How to avoid mixing personal and investment funds when paying IP expenses?

[shab]

Hi everyone,

I am trying to understand what the basic setup for paying IP expenses should look like. At the minute, I have 3 accounts with my bank:
1. Personal Savings account (offset for PPOR loan)
2. PPOR loan account
3. IP loan account

So for the people that don't use a LOC to pay the IP expenses, do you just pay for everything, including the IP interest and other expenses, out of the Personal Savings account? As in:
1. Salary goes in to Personal Savings account.
2. Rent from IP goes in to Personal Savings account.
3. P&I payment for PPOR comes out of Personal Savings account and goes into PPOR loan account.
4. Interest-only payment for IP comes out of Personal savings account and goes into IP loan account.
5. Any other IP-related expenses such as PM fees, rates etc get paid out of the Personal Savings account.

Now this doesn't appear to align with what I keep reading about ensuring that your personal funds are kept separate from your investment funds so that you don't lose any tax deductibility as far as the ATO is concerned.

But for the IP expenses, such as paying the PM fees, or the council rates, how else can I pay for them given that there is a shortfall between the IP rental income and the total IP expenses each month?

Even if I put the IP rental income into a different account to my Personal Savings account, it wouldn't be enough to cover the loan interest, the PM fees, the council rates etc, so how do I avoid mixing personal and investment funds altogether? Also, isn't the aim to have the IP rental income going into my PPOR offset account to be reducing my non-deductible debt as quickly as possible? If it's sitting in an account and not offsetting the PPOR interest, isn't it less efficient?

I am also following the "Paying IP expenses from LOC" thread, but to be honest I am not understanding it and think it's too advanced for me at this stage, and there seems to be a number of people that don't have a LOC for their IP, so I'm wondering what the basic/vanilla set-up for most people is?

Thanks in advance for any clarification!

 

[Singo]

Interest is deductible for any IP related loans. So the loan funds should not be mixed with personal funds. For example of you top up your IP loan by 10k to do a Reno and put that in your savings, then funds are mixed. Your accounts are straightforward and I don't see any loans getting mixed.

But using a separate account makes tax time easy though as you can track all expenses easily and not miss any deductions.

 

[Thann]

1. Rental Income goes into PPOR Offset Account (along with all other income)

2. All loan (PPOR and IP) interest charges come out of Offset Account

3. PM fees (And some minor repair charges) are deducted from Rental Income by PM

4. Insurance, Rates Body Corp, large IP repairs etc. are charged to Investment CC

5. Personal expenses are charged to Personal CC

At Tax Time:

Rental Income, PM expenses etc. are tracked by PM EOY statement
Investment expenses are tracked by Investment CC statement
IP interest is tracked by IP Loan account statement

Everything is categorized by my financial software, which is setup to give me reports by property, by account and by purpose.

 

[BMW]

All expenses can come out of you PPOR offset account. there is no need to keep it separate for the ATO, just keep track of the receipts etc for tax time.

Some people set up a LOC so they can capitalize on expenses but this shouldn't be done without tax advice.

Also be careful withdrawing money from a loan via your personal account to pay for IP expenses/deposits as it could contaminate the loan.

 

[Brady]

As touched on above. The main concern is mixing the offset if there are borrowed funds. When is solely just savings it doesn't matter. But issue is if you borrow money for IP and parked them in offset with personal savings... how could you determine whats used for each purpose.

Can one of the accountants clarify something for me if possible...

Say someone has put extra funds directly off the loan and gone into redraw, if they then switch to interest only and put all future extra repayments into the offset. Is there any issue in using the redraw to pay for IP expenses? My understanding is no issue as its IP expenses.

To go one further on that point, if someone was to switch repayment to salary credit were they would be responsible to make the payment, but because they are ahead repayment comes from the redraw... would that be an issue. Idea being again cash funds go into offset whilst interest is paid from redraw. This one I'm a little iffy on because its like capitalising interest, except its coming from extra repayments you have already paid on the loan in advance.

 

[Terry_w]

Redraw is considered new borrowings. So each time you take money out of a redraw to pay bills etc this is a new loan. Normal deductibility principals apply.

If you let the interest of a loan be paid from the redraw then this is borrowing to pay interest. ie. capitalising interest.

 

[shab]

Thanks everyone for the replies, I think I get it now. I was getting confused between two different topics:
1. the concept of mixing loan funds, and;
2. what account(s) you can use to pay for IP-related expenses.

