Tax issue

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From: Donna Larcos


On reading the posts I just want to clarify
something. If you have a home loan on
your home and you then decide to move
on and rent out your home, it was my
understanding that the interest on that
loan was not tax deductible because the
original purpose of the loan was to fund a
"home loan" not a rental property. Many
financial planners say the only way to get
around this is to sell the home and buy
another investment property. Is this
correct or are we being misled?
 
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Reply: 1
From: Rolf Latham


Donna

Get a new Financial Planner

There is some confusion as to purpose of moneys lent secured against your home.

Section 51.1 of the tax act makes it very simple. Paraphrased it says that you can deduct costs associated with earning an income (unless theres later specific legislation).


Ta

Rolf
 
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Sim

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Reply: 1.1
From: Sim' Hampel


As Rolf said, Donna... get a new financial planner. It sounds as if yours is just like the vast majority of financial planners who are either just plain stupid (oooh... that was nasty - I know most of them are not stupid - but some of the comments I have heard from a couple of them lead me to believe that they were - a lot of them may not be stupid, but they ARE ignorant)... or have a complete bias towards investments which they can get a commission from selling you.

As you might have guessed, I have a fundamental problem with financial planners who are supposed to give you independent advice on what is best for you (based on YOUR situation), but are reliant on you choosing investments which pay them a commission for their earnings. This is purely and simply a conflict of interest.

I have seen numerous cases of incentives given by particular investment product managers to financial planners, such as free holidays, even new cars, to planners who place a certain amount of business with their investment product within a certain amount of time. Pick up a copy of Asset Magazine sometime and read through it - you'll start to pick up little things about how financial planners think and work.

Now, there are planners who know their stuff and will be able to give you great advice on your investments, including direct property (notice how most of the financial planners recommend you go for listed property trusts... they can get a commission for investing your money with them !). Unfortunately, you will probably have to look really hard to find one of these great financial planners.

In my opinion, "fee for service" (and full disclosure and comparison of commissions paid) is the only way to get unbiased advice - or at least you can carefully weigh the amount of bias and make an informed decision.

Now, naturally most people are enticed by the idea of getting "free" advice from a financial planner, thinking that if he gets paid a commission by the investment manager then you are not really paying them.

But the investment managers are not just going to pay these guys out of their profits now are they ? They need to recoup the costs of commissions to financial planners from the investors... what do you think the MER is ?

Management Expense Ratio... an amount charged to you based on the amount of money you have invested with the investment manager (but surely it costs just as much to administer $10,000 as it does $10,000,000 ????).

This administrative charge is taken out of YOUR investment (not just your profits... if you didn't make any money, or indeed lost money, it'll come straight off your capital (or what's left of it). The charge is to pay for the fund managers administrative expenses - which includes any commissions paid to financial planners. And it continues to get charged and the planners continue to get paid long (years !) after the interview with the financial planner occurred.

If you instruct the fund manager to cease paying your financial planner a trailing commission (as you can in some cases), it's not as if your MER is going to drop... it just means more profit for the fund manager ! You lose either way.

Now I would like to say that I do believe that there is a valuable service that financial planners have to offer pretty much all investors, and I have used their services myself, indeed not all of my money is invested in only direct property. But I beseech you to ensure that your financial planner is not doing you a disservice by giving you biased advice.

As we all know, direct property investments are a completely valid way to invest money (these wealthy people around us can't be all wrong can they ?)... so if your financial planner goes to great lengths to advise against direct property investment, shouldn't that ring alarm bells ?

While we are on the subject of trailing commissions and "free" service, some people might be wondering about services like mortgage brokers. Mortgage brokers work in a similar way to financial planners in that they generally do not charge up front fees, and they get their money from trailing commissions from the lender once you have taken out a mortgage.

So can mortgage brokers really offer unbiased advice on loans ? In my opinion, the nature of the product they sell is such that you can make a very safe and informed decision about the loan product you choose.

