Are the banks less likely "now-a-days" to open a LOC to allow an investor just to capitalise their IP costs? That would put the kibosh on this sort of strategy. 
How do I get the equity out of my investment properties to reduce non deductable debt
- Thread starter krak
- Start date
Dear Krak
bene313 has got the strategy in one.
The planned actions you could take include:
Best Wishes
Corsa
bene313 has got the strategy in one.
The planned actions you could take include:
- have your IP revalued and borrow the maximum possible that they will lend you (avoid cross collatorisation) - assume redraw loan of $140k
- have your PPOR revalued and borrow what you can out of this as well as a separate redraw loan - assume redraw loan of $60k
- ensure you have an offset account against your PPOR and do not put funds directly into your PPOR loan
- use the $140k (and if applicable the $60k) to pay all your investment loan interest and all your investment costs. This makes all the interest deductible on these new loans.
- To diversify you could consider buying shares and/or you could use some of these borrowed funds to purchase another investment property using some part of the $140k and/or the $60k. Just ensure that you quantify and set aside say 3 years worth of investment costs (interest + ongoing costs) so that you can capitalise at least 3 years worth of investment expenses - by that time you may have enough equity to redraw again
- Ensure that the "bank purpose" for the loan is to invest in further investment properties and quantify the extra rent you expect to get from these investment to help with your DSR (Debt to Service Ratio with the bank)
- then put your own salary, cash, rents from your IP's into your PPOR offset account
- you dont need to sell your property to anyone, hide any assets/growth - forget all that
- you also do not need a private ruling for the above - just keep everything nice and separate - new borrowed funds only for investment and all cash into PPOR to reduce consumer debt
- you will find before you know it you will have paid off all your PPOR and then be ready to invest again using growth in all the properties.
Best Wishes
Corsa
Dear All
i have had a private request to outline a strategy for those who have only 100% deductible debt and 0% non-deductible debt.
Essentially the strategy remains the same. Depending on your life style requirements of course (ie cost of living, holidays, etc), income and status of your investment properties (positive cash flow or negative)
If one has no deductible debt then the strategy is:
Hope this is of some help
Best Wishes
Corsa
i have had a private request to outline a strategy for those who have only 100% deductible debt and 0% non-deductible debt.
Essentially the strategy remains the same. Depending on your life style requirements of course (ie cost of living, holidays, etc), income and status of your investment properties (positive cash flow or negative)
If one has no deductible debt then the strategy is:
- go to the bank and ask for the maximum borrowings against each individual investment property that you have (preferrably as a separate re-draw loan; avoid cross collatorisation)
- DEPENDING on how much you earn - ie if you earn over $80k then you want to increase your tax deductions THEN capitalise your interest + costs on your investment properties to BOOST up your investment expenses to DECREASE your tax paid
- DEPENDING on whether your investment properties are cash positive or negative - IF they are cash flow positive then use rents to live off and capitalise the investment debt. IF they are negative then it probably makes negligable difference
- overall if you follow the same strategy of "living off equity" and "capitliasing interest on interest". this strategy will allow you to retire off your investment portfolio (regardless of PPOR status) from rents/equity rather than sell everything off
Hope this is of some help
Best Wishes
Corsa
Corsa, Julia Hartman wrote in support of the above theory (the crediting rent against non-deductible borrowings and capitalising interest part) in an edition of API late last year after she obtained a Private Ruling for a client. In her article she recommended others wanting to go along the same path also obtain a Private Ruling.
Your posts on capitalising interest, etc. are always valuable. Could you tell me why, however, you are so sure that in doing what you say above a Private Ruling is not necessary? Thanks.
No problem at all Gordon.
The answer is really straightforward, interest is deductible to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purose and is not of a capital nature ITAA97 s 8-1.
Therefore, interest that is borrowed (from LOC/redraw) is deductible to fund investment properties that have been purchased with an (eventual) view of earning income.
IF you are feeling unsure of your situation in comparison to the above tax legislation then by all means get a private tax ruling but I personally do not feel that is particularly necessary when you read the essence of the tax law which has been summarised above.
Does this make sense?
Best Wishes
Corsa
Hi Corsa, thanks for your response, much appreciated.
Just wondering how you get around Part IVA when capitalising interest ?
I had a look at doing this awhile ago, but was advised against it.
Reason being was that the dominant purpose was to receive a tax benefit.
I certainly don't need an ATO auditor in my face, so chose against this course of action.
I had a look at doing this awhile ago, but was advised against it.
Reason being was that the dominant purpose was to receive a tax benefit.
I certainly don't need an ATO auditor in my face, so chose against this course of action.
