from 6 years ago with a description of "John Smith - Plumber" related to what IP without going through all the records for each IP and finding a bill for same amount.

 

[jrc77]

Don't mean to be rude, but are you serious

Yes - of course I'm serious.

Interest is calculated daily. The calculations are complex when the balance changes every day.

Not sure that you need to go to that level of detail. I'd have a look into the ATO rulings or check with your accountant however I have a recollection of a ruling allowing for the loan to be refinanced with the amounts split as long as you can show how the amounts were calculated in a reasonable manner. Maybe worth investigating.

Does the fifth loan made any payments for the other four loans? Or any capitalized interest in it? This would make it more complicated but you could proportion any capitalized interest on the current balance.

Interest rate changes frequently. I'll have to plug in all the interest rate changes for each IP.

You'd have to do this with any software that calculates it for you.

All transactions have to be assigned to the correct IP. Yes I have all this documentation but 6 odd years of 4 IPs, going through each transaction and matching it up to the related expense for the correct IP is a nightmare.
I'm not going to remember whether a transaction from 6 years ago with a description of "John Smith - Plumber" related to what IP without going through all the records for each IP and finding a bill for same amount.

You'd have to do this with any software that calculates it for you. I was assuming you knew or could work out which expense was for what - otherwise no software is able to help you.

If it's too complicated, then gather as much information as you can and give it to an accountant to work out for you.

Regards,

Jason

 

[poppy]

Yes - of course I'm serious.



Not sure that you need to go to that level of detail. I'd have a look into the ATO rulings or check with your accountant however I have a recollection of a ruling allowing for the loan to be refinanced with the amounts split as long as you can show how the amounts were calculated in a reasonable manner. Maybe worth investigating.

Does the fifth loan made any payments for the other four loans? Or any capitalized interest in it? This would make it more complicated but you could proportion any capitalized interest on the current balance.



You'd have to do this with any software that calculates it for you.



You'd have to do this with any software that calculates it for you. I was assuming you knew or could work out which expense was for what - otherwise no software is able to help you.

If it's too complicated, then gather as much information as you can and give it to an accountant to work out for you.

Regards,

Jason

Thanks for your reply. Yes the 5th loan does make repayments for the other loans, as well as having rental payments go into it. Generally the expenses are only a touch higher than the rental income - and we have no private debt - so the ATO cannot reasonably argue tax avoidance.

I can definitely determine which transactions were for which property - it is just that it is a huge task given my banks, which still live in the dark ages, have such a limited space available to enter the transaction description that it will be a huge process to match up the transactions for each property. Yes, I will still have to work this out no matter what software I have along with all the interest rate changes. That is why I was kind of hoping the ATO would have some kind of provision for allowing an estimate.

Hesitate to seek advice from an accountant without doing my own research. I have seen so many people given bad advice from accountants. I will see an accountant when I have a more clear idea of what I can do. I will investigate the possibility that the ATO will allow the amounts to be calculated "in a reasonable manner" as you suggested. Thanks

 

[jrc77]

Have a read of "http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20002/NAT/ATO/00001".

Particularly the sections on "Apportionment calculations".

Regards,

Jason

 

[Terry_w]

You really should get advice on this.

There is rollover relief for the transfer of assets on a marriage breakdown, in some circumstances, in relation to CGT.

But you are assuming that loans can be changed around from one person to another and still have the interest as being deductible. I don't know if this is the case.

 

[poppy]

But you are assuming that loans can be changed around from one person to another and still have the interest as being deductible. I don't know if this is the case.

Why would you think this?

 

[Terry_w]

Why would you think this?

You have to look at each property and each loan you have on that property. If property 1 is owned by A and the settlement involves changing the name on the property to B the loan will have to be changed. B will have to borrow to acquire this property for the loan to be deductible to B.

So is A's transfer to B a gift or a sale or bit of both?
Does A's purpose in getting the loan relate to buying the property or to pay out B?

 

[poppy]

You have to look at each property and each loan you have on that property. If property 1 is owned by A and the settlement involves changing the name on the property to B the loan will have to be changed. B will have to borrow to acquire this property for the loan to be deductible to B.

So is A's transfer to B a gift or a sale or bit of both?
Does A's purpose in getting the loan relate to buying the property or to pay out B?

I believe that A's transfer to B is neither a gift nor a sale/purchase, as it is not considered a CGT event nor does it trigger stamp duty. Even a gift, I believe, triggers CGT and stamp duty in most cases at the market value.