So if my understanding is correct, in a nutshell this means:
- Keep the loan funds away from any personal funds.
- From a taxation perspective, it doesn't matter whether you pay for IP expenses like the loan interest, rates etc from your main personal savings account, or from a dedicated IP savings account or IP credit card account. Using a dedicated IP savings account that is different to your PPOR offset account is just a matter of convenience and making it easier to track and report on IP-related expenses at tax time.

Thann, thank you for the walkthrough, that format is easiest for me to understand. A few questions:
- Do you use a different credit card for IP expenses just for convenience to make it easier to track IP expenses for your tax return? Or is there more to it than that?
- If you received something like Qantas frequent flyer points from your own personal credit card, would there ever be a scenario where you'd consider paying for IP-related expenses using your Personal CC rather than an IP CC just to get reward points (e.g. if you only had one IP)?
- Do you have one CC for each IP, or one CC for all your IPs?
- Do you mind telling me what financial software you use and what it takes an an input (e.g. CSV files from your online accounts)?

So I think I'm okay with doing the following:
1. Salary goes in to Personal Savings (PPOR offset) account.
2. Rent from IP (minus PM management fees and minor repairs) goes in to Personal Savings (PPOR offset) account.
3. P&I payment for PPOR comes out of Personal Savings account and goes into PPOR loan account.
4. Interest-only payment for IP comes out of Personal savings account and goes into IP loan account.
5. Any other IP-related expenses such as council rates etc get paid out of the Personal Savings (PPOR offset) account or Personal Credit Card (to accrue reward points).

Thanks again!

 

[Terry_w]

So I think I'm okay with doing the following:
1. Salary goes in to Personal Savings (PPOR offset) account.
2. Rent from IP (minus PM management fees and minor repairs) goes in to Personal Savings (PPOR offset) account.
3. P&I payment for PPOR comes out of Personal Savings account and goes into PPOR loan account.
4. Interest-only payment for IP comes out of Personal savings account and goes into IP loan account.
5. Any other IP-related expenses such as council rates etc get paid out of the Personal Savings (PPOR offset) account or Personal Credit Card (to accrue reward points).

Thanks again!

sounds fine to me.

Consider borrowing to pay for IP expenses too.

 

[Singo]

sounds fine to me.

Consider borrowing to pay for IP expenses too.

Hi Terry,
We have 3 IPs. And will have a LOC. I understand paying the IP related expenses (except interest) from LOC instead of cash is good idea. But with lots of small expenses going from LOC (for example monthly insurance payments), do we have to keep track of each expense and allocate the interest accordingly for each IP? It will be lots of calculations. Or is it possible just to claim all interest expenses without allocating towards IPs?

 

[Terry_w]

Hi Terry,
We have 3 IPs. And will have a LOC. I understand paying the IP related expenses (except interest) from LOC instead of cash is good idea. But with lots of small expenses going from LOC (for example monthly insurance payments), do we have to keep track of each expense and allocate the interest accordingly for each IP? It will be lots of calculations. Or is it possible just to claim all interest expenses without allocating towards IPs?

You could just run a spreadsheet working it out. You should allocate interest to each IP, but if the IPs are all the same owners if you get it wrong it won't result in any extra or less tax being paid.

ps, why pay insurance monthly? Isn't it cheaper to pay in one hit - and easier.

 

[shab]

Thanks Terry!

A few extra questions to help me understand what you are saying:
1. By borrow, is a LOC the recommended way to do that, e.g. get a LOC for $20K and use that to pay IP expenses?
2. Why is doing that better then just paying the IP expenses out of my personal savings account? If I pay the IP expenses out of a LOC, don't I have to pay the LOC (and the interest on the LOC funds) from my personal savings account at some stage? So why have a 3 stage process (personal savings --> LOC --> IP expenses) rather than 2 stage (just personal savings --> IP expenses)?
3. If I have to pay back the money taken from the LOC and the interest on the LOC funds, don't I end up having to pay more money then if I just paid the IP expenses directly from savings?
4. Isn't the tax deduction the same, i.e. regardless of which account is used to pay for the IP expense, don't I just get say 37c per dollar spent? Or do you get more from paying through a LOC our some other borrowed funds?

If someone has a sample scenario with numbers to explain the benefit of using borrowed funds to pay IP expenses that would be great. I imagine it comes back to leaving as much money in my PPOR offset account and not using those funds to pay IP expenses, but I can't connect the dots here.

Thanks!

