Paying IP expenses from LOC

[Pins]

Hi all,

"Paying your IP expenses from an LOC (except interest) and then diverting those funds to your PPOR"

I have seen this mentioned a few times from experienced folk but I have to admit, I don't quite understand exactly how it works and what the main benefits are (assuming tax deductibility and paying down your PPOR faster).

Can you please explain how it works and the benefits? Do you pay back the expenses into the LOC each year or let it build up? Why do you exclude interest from this as this is obviously the main expense? Is it something that's more effective when you have a higher number of properties?

Thanks in advance

 

[burning]

I can't specifically talk to your quoted text (is there a source for that quote, or is it a paraphrase?). I'm also a newbie, so I'm interested in hearing what some of the pro's suggest

Some of the benefits lie in the simplicity of having all investment related expenses on a single account. Print the txn list, hand to accountant. You don't necessarily need to use a Line Of Credit to do this, it's just one facility that will do the job.

Your point about the interest probably comes down to not being able to claim a deduction for the capitalised interest?

 

[justlearning]

I'm interested in this too. My purpose would be to pay off our ppor off firstt.

I've read a few things saying it's possible to claim the additional borrowing expenses but I think it goes back to your Intent.

I'd also like to continue to earn ff points for property expenses and pay the cc off from a loc monthly

 

[Rixter]

I pay all our property portfolio expenses ( loan interest & all holding costs) via investment LOC's. I dont do it to pay down my PPOR though as there was a ATO case that ruled against it a few years back. All our after tax income goes direct into PPOR & all our investment income goes into our investment LOC's.

 

[Terry_w]

This sounds similar to something I wrote last night.

Under the tax laws you are able to borrow money to invest and to claim the interest. You can borrow to pay for investment expenses and claim the interest.

The main advantage in this is it frees up the cash which you would otherwise have used to pay the expense. Thisallows you to pay dow any non deductible debt faster while building up tax deductible debt. i.e. it puts money in your pocket.

You may consider taking this a step further and to borrow to pay interest. Interest on interest is generally deductible if the underlying interest is deductible.TD 2008/27
But, if you are doing this with a dominant purpose of a tax advantage the ATO could apply Part IVA of the ITAA36 to deny the deduction. TD 2012/1. However this doesnt mean you cannot do it and it doesn't mean you cannot claim the interest on the interest - it all depends on the circumstances.

So, either way, seek tax advice before trying this at home

 

[Aaron_C]

Can you please explain how it works and the benefits?

The logic is thus:
Imagine you have a PPOR loan of say $500k and investment loans of $400k. Obviously the $500k loan is not tax deductible whereas the $400k one is. It would be better if the $500k loan was lower, and the $400k loan higher so you get more tax deductions and less private or 'non-deductible' debt.

What people are talking about with using LOCs to pay off your home loan faster is to accelerate this process. They use a LOC to pay the interest on the $400k loan each month. This means that the $400k loan gets bigger and bigger (and bigger interest deductions) since the LOC is used to pay the interest and is therefore itself deductible.

Meanwhile, you use all your after-tax income (from your wages, rent etc) to pay down your PPOR mortgage ASAP. This would be much faster than using that after-tax income to pay the interest repayments on your investment loans since it is all directed to the private mortgage first. Over time you will pay the PPOR loan off faster and have much larger investment loans and hence larger tax deductions.

The ATO can disallow this arrangement if they think you are trying to do it to maximise your tax deductions. Of course, if you have no PPOR debt to speak of, then there is no tax advantage.

 

[Terry_w]

Think of it this way.

You have a $5,000 expense for your investment property.

If you take $5,000 from your offset account and pay this then the interest on your home loan would increase by 5% x $5,000 = $250 per year.

However, if you borrowed to pay it your home loan would be the same as before yet your LOC debt would be $5,000 more so you could claim a deduction of 5% x $5,000 = $250.

If you were on the top tax rate then you would save around $110 - which you could then put into your home offset to save you even more - about $5.60 per year in interest! plus the compounding effects.

Do this with multiple expenses over multiple properties over multiple years and it starts to add up.

 

[luckyone]

So how do you do this Terry without the tax office trying to think you're minimizing tax?

 

[Terry_w]

So how do you do this Terry without the tax office trying to think you're minimizing tax?

There is no easy answer. I would suggest you not try it without a private ruling. one answer may be 'cash flow'.

 

[luckyone]

Thanks Terry, will have to try to organise one.

 

[Pins]

I pay all our property portfolio expenses ( loan interest & all holding costs) via investment LOC's. I dont do it to pay down my PPOR though as there was a ATO case that ruled against it a few years back. All our after tax income goes direct into PPOR & all our investment income goes into our investment LOC's.

Hi Rixter, does this mean your properties are negatively geared?

 

[Pins]

Think of it this way.

You have a $5,000 expense for your investment property.

If you take $5,000 from your offset account and pay this then the interest on your home loan would increase by 5% x $5,000 = $250 per year.

However, if you borrowed to pay it your home loan would be the same as before yet your LOC debt would be $5,000 more so you could claim a deduction of 5% x $5,000 = $250.

If you were on the top tax rate then you would save around $110 - which you could then put into your home offset to save you even more - about $5.60 per year in interest! plus the compounding effects.