The loan, I believe, could be considered partially non-deductible if it was for more than the existing loan (ie part of that loan is being used to pay out the other party for other things). This would be the same as if you refinanced a property purely to get a better interest rate, currently owing $150,000 on the property, you refinanced $170,000, $5000 of which was refinancing costs and the rest was to buy a car. In that case $15,000 of the new loan would be non-deductible, but there is no way that the entire loan is considered non-deductible just because it was refinanced.

Further, the name on the loans generally does not affect tax deductibility. Currently, the loans are in joint names, with titles in my name. If I refinanced the loan in my name only, that would not affect my tax deductions. I know that's not exactly the same scenario, but it adds to my feeling that the loan would continue to be tax deductible.

There is also the point that the CGT rollover on divorce, presumably designed to prevent forced sales upon marriage breakdown due to inability to raise cash for CGT, would be entirely worthless if all loan deductibility was lost. In fact, the CGT rollover may end up costing the couple more in the long term than if the transaction was considered a sale - this would mean the partner who took over the other's property would be able to deduct interest on whatever if cost them to "purchase" the property - even if more than the current loan balance. Hmm, perhaps this is the point of CGT rollover - to raise extra revenue in the form of appearing to "help" splitting couples

Anyway, I do believe the loan will continue to be deductible but thank you for challenging my assumptions, I will ensure I verify them before locking into anything... and I welcome other's point of view if they have arguments either for or against my opinions...

Edit: I've verified with solicitor that CGT rollover applies in our case.

 

[Terry_w]

I believe that A's transfer to B is neither a gift nor a sale/purchase, as it is not considered a CGT event nor does it trigger stamp duty. Even a gift, I believe, triggers CGT and stamp duty in most cases at the market value.

The loan, I believe, could be considered partially non-deductible if it was for more than the existing loan (ie part of that loan is being used to pay out the other party for other things). This would be the same as if you refinanced a property purely to get a better interest rate, currently owing $150,000 on the property, you refinanced $170,000, $5000 of which was refinancing costs and the rest was to buy a car. In that case $15,000 of the new loan would be non-deductible, but there is no way that the entire loan is considered non-deductible just because it was refinanced.

Further, the name on the loans generally does not affect tax deductibility. Currently, the loans are in joint names, with titles in my name. If I refinanced the loan in my name only, that would not affect my tax deductions. I know that's not exactly the same scenario, but it adds to my feeling that the loan would continue to be tax deductible.

There is also the point that the CGT rollover on divorce, presumably designed to prevent forced sales upon marriage breakdown due to inability to raise cash for CGT, would be entirely worthless if all loan deductibility was lost. In fact, the CGT rollover may end up costing the couple more in the long term than if the transaction was considered a sale - this would mean the partner who took over the other's property would be able to deduct interest on whatever if cost them to "purchase" the property - even if more than the current loan balance. Hmm, perhaps this is the point of CGT rollover - to raise extra revenue in the form of appearing to "help" splitting couples

Anyway, I do believe the loan will continue to be deductible but thank you for challenging my assumptions, I will ensure I verify them before locking into anything... and I welcome other's point of view if they have arguments either for or against my opinions...

Edit: I've verified with solicitor that CGT rollover applies in our case.

Do you have any authority to back up your claims?

I am not arguing one way or the other as I don't know the answer, but I don't think you are totally correct in your analysis above - other than the CGT roll over concessions and stamp duty concessions can apply.

s126-5 ITAA 97
http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s126.5.html

Please note you won't be transferring loans, but the transferor will need to requalify for the loan and it will be a new loan on settlement. Part of the loan may be refinanced from the old loan and part may be a new loan. The new loan may be deductible, but it could also be not deductible depending how this is structured. It is not as simple as you may think.

Stamp duty exemption NSW is s68 Duties Act 1997
http://www.austlii.edu.au/au/legis/nsw/consol_act/da199793/s68.html

 

[GaryT]

Obviously the CGT rollover is OK as long as the basic conditions are satisfied.

So the issue is whether the transfer of the loan maintains deductibility for the related interest.

At Terry has indicated interest is deductible to the extent of what the the funds where used for. The transfers did not involve the purchase of your spouse's interest in each rental property, nor did it involve the sale of your relevant interests in each rental property between spouses. In this case the borrowed money could be seen as not being used to buy the income-producing properties. The purpose and use of the loan is to pay the cash settlement. Accordingly, the essential character of the interest expenditure is of a private or domestic nature and probably not allowable as an income tax deduction.

