Interest on expenses tax deductibility

[sentsie]

Hi all .

I have a question regarding interest tax deductibility, your help/advice/opinion will be highly appreciated. Apology, if a similar question had been raised before.

Illustration:
1. PPOR loan acc linked with its PPOR offset acc.
2. IP loan acc linked with IP offset acc and initially there is $40K in this IP offset acc as a result of recent revaluation & refinancing.

Both PPOR & IP are Interest only Payment.

The IP offset acc is utilized to pay all IP expenses, (mortgage interest, council, building insurance, repair, etc) and some other business expenses.
Basically, this IP offset acc is set to pay all income generating expenses until the balance = $0 (and the IP loan acc = max), during which time all the salary plus rental plus business income (minus private expenses) paid into PPOR offset acc to reduce non-deductible interest.

At the end of current financial year, (using illustrative number):
1. The IP and business expenses (mortgage interest, council, insurance, business expenses, etc) = $38K which is tax deductible and,
2. The interest = $2K. (This is the interest component in the current FY accrued from: council, building insurance, repair, business expenses, etc, excluding mortgage interest).

Questions:
1. Is this $2K interest component tax deductible in the current FY?
2. Is this $2K+compounding, tax deductible in the next FY and beyond? (After tax deduction applied on the principal expense in the current FY).

I have this ATO link explaining the deductibility of interest charged on loan for repairs/reno/depreciating asset, but not sure for other expenses like council, insurance, land tax, business expenses, etc. Are they treated the same ?
http://www.ato.gov.au/individuals/content.aspx?doc=/content/00113233.htm



Thank You.

 

[Terryw]

initially there is $40K in this IP offset acc as a result of recent revaluation & refinancing.

It sounds like you have borrowed money to place into an offset account? The interest on borrowings is only deductible to the extent that you have invested it or purchased income producing assets etc. This money is no longer borrowings once it hits the account. It is then cash. Therefore none of the interest on the money borrowed to place into this account would be deductible.

Your thinking is probably that this account is only used for investment purposes so you borrowed in advance to set aside funds to be used to pay investment related expenses.

 

[sentsie]

Thank You Terry.

Yes, you are correct, says at the beginning of FY this $40K is not tax-deductible, but once it is spent (all of it) on IP expenses (Mortgage interest, council, insurance, water & sewerage service, land tax, repair, etc) and other business expenses then at the end of FY it will be tax-deductible, right ? (please correct me if it is wrong ...).
And at the end of the current FY, the IP loan acc will be increased by $40K and the IP offset acc = $0.

Also, the interest of $2k in the OP, will it be tax-deductible in current FY and beyond ?


Regards.

 

[Terryw]

Thank You Terry.

Yes, you are correct, says at the beginning of FY this $40K is not tax-deductible, but once it is spent (all of it) on IP expenses (Mortgage interest, council, insurance, water & sewerage service, land tax, repair, etc) and other business expenses then at the end of FY it will be tax-deductible, right ? (please correct me if it is wrong ...).
And at the end of the current FY, the IP loan acc will be increased by $40K and the IP offset acc = $0.

Also, the interest of $2k in the OP, will it be tax-deductible in current FY and beyond ?


Regards.

Now the $40,000 is no longer borrowed money. So even if you spent the lot the interest on this part wouldn't be deductible I'm afraid.

 

[eggnog]

wait a minute. I was always under the impression that if you took the equity out of a property and placed it into an offset acount with the account only used to pay bills associated with the property (ie: interest rates, council, management, etc) then the interst accrued from the equity draw down would be tax deductable.

 

[jroth]

Maybe you're thinking about a Line of Credit? Which is different to pulling out extra cash and sticking it in an Offset account.

 

[sentsie]

Sorry Terry, maybe I misunderstand some of the jargons.

Initially, after refinancing, the IP loan = $280K, with the IP offset = $40K (the interest cost is calculated on the $240K loan balance).

Then all the $40K in the IP offset acc spent on IP & business expenses (income generating activities) . So at the end, the IP offset balance = $0 and the IP loan balance is full $280K.

 

[sentsie]

wait a minute. I was always under the impression that if you took the equity out of a property and placed it into an offset acount with the account only used to pay bills associated with the property (ie: interest rates, council, management, etc) then the interst accrued from the equity draw down would be tax deductable.

Yes, me too.

 

[Terryw]

Sorry Terry, maybe I misunderstand some of the jargons.

Initially, after refinancing, the IP loan = $280K, with the IP offset = $40K (the interest cost is calculated on the $240K loan balance).

Then all the $40K in the IP offset acc spent on IP & business expenses (income generating activities) . So at the end, the IP offset balance = $0 and the IP loan balance is full $280K.

So what was the original loan before refinancing?

 

[sentsie]

So what was the original loan before refinancing?

The original amount before refinancing was $240K

 

[sentsie]

Maybe you're thinking about a Line of Credit? Which is different to pulling out extra cash and sticking it in an Offset account.

