Interest on Interest and Capitalising Interest - the Facts

[Peter 14.7]

I have been following this roughly so I cannot comment on detail but running a small business i do know how you pay for, pay off, apportion costs, etc.. is very critical to the ATO determination whether it is deductible or not.

I would suggest having a separate LOC for investment purposes as essential. Same for credit cards and accounts. That’s what we do and when ( not if) the ATO audit comes I will feel better for it. My Accountant agrees.

In 2011 will you remember or have records when ATO asks about the sale of your property? Note: the onus is on you to prove you paid it the right way from the right accounts, etc.. You don’t want to be in a position of having been told by the ATO that you actually paid back some of the capital in 2007 and thus own them tax back on interest claimed incorrectly and here is fine to boot.

Just being devils advocate, not negative. I always consider an audit as someday not maybe and don’t want to have to spend any more time and $$ than necessary to reply. I was audited by Workcover and despite being heaps easier than ATO, it still tool 12 months to resolve.

They found we underpaid $25 in wages one year ( they assessed five) and fined us $5.

Yet it cost me $800 in Accountant fees to reply their requests and fight their original finding that we underpaid $60k and would have been fined $15k.

Peter 14.7

 

[Ausprop]

so... the practicalities of this thing. My wife built a home and I had to lend some cash to it to make it work, paying for little bits and pieces. It was then completed recently and rented out. She has now extended a LOC against it, using the equity upon completion, to cover the rent shortfall.

So for example

1) a water bill has turned up, say $1000. Can I pay this on my credit card and then transfer from the LOC to the credit card? Or does the payment have to go directly from the LOC to the water corp?

and looking back, say for example

2) I paid out $500 for some downlights during construction from my own personal account, can I reimburse myself for this? i.e. transfer from the LOC to my account?

and what if

3) we paid say $500 for some rates 6 months ago from our joint account, can I now transfer that back to the joint account from the LOC?

Is there a difference between (1) and (3) other than the timing is a little longer? And if (3) is ok can we take it a step further and she reimburse herself for the equity she had to contribute upfront? I know the answer to this is no, so does that make (3) and (1) a no? In which case it is pretty difficult to administer unless you have a cheque book attached to your LOC?

 

[Brett]

While we're on dumb questions

What does A/C mean in this thread?

 

[Twitch]

so... the practicalities of this thing. My wife built a home and I had to lend some cash to it to make it work, paying for little bits and pieces. It was then completed recently and rented out. She has now extended a LOC against it, using the equity upon completion, to cover the rent shortfall.

So for example

1) a water bill has turned up, say $1000. Can I pay this on my credit card and then transfer from the LOC to the credit card? Or does the payment have to go directly from the LOC to the water corp?

and looking back, say for example

2) I paid out $500 for some downlights during construction from my own personal account, can I reimburse myself for this? i.e. transfer from the LOC to my account?

and what if

3) we paid say $500 for some rates 6 months ago from our joint account, can I now transfer that back to the joint account from the LOC?

Is there a difference between (1) and (3) other than the timing is a little longer? And if (3) is ok can we take it a step further and she reimburse herself for the equity she had to contribute upfront? I know the answer to this is no, so does that make (3) and (1) a no? In which case it is pretty difficult to administer unless you have a cheque book attached to your LOC?

I would guess that the answer to all those is an emphatic, no. In each of those cases you will poison the LOC.

There was a well known case recently where a large deposit for an investment was transfered to a personal cheque account and the a cheque then written for the same amount as the transfer for the investment. The interest deduction was disallowed by the ATO.

 

[LynnH]

Brett

A/C = account

Cheers
LynnH

 

[Brett]

Thanks for that Lynn.

When I first read the post I thought that's what it stood for.

But then I noticed "Housing A/C account" which threw me.

Thanks again.

 

[LynnH]

Brett

Glad I could help.

Cheers
Lynn

 

[regrow]

I have similar questions as Ausprop but instead of an LOC account I have a transaction account, and a visa card. Both are solely used for the IP only.

The rent goes into and costs come out of this account. The IP is held in a HDT.


Using Ausprops quote slightly altered to my senario.

so... the practicalities of this thing. I built a home and I had to lend some cash to it to make it work, paying for little bits and pieces. It was completed using some personal funds, then I have the final loan draw down deposited into this account and then used these funds to pay off visa card purchases (tiles, blinds) and to reimburse myself for personal funds used to buy carpets.

So for example

1) I need to purchase tiles and blinds. Can I pay for these on the credit card and then transfer from the transaction account to the credit card?

and say for example

2) I paid out $5000 for some carpets during construction from my own personal account, can I reimburse myself for this? i.e. transfer from the transaction account to my account?

Regards

Regrow

 

[Ausprop]

I would guess that the answer to all those is an emphatic, no. In each of those cases you will poison the LOC.

There was a well known case recently where a large deposit for an investment was transfered to a personal cheque account and the a cheque then written for the same amount as the transfer for the investment. The interest deduction was disallowed by the ATO.

wow, harsh. ok, need to be careful.

