interest deductibility...how to fix?

[dabear]

Was having a chat with a friend working in medical profession today. It stunned me the way she structured her loan.

She used to own a PPOR which has now been turned into an IP. Associated loan was a $600k variable with offset when she bought it. Around 20 months ago, she did a top-up to 690k when it's turned into IP, and the extra 90k proceed has sit in that offset account ever since. The problem is she has continued using this offset account for her personal income and expense (as many of her existing direct credit and debit were set up against that account). If my thought is correct, the proceed of the 90k top-up is contaminated, and interest on it is no longer deductible. Here are my questions:

1. Is there a way for damage control as it surely would affect her tax return in the last two years?
2. How to repair the loan structure going forward?

P.S Ironically, she and I use the same accountant, and I know he's not knowledgeable when it comes to property tax advice. This forum and my broker have always been more helpful when it come to pointing out tax problems.

 

[Terry_w]

Yes. ATO allows a mixed loan to be split into relevant portions.
TR 2000/2, para 18.

 

[Colin Rice]

2. How to repair the loan structure going forward?

600k is tax deductable assuming the principle wasnt reduced by paying extra or making P&I payments?

90k needs to be split into a sub account and treated as personal non deductable debt.

 

[Jamie M]

Which lender is it with?

Easiest solution is to do what Colin said - split the loan into two so you can identify which is deductible (the original $600k) and which isn't (the additional $90k)....unless of course the $90k is used for deductible purposes.

Cheers

Jamie

 

[Terry_w]

Did the $600k loan balance ever drop below $600k? Was the $600k loan used solely to purchase the residence?

 

[Paul@PFI]

Quite simple really. The original balance deductible but new borrowings did not acquire an interest in a new source of income. Loan has a mixed use. X % is now deducible. No fix. What the loan security is irrelevant.

 

[dabear]

Wow, spot on, Terry.

Yes. ATO allows a mixed loan to be split into relevant portions.
TR 2000/2, para 18.

I just viewed her last statement, it's 7 pages for last quarter alone. From flight ticket to utility payment to petty cash withdraw... I'd say proportion by purpose is a hell of a job...

 

[dabear]

600k is tax deductable assuming the principle wasnt reduced by paying extra or making P&I payments?

90k needs to be split into a sub account and treated as personal non deductable debt.

Which lender is it with?

Easiest solution is to do what Colin said - split the loan into two so you can identify which is deductible (the original $600k) and which isn't (the additional $90k)....unless of course the $90k is used for deductible purposes.

Cheers

Jamie

Thank you, Jamie and Colin.

It's with St George at 80% LVR.

 

[dabear]

Did the $600k loan balance ever drop below $600k? Was the $600k loan used solely to purchase the residence?

No, it's interest only and she never repaid principal. Yes, the 600k is solely for the property. She had got some cash in the offset account before the top-up, so the balance of the offset account never dip below 90k.

 

[dabear]

Quite simple really. The original balance deductible but new borrowings did not acquire an interest in a new source of income. Loan has a mixed use. X % is now deducible. No fix. What the loan security is irrelevant.

Thank you, Paul.

I asked why she topped it up without using it. She said she'd have used it as rainy day fund, but such occasion never raised. Now she has built a sizable saving in that account, together with the 90k proceed.

What you say confuses me a bit. If that's no private use in this scheme, the new borrowing is not deductible when it's used against an existing source of income?

 

[Terry_w]

I would say none of the $90k is deductible.

But if she gets in quick the $600k (or close to it) interest could be deductible if she splits the loan into relevant portions.

Interest must be apportioned before splitting and this will be a bugger to work out.

 

[dabear]

I would say none of the $90k is deductible.

But if she gets in quick the $600k (or close to it) interest could be deductible if she splits the loan into relevant portions.

Interest must be apportioned before splitting and this will be a bugger to work out.

Thank you, Terry.

Yes, she's now more worried of whether she's being ATO compliant. The deduction eligibility is all secondary. And Yes, it's a bugger to work it out.

Another example ill structuring advice could cost you, soon or later.