paying out loan and ongoing tax dedn

[Rolf Latham]

Hiya

We have 2 Ips, 2 loans, same lender

One has a fixed loan at 320 the other a variable loan of 310. no cross collateral

Client wants to sell the property that has the fixed rate loan attached, 15 k break cost.

We have suggested payng out the variable loan at nil break and porting the fixed loan to the pther property.

Accountant has come back with

As we are claiming loan xyz against property ABC we should not pay it out as it will upset future taxation claims.

Now, I believe the purpose of the funds in general is the issue not specifics, both loans are dedutible against pooled rental income. Yes it will cause minor doco issues, but at 15 k...................

Sure, we have lost the direct nexus of the loan money per se, but we are not changing nature of money, we are repaying one deductable debt rather than the other.

Im sure I have seen an ATO ruling in this regard. Any ideas ?

ta
rolf

 

[brendio]

While not directly address your case I think the principles of the following rulings could be applied.

TR 2000/2 relates to the deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities.

Paragraph 14 states:

14. Where borrowed money applied to a particular use is recouped and redirected to another use, it is necessary to examine that new application of those borrowed funds in considering the deductibility of interest. Where there are changes in the use of money borrowed under a line of credit facility, or in the amount of borrowed money used for a particular purpose, the deductibility of the interest accrued on that part of the outstanding debt will be determined by considering the advantages sought from that new application of those funds. Interest will be deductible under section 8-1 to the extent that it is incurred on that part of the outstanding borrowed money used at that time for an income producing purpose.

In effect you are taking the proceeds from the sale of the asset IP1 and rather than repay the loan for IP1, you are repaying the loan for IP2. That's sounds a bit similar to refinancing, so I searched for rulings on that.

TR 95/25 relates to deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith

Paragraph 42 states:

Borrowing used to repay an existing loan

42. Interest on a new loan will be deductible if the new loan is used to repay an existing loan which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is directed to the production of assessable income ( Roberts and Smith ATC at 4388; ATR at 504).

In your case you have an "old" loan rather than a new loan, but I would think that combining the principles of the two should allow you to do what you wish to do. However, it was be advisable to seek a private ruling on this.

 

[Rob G.]

I suspect the ATO will take the broad view, seeing as it is to their advantage here.

1) You sold property A and have been deemed to have recouped the loan funds.

2) Whereas property B is kept but had its original loan paid out ("paying out variable loan before porting"), and been loaded up with debt incurred for an asset you no longer have.

3) Result = Property B now is now loaded up with debt that is not incurred for a deductible purpose.

Normally refinance in this context involves exchanging one debt for another for the purpose of producing income.

The underlying asset does not determine the interest deductibility, the use of the funds decides this point.

Merely discharging a mortgage and porting a loan to another property might not destroy the debt owing, it merely charges the property as security for the debt (there may be exceptions and I might be confusing the definition of a mortgage with a charge ... so check this legal definition).

So it is tempting to swap the underlying mortgages arguing loan purposes have not changed.

The problem here is that the underlying properties are also the purposes of each loan. This is what I think the ATO will seize upon. Similar to a chattel mortgage - it attaches to the asset being acquired.

So where the loans are swapped, they may be deemed purposes of acquisition of their respective *original* properties - hence points 1), 2), 3).

For instance, if you had a chattel mortgage over a business car - but then refinance as a redraw on a mortgage over an IP (i.e. swap the underlying asset used as security) - this does not allow you to keep deducting that portion of interest if you then sell the car. Similarly, if you keep using the car and also use it as security for an equivalent part of your IP loan and transfer some debt over it (i.e. swap loans), then nothing changes - same problem.

This is in spite of no tax advantage being gained for Part IVA.

The problem is that you have two separately identifiable loans for separately identifiable purposes.

One possibility would be to combine the loans in one product as a split fixed/variable under similar terms. The rigid tracing might not be used to identify which part of the loan is paid down, since it is entirely used to produce assessable income.

You would need to get at least an opinion on this, if not a pbr. Also the bank needs to be amenable of course.

But like you say ... $15k is a lot of money, even if it is immediately deductible as a mortgage discharge expense.

Cheers,

Rob

 

[brendio]

I forgot to add in my reply that if you are making the argument that you are quasi refinancing the remaining loan with that of the sold property, your argument would be stronger if the two loans are the same amount. Thus, if the remaining loan is more than that of the one you are paying out, you may need to pay it down to the same amount, so that the remaining ported loan is of the same value as the one you paid out.

 

[chylld]

Can you just put the proceeds from property A into an offset account for property B?

 

[Jeith]

Can you just put the proceeds from property A into an offset account for property B?

You could do this but there would be no benefit as the outcome would be the same - no interest expense for property B. So the problem would still be whether you can claim a tax deduction for the interest on the original loan for property A against the rental income for property B.

Original purpose of the loan was for property A & I think this is the view the ATO would take - but if there is an ATO ruling that states the opposite I'd appreciate someone posting a link.

 

[Rolf Latham]

Can you just put the proceeds from property A into an offset account for property B?

Hi

Still means having to pay out the fixed rate loan which we dont want to do per se.

Once we pay it out, then there are little funds left over.



ta
rolf

 

[Rolf Latham]

For instance, if you had a chattel mortgage over a business car - but then refinance as a redraw on a mortgage over an IP (i.e. swap the underlying asset used as security) - this does not allow you to keep deducting that portion of interest if you then sell the car. Similarly, if you keep using the car and also use it as security for an equivalent part of your IP loan and transfer some debt over it (i.e. swap loans), then nothing changes - same problem.

Thanks Rob

On the above example though u are looking to double dip. You have taken an additional debt on the IP to fund the refinance for an asset u no longer have.

I this instance we are close to replacing one like debt for another, even close to the dollar, and not taking new borrowings.

Ur idealogy makes sense, and of course the ATO will want it both ways.

ta
rolf

 

[D.T.]

They don't have options available other than selling?

 

[Rob G.]

Yep ... acquire another income producing asset funded by porting the fixed loan against that asset (in other words buy another IP).

Then sell the original, and now unencumbered, IP.

It just gets messy when the ATO applies simplistic reasoning, rather than economic reality.

Cheers,

Rob

 

[Rolf Latham]

Hey Rob

Agree 100 %, thats why im here looking for non logical complicated reasons

ta
rolf

 

[PHF]

I don't see a problem with this at all.
From a taxation perspective, its just a simple refi.
If possible, try to reduce the fixed loan down to $310 when you swap it over. Alternatively, the Accountant can adjust the interest deduction down to account for the extra $10K in borrowings.

 

[Rolf Latham]

Hi dave

They do need to sell the asset to realise the profit

ta
rolf