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In reference to TD 2008/27 and Hart's case, Hart's case proceeded to the High court because the Court found Part IVA of the IAA 1936 applicable - in that the predominate purpose of the set-up/arrangment/scheme was to avoid tax (as opposed to expenses incurred to generate income). That is why Harts got in trouble because the had a split loan connected to a PPOR and a IP. They claimed the deduction for interest on both the IP and PPOR and the PPOR component (that would have otherwise been undeductible) was the part that contravened Part IVA. They should have been evenly proportioning each repayment against the PPOR and IP which they didnt do which increased there deductions and escalated repayment of the PPOR.
The case discussion itself talks about if a taxpayer took out two separate loans, and the terms of the loan for the investment property were different from the terms of the loan for the residential property in that they provided for a higher ratio of debt to equity, and for payments of interest only, rather than interest and principal, during a lengthy term, then ordinarily that would give rise to no adverse conclusion under s 177D.
Morg, the fact that you were advised against structuring might be because your arrangment was closer to the way Hart's structured it - or lack of understanding by your accountant and awareness of how Part IVA operates - risk adverse behaviour. Either way, you have to feel comfortable to ensure that you are operating within the constructs of the law.
My view only, if you keep borrowings separate for Investing and Personal use - this largely clears up all the debate and issues caused around Part IVA and any issues with deductibility.
Hope this is of some help
Best Wishes
Corsa
The successful Private Ruling that was obtained by Julia Hartman and detailed in November 2009 API was achieved by arguing that the dominant purpose was not to receive a tax benefit, but to pay off the mortgage on the applicant's PPOR faster. To want to pay off your PPOR mortgage as soon as possible is a natural wish and that was the dominant reason for directing the IP rent to the PPOR mortgage. It just so happened that this method resulted in a tax benefit becoming available that could be taken advantage of
. I highly recommend reading the article. Corsa, horses for courses as you say, but it's confusing that Julia Hartman is not as confident as you are with regards this theory and still recommends the private ruling path. To do so indicates that she sees it still as a grey area. The Private Ruling mentioned above taking over 6 months to be granted would further possibly indicate that the ATO is "unsure" of the method and tried their best to find a reason not to grant it...
The successful Private Ruling that was obtained by Julia Hartman and detailed in November 2009 API was achieved by arguing that the dominant purpose was not to receive a tax benefit, but to pay off the mortgage on the applicant's PPOR faster. To want to pay off your PPOR mortgage as soon as possible is a natural wish and that was the dominant reason for directing the IP rent to the PPOR mortgage. It just so happened that this method resulted in a tax benefit becoming available that could be taken advantage of
Corsa, horses for courses as you say, but it's confusing that Julia Hartman is not as confident as you are with regards this theory and still recommends the private ruling path. To do so indicates that she sees it still as a grey area. The Private Ruling mentioned above taking over 6 months to be granted would further possibly indicate that the ATO is "unsure" of the method and tried their best to find a reason not to grant it...
I'm curious why the confusion by the ATO in this regard when they quiet happily accept capitalising interest on Margin Loans for Shares?
*Note* I usually pre-pay any margin loan interest in June myself though; pre-paying usually gives me a discount and I claim against income in the new Financial Year.
Dear Gordon
I understand Part IVA very well as a Chartered Accountant.
As I said, my philosophy is to work completely with the constructs of the tax law as an accountant, investor and owner of my own businesses. Essentially any expense you incur to produce income is deductible. Any expense that is private in nature (ie in relation to a PPOR) is not deductible. Keeping those lines really clear clarifies most tax issues. Hart's blurred the two (PPOR & IP with the split loan) so that was the problem there.
However if people do feel uncomfortable or unsure of there situation then by all means get a tax ruling or further advice.
Sounds like you understand all the issues anyway so hope it is all working out for you.
Best Wishes
Corsa
I don't think there's an issue with capitalising interest whether it be on an IP loan or margin loan per: Terry W's post. They are deductible in both cases.
The issue is where the dividends (in the case of shares within a margin loan) and rent (in the case of an IP) should be applied as not applying them to the loan they relate to recycles debt from non-deductible to deductible (and increases tax benefits). The ATO was asked in the PR I mentioned, in effect, whether the rent income from the IP had to be applied against the IP loan. The ATO said no. The equivalent question from a margin loan perspective would therefore be "do the dividends from the shares within the margin loan need to be applied against the margin loan or can they be applied to other debt (ie. non-deductible debt)?". In line with the above you'd expect the ATO to be consistent and allow the dividends to be applied to a PPOR mortgage, but I don't know if it's been tested.
Corsa, your knowledge in this area is unsurpassed and I'm not querying your credentials or experience. Geez, you have you own Sticky on the subject!