Do this with multiple expenses over multiple properties over multiple years and it starts to add up.

I thought there might be other advantages, but yes it does seem you need some scale for it to genuinely make a difference. Is the ATO's issue just with borrowing to pay the interest rather than the expenses?

 

[Terry_w]

I thought there might be other advantages, but yes it does seem you need some scale for it to genuinely make a difference. Is the ATO's issue just with borrowing to pay the interest rather than the expenses?

Yes. I haven't seen any ATO information rejecting the borrowing to pay expenses part - just the interest part. But the ATO has said to at least one accountant that they are concerned about it.

 

[Rixter]

Hi Rixter, does this mean your properties are negatively geared?

In the early years after purchase some were negative to neutral. Then as the rent increased they become cash flow neutral to positive.

The investment LOC's are a big credit facility that provide me access to cash flow to fund any property shortfalls between incomes & outgoings each month.

Some months there is more income than outgoings, then other months the opposite. Then as time goes by rents increase (as well as the CG) and the surplus income remains constant making a positive geared portfolio.

I hope this helps

 

[Alex P Keaton]

In the early years after purchase some were negative to neutral. Then as the rent increased they become cash flow neutral to positive.

The investment LOC's are a big credit facility that provide me access to cash flow to fund any property shortfalls between incomes & outgoings each month.

Some months there is more income than outgoings, then other months the opposite. Then as time goes by rents increase (as well as the CG) and the surplus income remains constant making a positive geared portfolio.

I hope this helps

I'm still a little confused. If I use my loc to pay my holding costs for my NG ip when is it that I have to actually pay for the loc expenses out of my pocket.

I'm lining up an appointment with my accountant but in the meantime rixter when you say you use the line of credit to pay for holding costs do these holding costs include expenses such as pm fees, strata fees, water rates etc or do you also/can you also use the loc for the mortgage interest payment.

Also how much do you have on your loc to cover the holding costs.


I'm lining up a few mote appointments in order to get better educated about stuff

Thanks!

 

[Peter_Tersteeg]

All subject to discussing with an accountant, but my understanding is as follows:

You can use a LOC to pay your investment related bills, such as repairs, management costs, etc. As long as the LOC is used exclusively for investment purposes, the LOC should remain tax deductible.

You cannot use a LOC to pay the interest (or the shortfall between the rent and the interest). You can't use the LOC to pay the interest on the LOC.

 

[Rixter]

I'm lining up an appointment with my accountant but in the meantime rixter when you say you use the line of credit to pay for holding costs do these holding costs include expenses such as pm fees, strata fees, water rates etc or do you also/can you also use the loc for the mortgage interest payment.

My PM's pay all my outgoing expenses (apart from IP loan interest & Strata fees) from monthly rental income collected. The balance of rent (after expenses) the PM's then deposits direct into my Investment LOC.

I pay the Strata fees from the investment LOC and my banks debit the investment LOC for all IP loans interest each month.

The monthly Investment LOC interest gets added to the LOC balance each month.

Also how much do you have on your loc to cover the holding costs.

I have approx $90k available funds in the Investment LOC at the moment.

Does this explain it better Alex?

 

[Rixter]

All subject to discussing with an accountant, but my understanding is as follows:

You can use a LOC to pay your investment related bills, such as repairs, management costs, etc. As long as the LOC is used exclusively for investment purposes, the LOC should remain tax deductible.

Correct..you must keep all investment/business expenses away from Personal Expenses. Use the LOC solely for investment/business purposes.

You cannot use a LOC to pay the interest (or the shortfall between the rent and the interest). You can't use the LOC to pay the interest on the LOC.

That is not my understanding. It remains deductible providing you are not trying to debt recycle non tax deductible debt into taxable debt by redirecting rental income into a PPOR whilst IP loan interest is left to capitalise in an LOC.

 

[Terry_w]

Using a LOC to pay for interest on loans is possible as is capitalising interest. Basicially, if the underlying interest is deductible then the interest on the interest is deductible.

BUT, if you are doing this to increase deductions or to pay off the home loan sooner (non deductible portion) then the ATO can apply Part IVA of the ITAA36 and deny the deduction.

So you should always get advice on this and consider whether you should get a private ruling.

 

[el caballo]

http://www.finder.com.au/property-investment-chris-grays-investment-property-advice

From the attached, Chris Gray uses rising equity re-finances (presumably contained in a LOC) to pay interest. The key quotes are:

"The key to getting around that is by using equity to cover the losses. So if, for instance, my property
portfolio rises 5-10% a year, I make $500,000 - $1,000,000 a year in capital growth.

Assuming the banks lend me money at say 80%, they lend me $400,000-$800,000 and I use part of that money to pay for the negative gearing ? which is the out-of-pocket expenses. I'll also get some tax back as well and then I use part of the money leftover to re-invest so my portfolio's always growing and part of it I use as income as well.

You need to read the Empire book to really understand that, but ultimately what I'm doing is taking out the rise in equity to help cash flow for a few years and I constantly re-invest."

Chris also mentions in the interview "it's quite complicated to get your head around because you're basically borrowing more and more money to build wealth."

Thoughts?