Interest on Interest and Capitalising Interest - the Facts

[Shadow]

Is the amount in the off-set account taken into consideration when calculating the total loan amount, for the purpose of calculating LVR?

Or would using the structure described in this thread cause LVR to increase as the IP loan interest is capitalised?

If so, this could be a major disadvantage of capitalising the interest, if you suddenly find you have exceeded your allowable LVR because your total loan size has grown?

Having thought about this again... I suppose you would just ensure that the maximum limit on the LOC plus IP Loan was within the agreed LVR, and then you could capitalise up to the LOC limit with no problems.

It just means that using this structure you need a greater amount of equity initially, compared to paying the IP loan interest.

 

[emu]

I suppose you would just ensure that the maximum limit on the LOC plus IP Loan was within the agreed LVR, and then you could capitalise up to the LOC limit with no problems.

Hi shadow
I think you should read corsa's thread again

 

[Shadow]

Hi shadow
I think you should read corsa's thread again

Hi Emu... ok, just did, couldn't see anywhere it addressed my last question.

Was there a particular section you wanted to point out?

 

[emu]

Hi Emu... ok, just did, couldn't see anywhere it addressed my last question.

Was there a particular section you wanted to point out?

Hi shadow
I was pointing towards part 4a where the ATO can disallow a deduction if the sole purpose was for a tax deduction, my structure allows me to capitalise my interest when needed but also staying within the vague rules

 

[Shadow]

Thanks Shadow for your summary. It would appear a technicality is the key however don’t take my comment as anything other than an observation.

Hi Peter, thanks for your comments,

I think I'm sold now on the idea of using the LOC to capitalise the interest, rather than capitalising with the IP loan... probably easier to manage it this way, even if the interest rate is a bit higher using the LOC.

The bit I'm not sure about now is the use of an offset account for depositing IP income. I don't see why it has to be an offset account... couldn't it just be a normal transaction account from which you then transfer an amount each month into the PPOR loan. After all, IP income is just another form of income, like salary, so it should be up to the investor to choose where they put their income to best use.

One advantage of doing it this way is that LVR is not adversely affected, since I was advised (in another thread) that any amount in an offset account does not go towards reducing your total debt, in the eyes of the bank.

Any other opinions out there from the forum?

Cheers,

Shadow.

 

[Les]

A well-read, well-respected thread - thanks Corsa. I've made it a sticky so we all don't need to Search for it,

Regards,

 

[Peter 14.7]

So has the deal been sumarised in dot points on exactly how is works? And if not is anyone with better tax knowledge than me willling to help us all understand?

Reagrds, Peter 14.7

 

[bort]

Originally Posted by Shadow
Let me try to summarise this discussion to see if I understand correctly...

- - - - -

It's not OK to capitalise interest on an IP loan, but it's OK to pay the interest on an IP loan using a Line of Credit and capitalise the interest on the LOC. Right?

nope, i dont think that is the case, and pretty much the interest capitalisation can come from any source (even a credit card potentially)

So... if the same amount of interest is being capitalised, why is this capitalised interest tax deductible if it's in the LOC, but not if it's in the IP loan?

it shouldnt make a difference

-------


After all, IP income is just another form of income, like salary, so it should be up to the investor to choose where they put their income to best use.


Shadow.

I would agree with the last statement, that it should not matter where you are putting the rental income whether it be to a loan account, offset, or if you just blow it all on a new car ....

I believe it was recommended to put it to an offset account, as that gives you maximum flexibility ... initially if you have a PPOR, then offsetting is probably your best use of short term funds. later on if you dont have a ppor, then using an offset account against an IP you can draw back that money for private purposes, and the interest on the actual IP loan is still deductible.

the main issue with capitalising income (i think) has been in the instances where you capitalise income in a split loan for deductible debt, but pay down as much as you can in the non deductible debt... its unlikely that you'd get away with this, and at a minimum you should probably pay the interest component on both debts in a split loan facility.

 

[julia]

What I can add, if a technicality (and I don't wish to advise anyone doing this to stop, but) history tells us these loopholes (low docs loans, put rent in to PPOR, hybrid trusts, overseas cards and accounts, etc..) are found and that within 2 years of so that ATO catches up and closes the loophole.

