Settling with personal funds - deductable?

[Mal P]

Hi folks,

I have an issue regarding settlement on an IP. I was intending on using proceeds of a refinance (and at the same time release of equity) from one lender to another to provide the deposit for the IP, however, the refinance looks like it won't be ready in time.

If I use my own funds for the deposit, and then use the loan funds to replenish my savings, can I use the argument with the ATO that the loan funds really was intended for investment purposes and that it was merely a timing issue that meant I had to use my own funds as security?

Thanks,
Mal

 

[Perp]

If you purchase the IP within a structure (eg Trust), then you could draw up the funds as a loan from yourself to the Trust, which the Trust can then repay with the loan proceeds.

If the IP is in your own name and so is the savings, I think you're out of luck. (Even though I agree it's ridiculous for the ATO to view it that way.)

 

[belleran]

Hi Mal, I have just logged on to ask a very similar question. We were also held up by the bank in the settlement of a block of land we were buying in the name of our family trust for investment purposes. So we paid for it from funds in an online saving account which is in the name of the trust.
Now that the LOC has come through, we want to reimburse the on line saving account from the LOC. Our accountant is telling us that the amount we withdraw back from the LOC will not be tax deductible. Thank you bank!!

Surely this must make sense to the ato. Is it likely a private ruling with ato could help?

 

[mrsdawnrazor]

In the past I have paid the deposit from my own funds then reimbursed myself from the loan when it came through 2-3 weeks later. I have claimed all the interest from the investmetn loan as deductible, all that happened was the balance of the loan went up by the value of the deposit a couple of days after settlement.

My accountant has never had an issue with it. In fact this is how I have funded all my deposits.

 

[belleran]

Maybe the accountants can help us.

MrsDawnrazor, my accountant would say the amount you paid back to yourself would not be tax deductible.

 

[dr.jauncey]

Maybe the accountants can help us.

MrsDawnrazor, my accountant would say the amount you paid back to yourself would not be tax deductible.

Hi, so would I.

The principal of mutuality prevents this. You cannot owe money to yourself as it is a zero sum. However using other structures may allow for some creativity as Ozperp suggested.

 

[Perp]

In the past I have paid the deposit from my own funds then reimbursed myself from the loan when it came through 2-3 weeks later. I have claimed all the interest from the investmetn loan as deductible, all that happened was the balance of the loan went up by the value of the deposit a couple of days after settlement.

My accountant has never had an issue with it. In fact this is how I have funded all my deposits.

Is your accountant even aware that you "reimbursed yourself" in this manner? Unless the investment loan was for a different entity than yourself, you've definitely contaminated deductibility.

We work on a self-assessment system, so just because you've gotten away with this in the past, doesn't mean it won't get ugly if you're audited.

 

[belleran]

Ozperp,
Is my situation in the same boat as Mrsdawnrazor?
Is there any way we could make that original purchase money tax deductible?

 

[Perp]

Ozperp,
Is my situation in the same boat as Mrsdawnrazor?
Is there any way we could make that original purchase money tax deductible?

If the person taking out the investment loan and the entity providing the cash up-front are the same entity, then unfortunately, you're screwed with regards to tax deductibility. You can't "fix" it other than using the loan proceeds (in excess of those required for settlement) for further investments, eg to buy shares, or as a deposit on another IP. You can't repay your private funds with an investment loan and retain deductibility.

As I said before, the only way you can possibly get around it is if you as an individual contribute cash (by way of a loan to the Trust buying an IP), and the Trust repaid you as an individual with money borrowed by the Trust.

Another possibility is if that initial cash deposit was provided by a friend or relative (or even a spouse not on the title, if your finances are separate), and you had an agreement written up requiring the loan to be repaid. So if that friend or relative stumped up that cash, and they provided it to help you buy the investment, and you're required to repay them, then it's possibly deductible. You'd have to ensure, though, that you could demonstrate that the money came from that party, and that you have loan documents etc to support your position, which obviously would only be possible if that had been your intention since before the loan was made.

If you bought the IP in your name, and took out the IP loan in your name, and the cash contributed was yours, you've got no easy fix, unfortunately.

I agree with you that it's entirely ridiculous and pedantic. I think that for those people who are investors, all your loans, up to the extent of the purchase price of your investments, should be deductible.

