Offset vs redraw mixup

Hi Everyone,

I was sitting on the couch earlier this evening looking at our home loan for our IP and suddenly had a feeling that something was wrong..

We have an IP and the loan balance when the PPOR became an IP was $377K. Since then we have been claiming the interest paid on the $377K loan (interest only).

The property is slightly cash flow positive based on a $377K loan balance.

Earlier last year we refinanced our loans (PPOR and 2 IPs) to UBank to get a better rate and take advantage of a gift card promotion. UBank don?t offer offset accounts but I didn?t think about this too much at the time as a redraw facility is available instead.

Mid last year we sold one of our IPs and have put the funds onto the PPOR home loan (now close to $0 owing) and the remainder onto the remaining IP mortgage, reducing the IP loan balance to about $160K. I thought that this was a sensible idea to use the excess funds to reduce the interest payable on the IP.

I have been transferring as much as possible into the IP mortgage but also have made many redraws. The loan balance has been decreasing steadily but the balance has been fluctuating with the deposits and redraws. The redraws have been used for day to day (non-deductible) expenses.

I have just realised that this was a serious mistake. I think that what I have done now is to make the maximum interest claimable for the IP to be interest charged on a $160K balance. I had incorrectly assumed that if we redrawed from the mortgage back to a $377K balance in the future we could then claim interest on $377K again. Ie I assumed that an offset account and a redraw facility behave the same way.

It just so happens we have been in discussions with our Financial Advisor this week and he has recommended setting up a Discretionary Family Trust. The Trust will buy shares and we will distribute the income generated to the family member with the lowest income for the year.

Can I please ask what people might suggest as a fix for my mistake?
Eg.. If we redrawed from $160K to $377K (ie $217K) and sent this to the Trust (that we are about to set up) to be invested in shares would that restore deductibility up to $377K again?

Would transferring the IP into the Trust be a sensible way to fix my mistake? I have not considered this just yet but as it?s now cash flow positive with a low loan balance perhaps it?s a good idea?

I am kicking myself but am also a bit confused as although we will lose about $4000 in additional income tax payable ($10000 interest difference between $377K loan and $160K loan) we would save $10000 in interest payments, ie we?ll be $6000ish better off each year.

I will of course send this email on to my Accountant and Financial Adviser but I would very much appreciate any thoughts from the brains on this site. Feel free to give me a kick in the butt too for being a goose!

Thanks for your time!
 
I'm not an accountant but redrawing from a deductible loan for non deductible purposes sounds like you would have contaminated the loan.

Cheers

Jamie
 
There are some issues yes regarding interest deductibility.
But purpose of my post is to ask you this:
Are you going to buy another IP in the near (2-5) year future? Or upgrade to a more expensive home for yourself that requires additional borrowings?

If not then isn't it better to save a dollar on interest and not get 32 cents back in tax? I know I would rather a dollar in my pocket now and not be waiting for some of if back from the tax man.. Some investors get fixated on claiming interest and deductions.

I am not aware of objectives or goals so I apologise in advance if I have missed the mark, but thought id try to ease your worry if that was the case!
 
The deductibility of interest will be far less than you expect. If money has been going in and out the part relating to the original purpose of buying the property may be way less than the $160k.

Each deposit is a repayment and each redraw is a new loan.
It would be a night mare to work out.

And no way to fix it now.

Borrowing to invest into a discretionary trust won't be deductible. If the trust borrows to buy your property the trust's loan interest may be deductible, but if the trust has no other income this may result in a loss in the trust.

I suggest you speak to a lawyer about the trust up of a trust and an accountant or tax lawyer about the tax issue. Leave the financial planner for the financial advice.
 
If not then isn't it better to save a dollar on interest and not get 32 cents back in tax? I know I would rather a dollar in my pocket now and not be waiting for some of if back from the tax man.
Sure, it is. But it's much better still to use an offset account and have both benefits.
 