 

[Terry_w]

1. Yes, only a LOC, or a loan account from which transfers to pay bills can be made. Do not transfer to a cheque account to pay or the interest won't be deductible.

2. If you pay cash for IP expenses you are removing money from the offset account. This means you pay more non deductible interest.

3. Same amount (or slightly more if the LOC interest is higher). You will pay interest on the LOC, but would have paid extra interest on the PPOR loan anyway. difference is the tax deduction

4. no

 

[Singo]

If someone has a sample scenario with numbers to explain the benefit of using borrowed funds to pay IP expenses that would be great. I imagine it comes back to leaving as much money in my PPOR offset account and not using those funds to pay IP expenses, but I can't connect the dots here.

Thanks!

A sample scenario.

PPOR loan 300k
Loc 30k
IP loan 300k
IP expenses 30k

1. We just pay the IP expenses from wages. No added tax benefits.

2. We pay those 30k expenses from LOC. And park 30k of the wages as offset for PPOR loan. Effectively now we have 270k PPOR loan and 330k IP loan. The interest we pay for 330k loans can be claimed as deductions.

 

[Singo]

You could just run a spreadsheet working it out. You should allocate interest to each IP, but if the IPs are all the same owners if you get it wrong it won't result in any extra or less tax being paid.

ps, why pay insurance monthly? Isn't it cheaper to pay in one hit - and easier.

Thanks Terry.

Same owners, so no problems.

Say we have 30k LOC and used 27k. 9k for each IP. Now we sell one IP. From the sales we pay 9k into LOC. Will that payment be considered as paying off the 9k of that particular IP or considered as paying 3k of each IP related expenses?

 

[Terry_w]

A sample scenario.

PPOR loan 300k
Loc 30k
IP loan 300k
IP expenses 30k

1. We just pay the IP expenses from wages. No added tax benefits.

2. We pay those 30k expenses from LOC. And park 30k of the wages as offset for PPOR loan. Effectively now we have 270k PPOR loan and 330k IP loan. The interest we pay for 330k loans can be claimed as deductions.

And interest on $30k is about $1500 per year. that may be around $500 year year extra cash in your pocket. Pay this off the PPOR loan and let the compounding kick it. In year 2 you will have another $500 and so on.

 

[shab]

Hi Terry and Singo,

Thanks for the responses, especially so late at night.

So using those numbers, and assuming interest rates of 5% for PPOR and IP loans and 5.2% for LOC, and a salary in the 37c tax credit range, would the numbers look like this:
Scenario 1: Pay IP expenses from wages
PPOR loan interest: $300,000 x 5% = $15,000
IP loan interest: &300,000 x 5% = $15,000
Total losses of $30,000 per year ($15,000 + $15,000)

Scenario 2: Use LOC to pay IP expenses
PPOR loan interest: $270,000 x 5% = $13,500
IP loan interest: &300,000 x 5% = $15,000
LOC interest: $30,000 x 5.2% = $1,560
Tax credits on LOC interest = $1,560 x 37cents = $577.20
Total losses of $29,482.80 per year ($13,500 + $15,000 + $1,560 - $577.20)

So in Scenario B you are about $520 better off in the first year and then compounding benefits each year after?

 

[Singo]

Yes, seems right. (You will be getting tax credit for your IP loan interest as well but as it is the same amount it is correct that you don't have to include it to calculate benefits of these scenarios) And then you will park that $520 in your offset and that will further reduce your PPOR interest (compounding benefits)

 

[Thann]

- Do you use a different credit card for IP expenses just for convenience to make it easier to track IP expenses for your tax return? Or is there more to it than that?

We have a 'free' 30-day interest free CC as part of the ANZ 'Break free' package, so we use it for all IP expenses and pay it off at the end of the month. (Just means the money can stay in the offset account a little longer)

- Do you use a different credit card for IP expenses just for convenience to make it easier to track IP expenses for your tax return? Or is there more to it than that?

Mostly convenience, but it came as part of the package.

- If you received something like Qantas frequent flyer points from your own personal credit card, would there ever be a scenario where you'd consider paying for IP-related expenses using your Personal CC rather than an IP CC just to get reward points (e.g. if you only had one IP)?

The IP CC limit is quite small ($3k), so larger items would go on the personal CC (So far, only depreciable items; NEW furniture, Air-Cons)

 

[shab]

Nice one, thanks for the explanation Thann .

 

[Thann]

No worries

- Do you mind telling me what financial software you use and what it takes an an input (e.g. CSV files from your online accounts)?

I use iBank, which is Mac only