If the ATO try to stop capitalising interest other then when it is clear that the dominant purpose is a tax benefits all businesses big and small with an otherdraft will have an impossible record keeping responsability.

Just be careful of your thoughts. Don't dare deam of the tax benefits.

 

[Peter 14.7]

Thanks Julia

That is a good point to note that when the rule/s applies to other bus arrangments then it is more secure.

Something to add to my end of fin year questions to my accountant.

Peter

 

[WillG]

I think I'm sold now on the idea of using the LOC to capitalise the interest, rather than capitalising with the IP loan... probably easier to manage it this way, even if the interest rate is a bit higher using the LOC.

Probably a stupid question but ... What entity should the LOC be secured against ?

Cheers

 

[gooram]

It doesn't matter, whatever entity will allow you the highest LOC limit.

For us it will be our PPOR since this has alot of equity, for others it may be an unencumbered IP. Remember, it is what you use the borrowed funds for, and not what it is secured against, that determines deductibility.

 

[Ausprop]

so... if you had a LOC against say your PPOR and you were funding interest on various properties, the odd repair bill etc etc, you would need to keep an enduring record of what has gone out against which property in case you sold one? And then you would need to credit your LOC with the proceeds of the sale to the extent of the expenditures incurred and any compounded capitalised interest in respect of this. This would be an accounting nightmare. But you would need it anyway to itemise by property the interest claim in your tax return. So you would need to keep your own subledgers and every fee or interest bill woul dneed to be allocated out in propertion of the cost build up. Technically I can see it being done but I cant help but think it would be way easier to keep your LOCs property specific. However this is very very difficult for a newly acquired property where you have quite possibly maxed your borrowings in the first instance.

 

[emu]

so... if you had a LOC against say your PPOR and you were funding interest on various properties, the odd repair bill etc etc, you would need to keep an enduring record of what has gone out against which property in case you sold one? QUOTE]

This is a good point which i hadn't even thought about, and i use a LOC for multiple IP's.
If i had to sell one of the IP's i would most likely use the proceeds to pay off the LOC and then start again fresh.................unless someone has a better idea

Another question for those in the know is how acurately do i need to be able to aportion the interest from the same LOC to each IP and why? All IP's have the same ownership structure.
Cheers
Ken

 

[Ausprop]

um... pay off the LOC? why on earth would you do that? you would be undoing what you have been working so hard to do - reducing non-deductble debt. The only reason you would want to do that is if you have no debt on your PPOR, no private debt, no plans for any personal expenses and really can't think of anything else to do with the cash. There are many people out there in this position but I for one am not. Solution is to track everything that comes out of your LOC to a destination, broken down and categorised by investment, and if you sell an investment reverse just that component. Extremely painful but then waht tax recording isn't?

 

[emu]

Sorry i should have added that i will not have any non deductable debt in a 1 yrs time.

 

[emu]

. Solution is to track everything that comes out of your LOC to a destination, broken down and categorised by investment, and if you sell an investment reverse just that component. Extremely painful but then waht tax recording isn't?

I was of the opinion that if you had more than one IP in a loan account you would have trouble trying to pay off the debt incured on one part of the account, i thought you would have to apportion the money over the entire account.
If a IP was sold wouldn't it poison the account.

 

[Mry]

A well-read, well-respected thread - thanks Corsa. I've made it a sticky so we all don't need to Search for it,

Regards,

I would however recommend a disclaimer be posted in her original post pointing out that this is not tax advice and to see a registered tax agent to get advice on this matter.

I'm not trying to toot my own horn, but this area is rather controversial given Hart's case and you may need to point out in the Sticky that Somersoft is not giving tax advice by making it a Sticky and that the information is of a general nature only and may not apply to particular circumstances.

 

[geoffw]

A good idea MrY- I've done that.

 

[Ausprop]

I was of the opinion that if you had more than one IP in a loan account you would have trouble trying to pay off the debt incured on one part of the account, i thought you would have to apportion the money over the entire account.
If a IP was sold wouldn't it poison the account.

yep a very valid point - not sure of the answer. Seems to cloud the waters even more.