LMI Purpose and Tax - Delay between finance and investment

[jrc77]

All,

If I have a 80% loan currently secured on my PPOR for which the purpose was the PPOR, and then I do a top up to 90% (capitalizing LMI) to make funds available for investment purposes I think it could be reasonably argued that the LMI is an investment expenses as is only required for the additional borrowing (which is for investments).

If so, then the LMI would be deductible over 5 years and the additional interest on the loan (from the capitalized lmi) would be deductible.

This old thread discusses this is more detail "http://somersoft.com/forums/archive/index.php/t-4451.html".

However, what happens if there is a delay between setting up the new top up and using it for investment purposes? Say I get this set up as a IO loan - initial balance of $18k (the LMI) with drawdown available $150k. Then left it there for a year while I was searching for a good investment.

After a year I find my investment, and drawdown the $150k.

What is deductible in the first year?
What is deductible in the five years after that?
Is the first years deductability of the LMI lost as the loan wasn't used for an investment at that point?

Regards,

Jason

 

[Rob G.]

Nil deduction.

s.25-25 requires money to be "used to earn assessable income".

In fact it was not used, it was not even drawn.

Where you are an investor who earns income from the underlying property then costs of searching for the property are not incurred in earning assessable income, they are preliminary to the income earning activity.

Do not confuse case law concerning interest deductions since they relate to non-capital costs under interpretation of a different provision. Even then, the above arguments apply.

Cheers,

Rob

 

[Paul@PFI]

Lmi

I'm with Rob. I would consider that the expense is capital in nature and too early. In fact I would argue its private. You could use funds to buy a boat too couldnt you? I would be hesitant to claim any of it without seeking Commissioners private ruling. I wouldnt want to be reckless.

In theory you might have applied for the increased finance to buy a boat and now you changed your mind and want to to buy some shares. So you buy some CBA shares and later sell them. Does that mean the LMI should be deductible for 60 months. No.

I would estimate (!!) that if presented in right way, ATO might allow the 60months apportioned but for first 12 months it is non-deductible. I wouldnt assume that the remainer of 48 months would be deductible either. Only if loan remains drawn and then apportioned for days drawn and the available credit v's the sum used for income purposes.
ie You use $20K for 30days to fund share then 1/60th of LMI deductible x $20k/$150k.

ATO will strongly argue that the loan increase was a contingent decision made privately well in advance of a decision to invest. Dont think they would deny 100% deduction.

The issue of loan security is irrelevant. Its the old chestnut of what borrowed $$ are used for.

 

[jrc77]

Thanks Paul and Rob for the replies.

So if the situation was:

PPOR had three loans secured against it (at 80% LVR)
loan 1 - PPOR loan
loan 2 - deposit for IP1 (+ purchase costs)
loan 3 - deposit for IP2 (+ purchase costs)

IP1 one loan secured against it
loan 4 - 80% of IP1 purchase

IP2 one loan secured against it
loan 5 - 80% of IP2 purchase

And you wanted to extract more equity via increasing LVR and incurring LMI, would a better way might be to top up the loans 4 and 5 (capitalizing the LMI) and using them to refinance some of the debt from loans 2 and 3? Then using the refinance principal, the purpose of the top funds take on the purpose of loan 2/3, making the LMI deductible from day dot.

After this is done, then the redraw now available on loan 2 and 3 could be split off to another loan secured against the PPOR and left waiting for the investment opportunity.

Regards,

Jason

 

[Rob G.]

The "refinance principle" in tax law concerns replacing existing equity, which is already being used to earn assessable income, with debt funding.

You are in fact referring to existing loan refinancing.

If the purpose of incurring LMI is to gain access to a greater loan limit which is not to be used until the future then nothing is different from your first proposal.

All you are doing is hiding behind a loan reshuffle where the disturbance of the other loans would not have otherwise happened.

How can reasonably argue that it relates to some presently existing assessable income activity ?

Cheers,

Rob

 

[GaryT]

Thanks Paul and Rob for the replies.

So if the situation was:

PPOR had three loans secured against it (at 80% LVR)
loan 1 - PPOR loan
loan 2 - deposit for IP1 (+ purchase costs)
loan 3 - deposit for IP2 (+ purchase costs)

IP1 one loan secured against it
loan 4 - 80% of IP1 purchase

IP2 one loan secured against it
loan 5 - 80% of IP2 purchase

And you wanted to extract more equity via increasing LVR and incurring LMI, would a better way might be to top up the loans 4 and 5 (capitalizing the LMI) and using them to refinance some of the debt from loans 2 and 3? Then using the refinance principal, the purpose of the top funds take on the purpose of loan 2/3, making the LMI deductible from day dot.

After this is done, then the redraw now available on loan 2 and 3 could be split off to another loan secured against the PPOR and left waiting for the investment opportunity.

Regards,

Jason

If what you are saying is that you are increasing loan 4 (100% IP1) to pay out Loan 2 (100% IP1) and similarly with IP2, then I cannot see any problems. You are simply refinancing to amalgamate existing IP loans.

Assuming both Loan 4 and Loan 2 were initially only used to acquire IP1, then any like for like refinancing of these would also be 100% deductible. Any fees associated with this refinancing would also be deductible.

Loan 2 would then be reduced to zero. If it were subsequently used again to acquire an income producing asset then related interest would be deductible.

 

[s0805]

i don't know your actual figures and equity available....

how about refinancing loan 4 & 5 to 90% or 95% (if possible), pay LMI and use equities from both these loans for next purchase. I think
in that case case LMI and extra top up of Loan should be tax deductible.....if IP1 and IP 2 doesn't have eqnough equity (even after
increasing to 95%)....consider refinancing your PPOR to 79.90% (to avoild LMI) and set this up as seperate loan....

the way i read everyone's response here...they are suggesting if you refinance PPOR to more than 80% to fund the next IP than LMI on that wouldn't be tax deductible....

in any case you should seek professional advise....

 

[Rob G.]

Again, refer to the definition of "purpose of producing assessable income" in s.995-1(1).

This suggests an import of case law on s.8-1 interpretation.

Particularly case law in relation to interest deductions.

If you incurred LMI to give you greater borrowing capacity which you may or may not use at some unspecified future time for producing assessable income then this may fail.

It is not merely a game of ticking a box and the provision working automatically.

Cheers,

Rob

 

[s0805]

If you incurred LMI to give you greater borrowing capacity which you may or may not use at some unspecified future time for producing assessable income then this may fail.

Rob

Rob, what is the unspecified time here??? if you incur LMI to give you greater borrowing capacity which has been used for investment purposes....then its meets the income producing activity...????

 

[Rob G.]

The original post was about claiming LMI on a new loan where undrawn funds will or may be used at some point in the future.

Then the alternative suggestion was to refinance some existing IP loans, which did not need disturbing, to achieve the same outcome whilst claiming a deduction. The greater capacity will/may not be drawn until some undefined (maybe a year) period.

This then boils down to "purpose" and whether there is more than one purpose in incurring the LMI.

Cheers,

Rob