And as much as Poppy's analysis makes sense, tax law has to be followed.

I feel there may be a possible solution if the settlement was structured correctly. There may be room to move if you were able to include a direction in the settlement that you obtain a loan from a financial institution in order to obtain sole legal title to the rental properties (and ensure sole legal title to the main residence).

Regardless I would test this with a PBR to get certainty.

Interesting question though.

 

[poppy]

Obviously the CGT rollover is OK as long as the basic conditions are satisfied.

So the issue is whether the transfer of the loan maintains deductibility for the related interest.

At Terry has indicated interest is deductible to the extent of what the the funds where used for. The transfers did not involve the purchase of your spouse's interest in each rental property, nor did it involve the sale of your relevant interests in each rental property between spouses. In this case the borrowed money could be seen as not being used to buy the income-producing properties. The purpose and use of the loan is to pay the cash settlement. Accordingly, the essential character of the interest expenditure is of a private or domestic nature and probably not allowable as an income tax deduction.

And as much as Poppy's analysis makes sense, tax law has to be followed.

I feel there may be a possible solution if the settlement was structured correctly. There may be room to move if you were able to include a direction in the settlement that you obtain a loan from a financial institution in order to obtain sole legal title to the rental properties (and ensure sole legal title to the main residence).

Regardless I would test this with a PBR to get certainty.

Interesting question though.

Thanks for peoples replies, I am going to do some reading of ATO rulings to get an idea before I see an accountant.

Just to clarify Gary, we do intend to transfer two rental properties from my name only to his name only. Further, two other rental properties that are in my name only are to get kept by me and the loan refinanced (for the same amount as previous loan) purely to remove my husband's liability for the loan, assuming bank approval of course.

We also have another rental as joint tenants. Fortunately no loan funds or expenses for this IP have ever been mixed with the other four. I would hope that my husband would be able to claim a deduction for purchasing "my share" of the IP, although that may not be such an issue as he intends to live in it once the current tenants are gone anyway.

Obviously, I can understand that if I owned a property in my name only, which my partner was entitled to a half share, and I did not have sufficient funds or other assets to pay him his share, then any extra money I borrowed against that rental property to pay him out would clearly not be deductible.

My hope in this case is that:

The two IPs which will remain in my sole name and are simply being refinanced to my name only will have the normal rules of refinancing apply ie it is completely fine as long as you do not withdraw extra funds for other purposes.

My husband will be able to take out a tax deductible loan in order to "purchase" the two IPs currently in my name (whether he can take out a loan for up to market value or only for the current amount owing on the loan I have no idea, but either would be OK)

Anyway, once I manage to find out for sure I'll post back.

 

[Terry_w]

Further, two other rental properties that are in my name only are to get kept by me and the loan refinanced (for the same amount as previous loan) purely to remove my husband's liability for the loan, assuming bank approval of course.

This one sounds like you are increasing the borrowings. What the extra funds are borrowed for will determine if the interest on these funds are deductible.

 

[poppy]

This one sounds like you are increasing the borrowings. What the extra funds are borrowed for will determine if the interest on these funds are deductible.

No, I am not increasing the borrowings. My partner simply does not want to have liability for the loan for the next 25 years, fair enough. The new loan shall be for exactly the same amount as the old loan, only the loan will be in my name instead of both.

 

[Rob G.]

Deductibility of interest usually follows the purpose of the application of the funds.

A new borrowing to buy out the partner's interest in an income producing asset is relatively easy to trace purpose.

Assumption of liability for the partner's existing loan where it is clearly traceable to the acquiring of the interest in the income producing asset is also possible. This is provision of consideration in a contract.

What is messy is changing names on titles and loans in an equitable manner that is motivated out a separation of domestic affairs.

It is a complex restructure inviting the Commissioner to split hairs.

You need a tax adviser and a family law adviser working together, otherwise apparently doing the right and just thing may end up with adverse tax consequences.

For example, would one partner be better off taking a superannuation split and the other the investment property ?

Cheers,

Rob

 

[poppy]

Well, I had a good day today.

Saw an accountant and was happy with his knowledge and explanations.

He agrees that we should be able to maintain full tax deductibility of our loans.