So if you have a PPOR with a mortgage, an IP bought for $400K, and shares purchased for $150K, it shouldn't matter which loans are secured against what, or which cash actually went where, you should be able to claim the interest on $550K worth of debt.

If you own a PPOR outright and borrow $100K to buy shares, the interest on the $100K is deductible. If you bought $100K of shares with cash before purchasing a PPOR, then borrow $100K to buy your PPOR, the interest on the $100K isn't deductible. It's silly!

 

[dr.jauncey]

As I said before, the only way you can possibly get around it is if you as an individual contribute cash (by way of a loan to the Trust buying an IP), and the Trust repaid you as an individual with money borrowed by the Trust.

Hi, yes, other structures can be used to solve the problem. This also works when using trust funds for a personally owned investment property, for example.

However it appears Belleran has the property, the savings account and the LOC all in the trust name. Per previous posts, the principle of mutuality will deny any interest from being claimed from any reimbursement of those funds.

 

[belleran]

I presume the remaining money in the LOC if used for investment purposes will be deductible?

 

[dr.jauncey]

I presume the remaining money in the LOC if used for investment purposes will be deductible?

Hi, yes, this would be correct. Also if the trust owes you (personally) money then it could use other borrowed funds (such as the LOC) to repay that debt. Then the interest on the LOC may also be deductible.

 

[Perp]

Hi, yes, this would be correct. Also if the trust owes you (personally) money then it could use other borrowed funds (such as the LOC) to repay that debt. Then the interest on the LOC may also be deductible.

That's interesting. So if you had a "currently non-deductible" debt (or potential debt, ie funds in an offset or LOC) in your own name, for example, you could lend those funds to the Trust, which the Trust could use to repay you (if it owed you money, which most Trusts probably do - mine sure does!), and the loan becomes deductible because of the "flow through" an investible purpose?

 

[dr.jauncey]

That's interesting. So if you had a "currently non-deductible" debt (or potential debt, ie funds in an offset or LOC) in your own name, for example, you could lend those funds to the Trust, which the Trust could use to repay you (if it owed you money, which most Trusts probably do - mine sure does!), and the loan becomes deductible because of the "flow through" an investible purpose?

Hi, I was referring to what may be known as the refinancing principle. This means that if a new debt is obtained in order to pay out an existing debt, then the new debt will be taken to have the same purpose as the previous one. Therefore if the (potential or actual) interest on the existing loan is deductible then such deductions would also apply to the new loan.

Many investors use this principle regularly through ordinary refinancing of their investments.

However there is potential to be creative when also using trusts or companies. Often such entities will owe funds to their beneficiaries / shareholders due to contributions made or entitlements not taken. While there may not be interest charged on these loans, it would be deductible to the entity if there was any interest charged. So it stands to follow that if the entity was to borrow funds (from a LOC, for example) with which to clear out the debt to the beneficiary / shareholder, then the interest on such a loan may be deductible also.

This could apply regardless of what the beneficiary / shareholder does with those funds, including the repayment of personal debt or direction towards private expenses. The use of repaid moneys, once received, is irrelevant for the entity who is repaying them.

In regards to your example, borrowing money to lend to your trust and having it repaid immediately would be fairly pointless as you could only claim the interest in your own name if also receiving an entitlement to income. Usually not the case with a discretionary trust unless such trust is paying interest to you on that loan in which case the trust is still effectively claiming the interest, not you. This would work much better if the trust took out a new loan to repay you per the above, instead of using your own funds to do so.

 

[Terryw]

Hi folks,

I have an issue regarding settlement on an IP. I was intending on using proceeds of a refinance (and at the same time release of equity) from one lender to another to provide the deposit for the IP, however, the refinance looks like it won't be ready in time.

If I use my own funds for the deposit, and then use the loan funds to replenish my savings, can I use the argument with the ATO that the loan funds really was intended for investment purposes and that it was merely a timing issue that meant I had to use my own funds as security?

Thanks,
Mal

A possible way around it would be to gift some money to a close relative and borrow from them. Then when your loan funds come through refinance this loan with the newly borrowed money.

Hopefully your relative will gift some money back to you at the end!

Check with your accountant.