With investments, you are taking the advice of someone in the hope that it performs well and you make money. There are never any guarantees - and there are many things which affect investments which are beyond everyone's control. There are many unknowns, and indeed to a certain degree you are gambling with your investment money. The risks involved with investing your hard-earned capital are such that you really do want to make damned sure that it is being invested in the RIGHT place, not in the place where the financial planner gets the most return for himself.

For loans, they really are commodity items these days - they all work pretty much the same, the interest rates are very comparable, and the differences between the products are relatively subtle. What's more, before you enter into a loan product, you can fairly accurately predict exactly what is going to happen with it over the next 25-30 years. Of course an exception here are interest rates, but they affect all loan products, and make little if any difference to your broker's commissions.

So, even though my broker goes through and describes the different products to me, and gets excited over a couple of them because they pay higher commissions than others... I can still see the differences with the other products quite clearly and make my own informed decision without relying on assumptions.

 
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Reply: 2
From: Eddy Morris


Hi Donna,

Its my understanding that you can only negatively gear the property to the extent of the amount of mortgage held over the property. Trust that makes sense.

Regards,

Eddy
 
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Sim

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Reply: 2.1
From: Sim' Hampel


Not really... do you care to elaborate ?

 
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Reply: 2.1.1
From: Paul Sheldon


I am only a beginner in this, but be careful blaming this sort of info on "financial planners". I have read several books on real estate investment and tax, and they all say the "deductibility or otherwise of interest on a loan is based on the 'original purpose' of the loan, so that if you take out a home mortgage, then later rent out that property, the loan interest is 'not deductible'". Now this may well be wrong, but I have never read anything contrary to it.

Regards
Paul.
 
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Reply: 2.1.1.1
From: See Change


I'm with Paul on this one

It would be nice if it were to the contrary , but I'd like to see a written opinion about this ( preferably from ATO ) before I'd be convinced otherwise. I know some people say they know people who have done this , but have they been audited as of yet ?

see change


it's better to be guided by your dreams than your fears
 
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Reply: 2.1.1.1.1
From: Owen .


In the bad old days there used to be differences between a "home mortgage" and an "investment mortgage", primarily different interest rates and a few rules. Today that is not the case. A loan for residential property is a loan for residential property.

However, the claimability of the interest on the loan and other costs depends on whether or not you are living in the property or making and income out of it. If you living in it, too bad, all the costs are yours. It you rent it out you can claim all you like. I have rented my own home before and the minute a lease was signed until the day I moved back in, I claimed every cost. The bank certainly didn't care and neither did the ATO as no rules were broken.

Just my 2.2c worth. Check it out.



Owen

"Gambling promises the poor what property performs for the rich – something for nothing"
 
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Sim

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Reply: 2.1.1.1.2
From: Sim' Hampel


You are absolutely correct in that professional advice should be sought on this matter, and even a private ruling from the ATO arranged if it concerns you that much.

However, I think you are taking the statement "original purpose of the loan" a little too literally and a little out of context.

What you have done is buy an asset, a house, with borrowed money. While you live in this property or it is not available for rent, the interest is not deductible. We all understand this.

When you move out and make the property available for rent, you have not changed the usage of the borrowed funds. They are still being used for the same house, the same asset.

The "original purpose" clauses used by the ATO are to cover redrawable and LOC style loans where you make payments and then redraw some of the funds for other purposes, like a holiday, or a car.

Once a loan has been paid off it is deemed to be always paid off, you cannot redraw the funds and then count them as being for purchasing the property. This is the same for properties bought solely for investment purposes.

Of course, the interest on any redrawn funds which are used to purchase additional investment properties (or indeed any income producing asset) is able to be claimed as a deduction against the income earned from that asset.

Basically, once the asset becomes income producing, the nature of the loan funds changes, and the interest from the day it is available for rent becomes deductible.

Similarly, if you move back into a property which was used for investment purposes, the nature of the loan funds changes again, and the interest from that day it ceased to be available for rent, is no longer a valid deduction.