I don't mean to be difficult, but your above quote illustrates my confusion: keeping the lines of deductible and non-deductible transactions clear is important. So, logically, rent (taxable income) therefore should go against from where it's associated - IP loan (deductible). But you're advocating it go against PPOR mortgage (non-deductible). Isn't this a contradiction?
Don't get me wrong, I think you are correct and the PR agrees with you. I'm just concerned where the ATO fits in with all this as there seems to only be a single PR to rely upon that was positively released only after lengthy thought.
That is okay Gordon, I understand the confusion and the potential contradiction, that is why so many years ago I sat down and wrote the Interest on Interest post. I have my coffee on this lazy Sunday morning so will try and communicate my thoughts to you:
The Tax Office has clarified via the PR that you do not neccessarily have to apply income (rental or shares) against the related security loan. If we agree on this point then this automatically provides some assurance to use any investment income to pay down PPOR debt and/or live off.
When we talk about keeping things nice and separate, the only eg I can give is the way some people have set-up VLOC's and have investment & personal expenses coming out of the VLOC and then all salary + rents coming into the VLOC. This creates a lot of confusion about the deductibility of interest in this scenario and the tax office basically says you need to apportion the money coming into the VLOC evenly against Personal debt and Investment debt and you cant just apportion the repayment as all personal. Or some people try and claim all interest on the VLOC instead of splitting it out correctly.
So on that basis, if you have a redraw on an IP for eg - I think it is better to keep these funds separate and use all those funds for investment purposes and then all interest is clearly deductible
Then use all rents to fund lifestyle or pay off non-deductible debt
Then eventually when you have no income and no non-deductible debt then you might "live off" equity via some of the redraw but then the interest associated with that redraw component is not deductible as it is personal
Or you sell everything or part and live off Cash. For anyone not comfortable with the "Interest on Interest" discussions I guess this would be the back-up/last option.
Again, this is a complex area so I am trying to simplify it down to a few dot points in a short post.
Are you currently living off your portfolio or planning on how you are going to retire from your portfolio?
Hiya Corsa,
Long time no see on SS - fantastic to see you back.
Yeah goes without saying. Either via offset stucture if there's a chance of the ppor being turned into a IP some time down the track, or if no chance of that then via redraw facility and/or LOC.
Yes, we agree on this point. Perhaps I'm overplaying this, but applying rent to a PPOR mortgage will save years and lots of interest (and shift non-deductible debt to deductible) and so is definitely worth it. But unfortunately the PR does only relate to the applicant's specific situation. It provides guidance and clarification somewhat, yes. Total reliability, no. But I so want to believe!
Certainly agree. Mixing personal and investment expenditure is fraught with danger. Won't ever be going there.
I suppose ultimately the latter - planning on how to retire from our portfolio - but we're only relatively young. At this stage it's just a matter of investigating all avenues to get rid of the PPOR mortgage and the crediting rent to it/capitalising deductible interest methodology appeals. Logically then, if it can be done for one IP then you could then look to getting a second IP and doing the same for double the effect, 3 IPs would be triple....(!)
Very much appreciate your time and advice on this thread, Corsa, thanks.
"16. This Determination does not deal with the question of the application of Part IVA of the ITAA 1936 to arrangements involving compound interest."
Very interesting discussion guys. Corsa your knowledge, as an accountant, and contribution to this thread is much appreciated.
"Morg, the fact that you were advised against structuring might be because your arrangment was closer to the way Hart's structured it - or lack of understanding by your accountant and awareness of how Part IVA operates - risk adverse behaviour. Either way, you have to feel comfortable to ensure that you are operating within the constructs of the law."
My current finance arrangements consist of an STG Portfolio LOC. This is purely for investment purposes. Each property has it's own "sub account".
These sub accounts have their own individual credit limit, account #, interest allocation and statements.
In my view, this allows clear visibility as to what property is incurring what interest. All nicely separated.
I was then proposing to open another sub account within this LOC, and draw this down to service the interest payments for the existing accounts.
Again, I believed this setup to clearly show what, why, and where the expenses were coming from.
My PPOR loan is with another institution all together.
I must admit, I still don't fully understand the ATO's distinction between split loans and LOCs, so that maybe where my plan fell over, but I was led to believe Part IVA was the issue.
And yes, Corsa, I think you are quite correct in saying that my accountant is risk averse.
Whilst I am comfortable with the financial risks of this method, I can't say the same of the legislative risks (if that is the correct term).
My thinking is that I'm paying this man for his professional advise, so I'd be a mug not to follow it.
Having said that, I'm still very interested in the subject and the opinion of others in this field.
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