I think LOC or draw down from offset acc is the way how to get the funding, but the deductibility is based on purpose test, if the fund is used for expenses on income generating activities then it will be deductible, ..... but I may be wrong.
The other question : is the interest accrued also deductible ?

Regards.

 

[Terryw]

The original amount before refinancing was $240K

The interest on this loan should be deductible.

You also have an additional loan of $40,000 (even though it may be in the same loan number) which you have borrowed to invest into a bank account which doesn't pay interest.

Strictly speaking you cannot claim the interest on this loan.

But, if you have never deposted any cash in the offset other than the borrowed funds, and if you only ever withdraw from this account to directly pay investment expenses then you may be able to argue that, by tracing the funds, these are the borrowed funds and therefore the interest deductible.

This is not certain though. also probably unlikely the ATO is going to be too picky about it.

Best to use a LOC I think,

 

[sentsie]

The interest on this loan should be deductible.

You also have an additional loan of $40,000 (even though it may be in the same loan number) which you have borrowed to invest into a bank account which doesn't pay interest.

Strictly speaking you cannot claim the interest on this loan.

But, if you have never deposted any cash in the offset other than the borrowed funds, and if you only ever withdraw from this account to directly pay investment expenses then you may be able to argue that, by tracing the funds, these are the borrowed funds and therefore the interest deductible.

This is not certain though. also probably unlikely the ATO is going to be too picky about it.

Best to use a LOC I think,

Yes, this $40K is the only fund available for this IP offset acc and no other added deposit (pure and no contamination).
This fund will be drawn down to $0 for IP expenses & other business expenses, (not related to IP).
However, in future, this IP offset may get extra fund through IP loan increase and the cycle continues.

Regards.

 

[Terryw]

Would any accountants out there like to comment on this?

ie the borrowing and parking in the offset account until use.

 

[Aaron_C]

Would any accountants out there like to comment on this?

ie the borrowing and parking in the offset account until use.

Doesn't Steele's case apply here?

 

[Terryw]

Doesn't Steele's case apply here?

Steele was about claiming deductions on land before the contruction of an investment property. its about claiming interest too soon, so don't think it is too relevant to this one.

There is another case - Domjan - which covers this situation. From memory the deductibility of interest was denied, or reduced, because the person took money from a loan and parked it in a cheque account so as to write a cheque to pay for the expense. The cheque account had other non borrowed funds in it so it is not identical to this scenario, but still relevant.

 

[sentsie]

Steele was about claiming deductions on land before the contruction of an investment property. its about claiming interest too soon, so don't think it is too relevant to this one.

There is another case - Domjan - which covers this situation. From memory the deductibility of interest was denied, or reduced, because the person took money from a loan and parked it in a cheque account so as to write a cheque to pay for the expense. The cheque account had other non borrowed funds in it so it is not identical to this scenario, but still relevant.

Thanks Terry, I was googling the Domjan case and got this :

"...... A recent AAT case decided that if loan funds are intermingled with other funds before being used for income producing purposes they are no longer considered to have their source in the loan.
Interest is not deductible on a loan unless the proceeds of the loan have been used to purchase or in relation to an income producing investment. The link can be simply lost by paying some spare cash off the loan and drawing it back later, or not being able to trace the flow of the funds to the investment. The ATO's own ruling states 'a rigid tracing of funds will not always be necessary as appropriate.' Yet in Domjan and Commissioner of Taxation [2004] AATA 815 the ATO successfully argued that the placing of borrowed money into a savings/cheque account with other personal funds broke the link necessary to prove the funds were borrowed for tax deductible purposes.........".

I think, this is more on the contamination/intermingled of the fund with other private fund.

 

[Terryw]

Domjan and Commissioner of Taxation) [2004] AATA 815 http://www.austlii.edu.au/au/cases/cth/AATA/2004/815.html

This will be a good read, although it is slightly different in this situation because there is no intermingling of funds.

 

[eggnog]

Yes you assume correct jroth. Should have used the appropriate terminologies.

Keep the existing IP loan as is and establish a new LOC for the remaining equity. Then park the LOC funds into an offset account which does not have any non-deductable debt. Any funds in the offset account is purely used to pay expences related to this particular IP.

I have heard a lot of people say that the interest accrued from the LOC is still tax deductable. I have always taken this on face value as I have heard several investors say that this is correct. Trap for young players, never assume anything.

Would like an accountants view as I believe there is a loooooooooooooot of people on this board that is using this strategy.

Maybe you're thinking about a Line of Credit? Which is different to pulling out extra cash and sticking it in an Offset account.

 

[stinadaze]

very interesting and would also like to hear from accountants...

bit of a twist to this.... say for an IP bought at 200k a loan of $300k is drawn down. that is to allow for renos etc... obviously the excess funds need to be deposited somewhere, so they are (immediately) deposited into a new savings account opened just for these funds. over the period of 2 months they will be used up (paying for various reno components). in the meantime though, whatever sits unused for those 2 months is offset against the initial $300k.

all interest can be claimed in this set up? seeing as the $300k is offest, you are only charged interest on what is actually spent for the property.

Cheers!