Regrow it sounds like it's no all round.

 

[Ausprop]

in fact this is probably the biggest downside to build and hold, as you often need to make payments prior to being able to complete and set up your new LOC

 

[regrow]

Hi Ausprop

I'm not using a LOC just a plain ordinary bank account which is used only for the IP.

Personal funds will be only used to finish the house until I have the final drawdown from the loan and not for the repayments.

Is this a viable option?

Regards

Regrow

 

[gooram]

Can I ask a more fundamental question about this structure?

When obtaining the (or several) LOC for investment purposes, what is best practise in determining a limit?

i.e. should you go for the maximum the bank will allow you? Downside of this would be that you now have to wait for your portfolio to grow before you will be allowed to refinance for further purchases. Assume some discretion is advised if say you could get a LOC for 500k, but wanted also to buy another IP at 200k, to only go for a 300k limit on your LOC to allow for further borrowings to buy the IP? Then increase the LOC in the future as appropriate?

Or do you go for the maximum LOC available to you and then move towards no doc loans?

 

[Ausprop]

Hi Ausprop

I'm not using a LOC just a plain ordinary bank account which is used only for the IP.

Personal funds will be only used to finish the house until I have the final drawdown from the loan and not for the repayments.

Is this a viable option?

Regards

Regrow

not sure what you are getting at... a plain bank account usually has a credit balance - so how is this generating a deductible interest component? if you are saying you are reimbursing to it, then it doesn't matter if it is bank account, credit card or crisp 50s in the safe, it is where it is coming from and who it is going to that is of essence, not the type of account you are operating to reimburse.

 

[stargazer]

Hi all

My questiion is if you have tax deductible debt on a LOC for an IP and you sell the asset so now you have no income producing asset. Is the LOC interest still tax deductible.

cheers
BC

 

[skater]

Hi all

My questiion is if you have tax deductible debt on a LOC for an IP and you sell the asset so now you have no income producing asset. Is the LOC interest still tax deductible.

cheers
BC

I'm not an accountant, but I believe that no, you can't do that! If you sell the IP, you would be expected to pay down the loan with the proceeds. If, however, you sold it & the proceeds didn't cover the entire loss, then I believe the remainder would be deductable.

 

[Rixter]

Hi all

My questiion is if you have tax deductible debt on a LOC for an IP and you sell the asset so now you have no income producing asset. Is the LOC interest still tax deductible.

cheers
BC

BC, I would strongly suggest you approach your own tax accountant or the ATO to get a ruling & definative answer in writing to this question.

That way there is no gray areas or non qualified forum hearsay to throw confusion onto it for you.

Hope this helps.

 

[gooram]

When obtaining the (or several) LOC for investment purposes, what is best practise in determining a limit?

i.e. should you go for the maximum the bank will allow you? Downside of this would be that you now have to wait for your portfolio to grow before you will be allowed to refinance for further purchases. Assume some discretion is advised if say you could get a LOC for 500k, but wanted also to buy another IP at 200k, to only go for a 300k limit on your LOC to allow for further borrowings to buy the IP? Then increase the LOC in the future as appropriate?

Or do you go for the maximum LOC available to you and then move towards no doc loans?

Can anyone offer any advice here? I'm planning to meet with my bank manager this week to initiate the "restructure".

Thanks!

 

[Rixter]

Can anyone offer any advice here? I'm planning to meet with my bank manager this week to initiate the "restructure".

Thanks!

Gooram,

The answer to that question is determined on what you are trying to achieve. Then structure to suit.

No good structuring something thats going to restrict you.

Confusion reins when no clear definative direction is planned.

A millionaire mentor told me many years ago- if you know where you are heading one road will take you there but if you dont know where you are heading any road will appear to.

Where are you wanting to go or what are you wanting to achieve?

 

[gooram]

Gooram,

The answer to that question is determined on what you are trying to achieve. Then structure to suit.

No good structuring something thats going to restrict you.

Confusion reins when no clear definative direction is planned.

A millionaire mentor told me many years ago- if you know where you are heading one road will take you there but if you dont know where you are heading any road will appear to.

Where are you wanting to go or what are you wanting to achieve?

Hi Rixter, I didn't want hijack this thread and make it about me, so I was hoping for a general answer rather than one tailored specifically to my needs.

So we have the capacity to buy two IPs right now, if I applied for a LOC to be used for deposits on these + expenses (in the short term, but further IPs and investments + expenses in the future), and I am yet to secure finance for the two IPs that I want to buy, do I need to impose a limit on the LOC such that I will still be able to get the 2 IP loans. i.e. don't go all the way up to 80% LVR with the LOC because this will limit my borrowing capacity.

I'm just not sure whether the bank considers the LOC limit or the amount drawn on the LOC when you apply for finance.

Appreciate your thoughts...
Gooram

 

[Rixter]

Gooram,

The banks will work out your DSR on the LOC\s as if they're full drawn.

I would suggest you maximise your LOC\s limits as high as you possibly can. Then finance (possibly lo/no doc) the IP loans with another lender to spread your exposure risks...

Hope this helps.