Page 8 of the Rental Properties 2001 guide from the ATO:

http://www.ato.gov.au/content/individuals/downloads/RentalProperties2001.pdf

or at this address:

http://www.ato.gov.au/content.asp?doc=/content/Individuals/9033.htm&page=9#H9_5

Quote:

"Some rental property owners borrow money to buy a new residence and then rent out their previous residence. If there is an outstanding loan on the old residence and that property is used for income-producing purposes, the interest outstanding on the loan, or part of the interest, will generally be deductible."

I think this says it all very clearly.

 
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Reply: 3
From: Rolf Latham


Ok folks lets kill the confusion

Purpose of the loan.

PPOR = Principal place of residence.

Purpose - definition. This term is commonly used where an owner has a PPOR and wants to move to another PPOR.

The owner wants to gear up the old PPOR with debt and to turn it into an IP. The funds raised from gearing the old PPOR are used buy the new PPOR. While the debt is secured by the old PPOR and now an investment property, the proportion of the debt used to buy the new PPOR is NOT tax deductible because the Purpose of that money is not for investment.

Ta

Rolf
 
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Reply: 3.1
From: Les .



G'day Donna,

I don't know how to attach the original file, so I've created a Word document from a VERY old posting. It's my old favourite - the "Blinding Flash of the Obvious" post.

I hope this clarifies things for you too.

(I have "Attach file" selected - I hope it prompts me for the filename as I post it ...)

Regards,

Les


- "Eschew Obfuscation" - ;^)
 
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Reply: 3.1.1
From: Dale Gatherum-Goss


Hi

The original purpose of the loan was to buy the property, not as some have said, to buy the PPOR.

Therefore, the interest on the loan is tax deductible as soon as the property is made available for rent.

This IS the law and a ruling will only confirm this after costing you quite a few dollars and wasting your time.

Have a great year!

Dale
 
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Reply: 3.1.1.1
From: Ten of Diamonds


Hi Everyone,

This is a related question to the above thread – just deviating a little....

I understand that you cannot claim deductions against redrawn money if you are redrawing to buy a non-income producing item, ie a car. Does the same thing apply when you have an offset account? For example if I had an offset account with say $40,000 in it, could I leave the money in the offset account for 6 months (reducing the interest I pay on the loan over that time) then buy a car using say $20,000 of the offset money? After I had bought the car, the interest payable on the loan would increase – can I still claim all this?

I have read Taxation Ruling TR 93/6 (Loan account offset arrangements) and I think it is okay to do the above. Taxation Ruling TR 2000/2 applies to redraw and LOC but doesn’t mention offset.

I’d love to know what people think!!

Regards,

TOD
 
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Reply: 3.1.1.1.1
From: Owen .


This is exactly the difference between an offset account and a LOC and a very important distinction. If you intend to withdraw money from your "investment" LOC for personal stuff like a car then the interest for that portion of your debt (ie $20k) is NOT deductible.

However, if you have cash sitting in an offset account that effectively reduces the balance of your debt and you bought a car for $20k out of this cash, then all that happens is the balance of your debt is increased because the offset is no longer there. You have not increased your debt, you have reduced your offset and therefore, increased the interest on the existing loan. The purpose of the loan remains the same. Because of this, the new increased interest on the new increase effective debt is fully claimable.

You also get to drive around in a new car!

Owen

"Gambling promises the poor what property performs for the rich – something for nothing"
 
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Reply: 3.1.1.1.2
From: Rolf Latham


No an offset account will not affect your tax deductability. This gets around one of my pet hates with LOcs and Redraw loans

Ta

Rolf
 
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Reply: 3.1.1.1.2.1
From: Ten of Diamonds


Thanks guys,
I am delighted with your responses!!
TOD
 
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Reply: 3.1.1.1.2.1.1
From: Dale Gatherum-Goss


Hi

I agree with the distinction, for what it is worth. Well done!

Cheers

Dale
 
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