tax deductibility of loan if PPOR->Refinance->IP

[masterjunko]

Originally I was going to upgrade to a bigger place and sell the current unit we are living in. But having started reading this forum since late last year, I have become more convinced of investing in property should form part of my investment strategy. So I am planning to turn my PPOR into IP.

Situation:
PPOR worth: ~320K
outstanding loan amount: 100K

I would really hate to sell the current place because of the significant cost associated with selling it and buy another IP. Sad thing is I didn't know much about IP when I took out the current loan and it doesn't have offset account or redraw. Also it is a fixed rate 5 year loan which costs me about $2k to break the contract.

If I refinance to borrow up to 256K(80%) again with offset account holding freed up captial and IO. In about half a year's time after refinancing, I would use money in the offset account to by another property as my PPOR, current PPOR become IP.

How would deductibility of interest on loan work. Will I be able to claim interest for 100K or 256K?

Suggestions for other ways of doing it would be appreciated too.

 

[Twitch]

Just the $100k would be tax deductable.

 

[julia]

masterjunko,

Do you have a spouse that you could sell the property to?

Julia
www.bantacs.com.au

 

[masterjunko]

masterjunko,

Do you have a spouse that you could sell the property to?

Julia
www.bantacs.com.au

Yes, but the problem is she has just started working this year so there is no tax record for her to show. I guess I might be able to get around this if I provide garantee for the loan.

Also if I sell the property to her, we don't have spare 20% to put in as deposit for the loan.

 

[julia]

masterjunko,

Holding the property in your wife's name compared to holding it as the rental property you already described should not make any difference to your capacity to borrow. The equity and the amounts would be the same it is just what the money is borrowed to purchase that is different and much better for tax purposes.

Before you do this apply to the ATO for a ruling. Do it yourself do not get a professional to do it. Just say you and your wife disagree. You want to sell and she wants a rental property so she wants to buy it but unless the interest on the money she has to borrow to pay you out is deductible and not caught by Part IVA it would not be an attractive investment and you would have to sell it and she buy elsewhere to hold a property she could afford after tax. In the ruling quote ID 2001/79

Tabone's case makes me a bit nervous now about borrowing in joint names for a property owned only in one spouse's name. If the bank persists in having both your names on the loan contract and you can't just go guarantor then make sure there is a paper trail showing that your wife is the one actually making the repayments.

Crunch the numbers and make sure this is all worth it considering your wife's tax bracket. January edition of API has an article on how to do this.

 

[masterjunko]

masterjunko,

Holding the property in your wife's name compared to holding it as the rental property you already described should not make any difference to your capacity to borrow. The equity and the amounts would be the same it is just what the money is borrowed to purchase that is different and much better for tax purposes.

Before you do this apply to the ATO for a ruling. Do it yourself do not get a professional to do it. Just say you and your wife disagree. You want to sell and she wants a rental property so she wants to buy it but unless the interest on the money she has to borrow to pay you out is deductible and not caught by Part IVA it would not be an attractive investment and you would have to sell it and she buy elsewhere to hold a property she could afford after tax. In the ruling quote ID 2001/79

Tabone's case makes me a bit nervous now about borrowing in joint names for a property owned only in one spouse's name. If the bank persists in having both your names on the loan contract and you can't just go guarantor then make sure there is a paper trail showing that your wife is the one actually making the repayments.

Crunch the numbers and make sure this is all worth it considering your wife's tax bracket. January edition of API has an article on how to do this.

Thank you very much Julia. I shall follow the wise advice.

 

[ralwig88]

masterjunko,

Holding the property in your wife's name compared to holding it as the rental property you already described should not make any difference to your capacity to borrow. The equity and the amounts would be the same it is just what the money is borrowed to purchase that is different and much better for tax purposes.

Before you do this apply to the ATO for a ruling. Do it yourself do not get a professional to do it. Just say you and your wife disagree. You want to sell and she wants a rental property so she wants to buy it but unless the interest on the money she has to borrow to pay you out is deductible and not caught by Part IVA it would not be an attractive investment and you would have to sell it and she buy elsewhere to hold a property she could afford after tax. In the ruling quote ID 2001/79

Tabone's case makes me a bit nervous now about borrowing in joint names for a property owned only in one spouse's name. If the bank persists in having both your names on the loan contract and you can't just go guarantor then make sure there is a paper trail showing that your wife is the one actually making the repayments.

Crunch the numbers and make sure this is all worth it considering your wife's tax bracket. January edition of API has an article on how to do this.

Let's see if I understand this:

If your spouse (person B) buys the PPOR off the main income earner (person A), then all the interest on the mortgage would be in the name of B (who has, in this example, nil or low income)?

Also, if A goes guarantor for B, what if A borrows money to lend to B to make those repayments? Is that borrowing by A tax deductible? If no borrowings are made, payments by A as guarantor to B I assume would not be tax deductible by A (?)