The obvious exception (which I knew would be the case) would be if I refinanced one of the IPs that I own in my name only and borrowed extra funds because I needed them to pay out my partner for other things that I didn't have sufficient liquid assets to cover. Clearly the extra borrowings would not be deductible in this case.

If my partner wants to keep an IP that we own in both names, then he will be able to claim a tax deduction for the interest on paying out my half of the property.

The accountant also advised me on the issue of a loan used to cover deposits and expenses for multiple IPs. Whilst I was the owner of all the IPs, apportionment of the interest between the IPs didn't matter that much as it made no difference to my tax outcome. But now some of the IPs will go to him and some to me, it seems necessary to apportion things properly. The accountant advised that it was not necessary to calculate the effect of every transaction and a reasonable estimate would be acceptable.

 

[GaryT]

Just to clarify Gary, we do intend to transfer two rental properties from my name only to his name only.

This transfer should not be a problem if treated as a simple commercial transaction. For the ATO purposes it is simply a sale from your husband to you and you financing a new acquisition. You could increase the borrowings to the sale price if you wished.

Further, two other rental properties that are in my name only are to get kept by me and the loan refinanced (for the same amount as previous loan) purely to remove my husband's liability for the loan, assuming bank approval of course.

This transfer is not so simple. You already own the property so what are the funds being borrowed for? Are they being borrowed in effect to pay out your husband. I.e. the funds are not being used to buy the property because you already own it. I know its a fine distinction but that's how law works. You have got to try and avoid assuming logic will prevail and simply apply the law.

Alternatively as you argue it is simply to finance the remaining balance of a loan that was originally used to purchase an income producing asset. But in the process you are changing the borrower from you and your husband to just you. So the question is - is their enough nexus to allow the claiming of interest on the new loan? Maybe, and I think probably, but I would suggest that you get a ruling to be sure. It would be nice to hear how that goes.

Currently I assume you are claiming 100% of the interest for these loans in your tax returns as the title is in your name. Even though the loan is held jointly, the ATO does not seem to have a problem with this.
[/QUOTE]

We also have another rental as joint tenants. Fortunately no loan funds or expenses for this IP have ever been mixed with the other four. I would hope that my husband would be able to claim a deduction for purchasing "my share" of the IP, although that may not be such an issue as he intends to live in it once the current tenants are gone anyway.

This looks fine as your husband is applying the funds to purchase 1/2 share in the house. Again he could in fact increase the borrowings to the market value of that 1/2 share.

 

[poppy]

This transfer is not so simple. You already own the property so what are the funds being borrowed for? Are they being borrowed in effect to pay out your husband. I.e. the funds are not being used to buy the property because you already own it. I know its a fine distinction but that's how law works. You have got to try and avoid assuming logic will prevail and simply apply the law.

Hi Gary,

The accountant advised that in this situation (ie, I already own the property, and am refinancing purely to remove my husbands name from the joint loan), I would retain full tax deductibility providing I did not borrow extra funds, if I borrowed more than the original amount then the additional funds would not be deductible. This is consistent with the law when refinancing any tax deductible loan, and consistent with the ATO's view that a husband and wife having joint names on a loan does not affect the tax deductibility of that loan (it only matters whose name the title of the property is in). You do not lose deductibility simply for refinancing a loan, whether it's to get a better interest rate or for any other reason. You only lose deductiblility if you refinance the loan and borrow additional funds and use them for a non deductible purpose.

I do appreciate the only way to certainity is a private ruling, but having done these in the past, they are problematic. The ATO cannot be penalised for ruling on the side of revenue whenever there is a grey area, but the ruling is binding on the ATO if they rule on the side of the taxpayer. So what do they tend to choose? I have had an unfavourable ruling overturned on appeal in the past (it was OBVIOUSLY just quickly cut and pasted word for word from a similar but DIFFERENT unfavourable private ruling), but if I DO get a ruling that is clearly hurried, poorly argued and unfavourable and just erring on the side of revenue, and I go against it - I will get slapped with much higher penalties and interest than if the ATO had ruled I had simply made a mistake.

Rolling over and just stopping claiming all interest on my IPs is clearly NOT an option, the slightly better alternative is selling up everything but having a fire sale on all your assets on the small possibility that the ATO might audit and impose a very harsh view (that the best accountants money can buy can't win) would not seem to be a great way to go either.

Thanks for your opinion.