Limit to Tax deductable borrowings

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From: Steve Kiddle


Typically, most people using their existing properties as security for a loan will purchase an IP for say $250K and take out an I/O loan for $265K to cover all borrowing expenses, stamp duty etc.
This loan is about 106% of the property value on which the interest is fully tax deductible, as I understand.
Is there a set limit on the loan value for an IP as far as the ATO is concerned as I am considering taking out the loan for say $270K and using the small surplus to pay the first few years of costs (net after tax etc)

Thanks for your input people
 
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Reply: 1
From: Duncan M


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Hi Steve,

By my understanding, interest on money borrowed to pay ongoing costs of an
IP is deductible. But if you borrowed the extra money, put it into an
account somewhere and slowly paid costs, the interest would only become
deductible as you paid costs.. lots of record keeping!

Regards,

Duncan - Non Accountant.

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<TITLE>RE: Limit to Tax deductable borrowings</TITLE>



Hi Steve,


By my understanding, interest on money borrowed to =pay ongoing costs of an IP is deductible. But if you borrowed the extra =money, put it into an account somewhere and slowly paid costs, the =interest would only become deductible as you paid costs.. lots of =record keeping!

Regards,


Duncan - Non Accountant.




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Reply: 1.1
From: Bob Quiggin


From a similar non-accountant:

If the money is borrowed and put into an interest bearing account or bonds then it has been borrowed for investment purposes and can be claimed.

Any other takers?

Bob
 
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Sim

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Reply: 1.1.1
From: Sim' Hampel


This is easy.

If your total purchase costs are, say, $110K, and you take out a loan for $120K, then the interest on the $110K portion of the loan is tax deductible (as we expect), and the interest on the remainder of $10K is deductible depending on what it is used for.

If you use the $10K to pay for a holiday then it is not deductible.

If you use it to pay some costs incurred on your IP, such as new carpet and a new paint job, then it is deductible - include it in the tax pack question about IPs along with the claim for the interest on the other $110K. However this would only be deductible from the date the cost was incurred (ie. the date the money was actually used - regardless of when you borrowed the money) and you would have to apportion the interest costs - which is exactly what Dunc said.

If you use the $10K to buy bonds or put it in a CMT or Term Deposit (then you are an idiot because I'd be pretty darn sure you're earning less on your money than you are paying in interest, but that's beside the point), then the interest would be deductible, and you would include the cost in the tax pack question about earning interest on bank accounts or something.

See... it all depends on how you use the money, and you must have actually incurred the cost and used the money for it to be deductible.

A better way to do it would be a split loan facility with $110K in the primary facility with a $10K LOC as a secondary facility. You only draw on the money in the LOC when you need it, and don't incur interest charges until you use the money. You save money, the ATO is satisfied, everyone is happy

Anyone else care to comment ?

 
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Reply: 1.1.1.1
From: Owen .


I think the original question is can that extra $10k be used to pay the interest on the $100k? Is the interest on the $10k then claimable?

Owen

"Gambling promises the poor what property performs for the rich – something for nothing"
 
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Sim

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Reply: 1.1.1.1.1
From: Sim' Hampel


Ahh... the answer to this one is easy also (please correct me if I'm wrong though !)

Information on the ATO website clearly states that the "interest on money borrowed to pay interest" is NOT deductible.

If there is a way, I'd be interested to hear it.

 
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Reply: 1.1.1.1.1.1
From: Dale Gatherum-Goss


HI Sim!

I'm not so sure about that. If there is a commercial reason for doing so, then you should be able to claim a tax deduction for the interest on the total borrowing so long as the funds are used for an income producing purpose.

So, if I borrow $110k to pay $100k Ip and use the other $10k for Ip related costs including interest then there is no problem,

Moreover, as an example, if the extra $10k meant that my borrowings were over a certain amount and in doing so, I now qualify for a lower interest rate then I have a commercial reason that will withstand scrutiny.

Does this help?

Dale
 
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Reply: 1.1.1.1.1.1.1
From: Owen .


Even if the interest on the $10k is not claimable, it's still far less out of your pocket than the interest on the $100k.

$100000 * 6.5% = $6500 / 12 = $541pm
$ 10000 * 6.5% = $ 650 / 12 = $ 54pm

I guess it depends on how negatively geared you are as to the benefit. If your cashflow is so bad that it costs you $80pm out of your pocket to support the interest on the $100k loan then getting a second loan for $10k and paying it out of this instead will only cost you $54pm. A simplistic view but maybe one worth thinking about.

If the $10k was a LOC then the interest costs to start off with will be considerably smaller and even if the interest is capitalised, and not paid month by month, up to the $10k balance limit it could last for couple of years (didn't really work it out). Maybe there would be no costs involved and then you could refinance to wrap up the extra $10k in a few years time. Have to think about the use of the loan money I guess to ensure that all of the new loan is claimable including what was orginally, the cost of the original interest. Could be messy?!?!?

Maybe it would work as a short term scenario while renovating a place and there is no income coming in. As long as the revaluation and increase in rent covers the balance then it will work out in the end.

Mmmmmm...got to think about this a bit more.

Owen

"Gambling promises the poor what property performs for the rich – something for nothing"
 
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Sim

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Reply: 1.1.1.1.1.1.1.1
From: Sim' Hampel


Owen, I think there have been a few examples here in the forum of people suggesting that capitalising the interest (whether deductible or not) would be a reasonable short term option in certain circumstances.

Examples I seem to remember are while renovating a newly acquired property prior to a tenant moving in. This allows you to minimise the actual out-of-pocket expense - especially if the property will be cashflow positive once tenanted.

A similar example would be capitalising interest on a loan to purchase land and build a house, again while waiting until it is tenanted.

Like you said, it's just a matter of doing the sums and seeing if the short term cost of not paying the interest is sufficiently offset by the short term cashflow benefits and the longer term gains to be made in the transaction.

- - -

Dale, I went back and tried to find some examples from the ATO site... the only things I could come up with from a short search was to related documents:

http://www.ato.gov.au/content.asp?doc=/content/Corporate/mr9718.htm

and

http://www.ato.gov.au/content.asp?doc=/content/Corporate/mr9729.htm

which are actually referring to linked loan schemes used for paying down personal loans while capitalising and maximising interest on the tax deductible IP part of the loan.

After reading them more carefully, they do indeed refer to concepts such as "commercial reasons" for justifying actions.

Okay, so now that we've mastered the concept of "intent" with property trading businesses, we can now add the concept of "commercial reasoning" in our actions to help us with our understanding of the ATO mentality.

This has definately been a learning experience, grappling with these concepts and taxation realities, and I would like to express my thanks to you Dale for taking the time and having the patience to answer our questions and clarify and correct our responses.

I have certainly got a lot out of these discussions, thanks !

 
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Reply: 1.1.1.1.1.1.1.1.1
From: Dale Gatherum-Goss


Hi Sim!

No problems, I too learn from this forum and the people kind enough to give of their knowledge and time.

I hope to have a beer with you at the pub crawl!

Dale
 
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