Hi Everyone,

Thanks so much for the replies and the sage advice, especially on the weekend!!
I'm not an accountant but redrawing from a deductible loan for non deductible purposes sounds like you would have contaminated the loan.

Thanks Jamie for confirming my fears.

If not then isn't it better to save a dollar on interest and not get 32 cents back in tax? I know I would rather a dollar in my pocket now and not be waiting for some of if back from the tax man.. Some investors get fixated on claiming interest and deductions.

Thanks Grey Ghost for your reply. You're right about a full dollar in your pocket vs part of a dollar in a years time. I am definitely not a sophisticated investor like others here so it may not affect us too much - we may need to buy a house in another catchment area for schooling and we were thinking about another IP in the future.

I suppose what this will do is tie up more cash on the existing loan meaning less funds available as a deposit for another IP. In terms of PPOR I suppose we would have to refinance the properties and get the loans / offset accounts organised and tidied up.

The deductibility of interest will be far less than you expect. If money has been going in and out the part relating to the original purpose of buying the property may be way less than the $160k.

Each deposit is a repayment and each redraw is a new loan.
It would be a night mare to work out.

And no way to fix it now.

Borrowing to invest into a discretionary trust won't be deductible. If the trust borrows to buy your property the trust's loan interest may be deductible, but if the trust has no other income this may result in a loss in the trust.

I suggest you speak to a lawyer about the trust up of a trust and an accountant or tax lawyer about the tax issue. Leave the financial planner for the financial advice.

Hi Terry, thanks very much for your time as well. I will explain the situation to my accountant and hopefully he can advise me what the deductible loan balance is now. I suppose we will then pay the loan down to that amount and then I promise not to touch it!!

Thanks for the Trust information too. We live in WA and the IP is in NSW (I don't know if the states have different rules) so I assume that we would have to pay stamp duty to transfer the IP into the Trust as well as CGT?

But it's much better still to use an offset account and have both benefits.

Hi Perp, I agree with you but it's too late now. Hopefully someone reads this thread and can avoid the same mistake that I have made.

Thanks again for the replies, I will contact my accountant on Monday and let you know what happens next.

Enjoy the rest of the weekend!
 
Hi Terry, thanks very much for your time as well. I will explain the situation to my accountant and hopefully he can advise me what the deductible loan balance is now. I suppose we will then pay the loan down to that amount and then I promise not to touch it!!

Thanks for the Trust information too. We live in WA and the IP is in NSW (I don't know if the states have different rules) so I assume that we would have to pay stamp duty to transfer the IP into the Trust as well as CGT?

Make sure you split the loan before depositing any more money in it. Otherwise the deposit will come off both the deductible and non deductible portions.

Yes stamp duty, CGT for a transfer to a trust - at market values. Don't forget land tax in NSW is 1.6% pa of land value with trusts receiving no threshold.
 
Can I please ask what people might suggest as a fix for my mistake?
Eg.. If we redrawed from $160K to $377K (ie $217K) and sent this to the Trust (that we are about to set up) to be invested in shares would that restore deductibility up to $377K again?

I take it you don't have $377k in other assets available? Silly quesiotn - but worth asking.

You can liquidate other assets, effectively pay off the ip, draw down, and rebuy the other assets.

The Y-man
 
Make sure you split the loan before depositing any more money in it. Otherwise the deposit will come off both the deductible and non deductible portions.

Yes stamp duty, CGT for a transfer to a trust - at market values. Don't forget land tax in NSW is 1.6% pa of land value with trusts receiving no threshold.

Thanks again for your reply Terry. That's more great information to make decisions moving forward from here.

I take it you don't have $377k in other assets available? Silly quesiotn - but worth asking.

You can liquidate other assets, effectively pay off the ip, draw down, and rebuy the other assets.

Hi Y Man, thanks for your reply too. No we don't have that much available. We could redraw the $377K off our PPOR mortgage or otherwise sell some shares but only $120K worth.

Thanks again for the replies Gents, have a good weekend.
 
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