 

[alexlee]

Julia, am I right in thinking the deductibility follows the name on the loan, and not the name on the title?

In the case of B not having income (and never expecting to have income above person A), it would be best to have the name of the PPOR loan in A's name? Then if the PPOR changes into an IP, all deductions would flow to A.

If a join loan is insisted upon by the bank, can a private loan agreement be signed between husband and wife to pass the deductions to A (i.e. A reimburses B for all interest payments on the loan). Are such loan agreements acceptable?

My situation is that I will always be the higher income earner (as my partner doesn't plan to work, though I plan to use family trusts to distribute investment income to her). I plan to buy the PPOR 50/50 in our names, but I want the loan to be in my name only in case it ever becomes an IP.
Alex

 

[Twitch]

am I right in thinking the deductibility follows the name on the loan, and not the name on the title?

Alex, it follows the name on the title, not the loan.

 

[alexlee]

Alex, it follows the name on the title, not the loan.

So, say I have a 50/50 PPOR owned with my spouse. In future years I take out a second mortgage on the PPOR and use the proceeds to buy shares held in my name. Dividends will be assessable to me only, but the interest deductions will be split 50/50 (assumine the second mortgage is also in joint names)?
Alex

 

[Twitch]

So, say I have a 50/50 PPOR owned with my spouse. In future years I take out a second mortgage on the PPOR and use the proceeds to buy shares held in my name. Dividends will be assessable to me only, but the interest deductions will be split 50/50 (assumine the second mortgage is also in joint names)?
Alex

Alex, interest will be 100% claimable by you as you have 100% ownership of the shares.

 

[julia]

ralwig88

What makes you think the wife is the lower income earner? Sexist?
All we know is she has just started work as long as long as they both earn between $25,000 and $75,000 they are in the same tax bracket so if they stay there after the effect on their incomes of the rental property then it does not matter whose name the rental is in. Tax is minimised by being in the same bracket not by having exactly the same income.

Twitch,

What you say about % on title is % of interest you can claim is usually right but as I pointed out Tabones case suggested different and said in theory that as both parties contributed to the repayments and both names were on the loan they were entitled to claim half the interest each and as the wife did not use her share to buy income producing assets in her name Half of the interest is not a cost of her earning income and so not deducible.
Now this was only an AAT case and only a comment by the court as the issue was finally resolved on a different angle. But nevertheless it leads me to warn people if they can have just the investors name on the loan all the better. If they can't it may be worthwhile organising a loan agreement between the parties as well.

 

[ralwig88]

ralwig88

What makes you think the wife is the lower income earner? Sexist?
All we know is she has just started work as long as long as they both earn between $25,000 and $75,000 they are in the same tax bracket so if they stay there after the effect on their incomes of the rental property then it does not matter whose name the rental is in. Tax is minimised by being in the same bracket not by having exactly the same income.

Twitch,

What you say about % on title is % of interest you can claim is usually right but as I pointed out Tabones case suggested different and said in theory that as both parties contributed to the repayments and both names were on the loan they were entitled to claim half the interest each and as the wife did not use her share to buy income producing assets in her name Half of the interest is not a cost of her earning income and so not deducible.
Now this was only an AAT case and only a comment by the court as the issue was finally resolved on a different angle. But nevertheless it leads me to warn people if they can have just the investors name on the loan all the better. If they can't it may be worthwhile organising a loan agreement between the parties as well.

I'm not sexist - if you look at my previous post, I was quite careful to use "Person A" and "Person B" in my query. Please note also that I did not use "he" or "she" in framing my question. Feel free to go back and check.

In any respect, I think what is being said is that in answer to my first question, Person B would indeed have 100% interest deductions after buying it off Person A (correct me if I'm wrong), even though they are spouses and even though Person A might be "funding" the repayments as Person B is the low/nil income earner.

However, I'm still unsure about my second question. Could you frame a contract whereby A borrows money to lend to B, and B passes through income to A (so that the money A is borrowing is for "income producing purposes), but the property is in the name of B? It's unusual in that A is borrowing to lend to B so that B can buy the property off A (but vendor finance isn't exactly unheard of).

Anyone got any ideas?

 

[masterjunko]

I am sorry answering my questions brought up all these arguments .

To clarify, in our case my wife is on a lower tax bracket.

After thinking this through again, I decided to do following.
Setup 2 LOCs on current PPOR(future IP). LOC 1 to invest in some managed funds to provide some diversification and extra cashflow. This is deductible. LOC 2 I would use to pay for the 20%+purchasing cost. This is non-deductible. With the extra cashflow from managed funds go into offset account for LOC 2. I then have the option to borrow more in LOC 1 for another IP or more managed funds depending on the market cycle.

Sort of works out alright as over time I would be "shifting" borrowing from non-deductible loans to deductible loans.

Is there any problems any one can see from this strategy?