Strategy to bring fwd deductions

[Paul@PFI]

Just identified a strategy for some owners of IPs with fixed rate loans and thought it worth sharing.

Client has a three year fixed rate loan. Wants to prepay a years interest. Bank must break the 3 year loan to do this (you cant do a years prepaid on a three year fixed rate) and this generates a decent upfront deduction for the breakcost. Then they do the years prepaid which further brings fwd a full year of interest.

Bank is allowing the breakcost to be capitalised over the 12 months too.

 

[spludgey]

Doesn't really sound like your client will be better off by doing this.
A little bit like the people that specifically buy a negatively geared "investment" just for the tax benefits.

 

[D.T.]

Is there any issues with the breakcost being deductible given sole purpose of scheme is to reduce tax?

Can you demonstrate a commercial benefit?

 

[speary]

Isn't that the same as going to the bank and saying can you increase my interest rate so I can claim more deductions. While it may provide an initial tax benefit, surely in the long run it will cost them more?

 

[Paul@PFI]

Doesn't really sound like your client will be better off by doing this.
A little bit like the people that specifically buy a negatively geared "investment" just for the tax benefits.

Husband needs every possible strategy to pull income down to save 49% tax . Wife needs to max income and use low rate threshold from 0-35%. Refinance will address that and benefit long term. First year may save $15K. In tax without impact on CF. Net debt doesn't change....Refinance and leave debt with taxpayer with highest marginal rate and neg gearing benefit

Strategy is often about many small changes which combine and compound. Some short term, some long term. Tax is just a part of the equation. And at 49% its a larger reason than at 0%.

 

[Paul@PFI]

Is there any issues with the breakcost being deductible given sole purpose of scheme is to reduce tax?

Can you demonstrate a commercial benefit?

1. Its not a scheme. Its an unavoidable cost in the loan contract.
2. Its interest paid in advance to the bank to compensate for the changed rate .

If you understand how a break cost is calculated it represents the discounted (PV) time cost of a stream of money for making the bank agree to cut the rate v's the rate originally agreed. So you pay them up front to compensate for the lower future rate now agreed and you get savings (and lower deductions) over time. In reality the cost over say three years should be identical if all economic factors are held constant. Its a timing issue.

eg : I can pay you $90 now or $25 a year for 3 years. What would you choose ?

There is no "commercial benefit". Does not need to be one. People break loans all the time for all sorts of reasons : speculation on rates, opinion, need to sell, reduce debt, windfall cash and decision to reduce debt and pay no future interest, refinance etc.

One of the problems with people who buy property in different names can be a long term problem with one having high income from +ve gearing and other stuck with neg gearing. Sometimes a refinance etc can work and can allow strategies that reduce the worst debt so that and deduction from interest is them to the benefit of the higher income taxpayer. Its like choosing to repay your PPOR loan first. That's the same idea.

Sometimes I wonder why people say it wont work" when they don't know or don't think long enough about the problem. They ask how can I change ownership when the answer may be to hold one debt constant and pay the other one down.

 

[Terry_w]

Is there any issues with the breakcost being deductible given sole purpose of scheme is to reduce tax?

Can you demonstrate a commercial benefit?

Commercial benefit is the reduced interest rate going forward.

Paul, what do you think about a person with a main residence with a fixed loan and a large break fee. if they moved out and rented the property and then broke the loan do you think there would be any issues with claiming the whole break costs against the rental income? Would your answer change if they moved back into the property in the next financial year?

I had a client pay $90k break costs a few years ago, it was a biggish loan.

 

[Paul@PFI]

Commercial benefit is the reduced interest rate going forward.

Paul, what do you think about a person with a main residence with a fixed loan and a large break fee. if they moved out and rented the property and then broke the loan do you think there would be any issues with claiming the whole break costs against the rental income? Would your answer change if they moved back into the property in the next financial year?

I had a client pay $90k break costs a few years ago, it was a biggish loan.

That's a good one Terry. Hmmm. Thinking.

The purpose for the loan is to acquire the property so it becomes deductible from the time the property use is to earn assessable income. The ATO views in TR93/7 and BPR 1011691954845 https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/1011691954845.htm appear to consider that if the penalty is incurred to lower the deductible then the penalty itself is deductible. The nexus seems to be given in these views that yes the taxpayer gets a ongoing lower deductible and a upfront penalty cost is incurred.

In tr93/7 Para 3b it says where such interest would itself have been deductible that suggests to me (rushing) that if the payout was for two years and after a year it becomes a PPOR you would need to amend to reduce the deduction claimed. The non-deductible element would then add to cost base.

 

[Paul@PFI]

Terry - I may be incorrect with that view that the full claim would need amending.

The ruling takes the view that that at the time the cost is incurred it is necessary to consider the property use. As its rented I believe its 100% deductible. I'm conflicted about the need to amend if use later changes as the rulings seems to take the approach that at the time the cost is incurred is the basis for its deductibility. The deduction does not reflect a time based approach top the loan period like prepaid interest etc.

Anyone agree / disagree with that view ?

 

[Terry_w]

Yeah it is a tough one. I think it would be deductible in general - putting aside Part IVA.