Tax Question

I have a quick question for the tax experts out there.

I am currently refinancing my PPOR to get access to the equity to use to invest with. My broker has suggested the following arrangement:

1. Refinance to 90% of valuation figure of $405k.
2. Create a separate interest only loan for the amount of $67.5k which is the equity I will have access to.
3. Fully draw the new loan as an investment loan and place into existing home loan redraw facility.
4. Use the redraw on existing loan to fund IP's

According to him, the benefits of this are the interest on the PPOR loan will be reduced as it will have the extra money paid off the priciple until it is redrawn and the interest can be claimed on the full amount of the second loan as it is an investment account for tax purposes.

Can anyone see any potential problems with this setup?

Cheers,

Mathew.

(I hope I have explained this correctly)
 
Hi Hutch,

This is a highly ineffective structure for tax purposes.

Firstly, the draw down of funds from the interest only loan to pay down the PPOR loan will not change your net non-deductible debt. That's because interest incurred on the interest only loan will be non-deductible as its use can be simply traced to the pay down of the PPOR loan.

Secondly, the fact that you will redraw funds from the PPOR loan to ultimately use for investment purposes will result in the PPOR loan becoming a mixed purpose loan (ie combination PPOR & investment debt). This will impact you in two ways:

1. You would be required to produce additional detailed documentation to adequately record for the ATO the demarcation between the PPOR and investment debt and the respective interest accruing to each debt; and,

2. Assuming your PPOR loan is a P&I loan, under existing ATO rulings you would need to apportion part of the principal component of each regular PPOR loan repayment to the investment debt included in the PPOR loan. In effect this would render what otherwise would (and should) have been an interest only investment loan into a less tax effective quasi P&I loan.

Other issues you may need to address include:

- if possible, avoid refinacing the PPOR debt to a different lender to minimise any mortgage stamp duty costs;

- if your investment strategy requires you to borrow above 80% LVR and incur LMI, make sure you analyse the difference in the LMI premiums between say going 90% on the PPOR or alternatively capping the PPOR lend to 80% LVR and going above 80% on the IP;

- ensure when your analysing LMI premiums you take into account the likely tax deductibility of the LMI premium. For example, if you proceed to go 90% lend against the PPOR, you can expect that the ATO may seek to restrict your tax deduction (borrowing cost) on the basis of that "portion of the investment debt component as bears to the total debt". Based on the numbers provided this would equate to only about 18.5% of the LMI premium being deductible.

In contrast, to avoid the possibility of apportionment it may be more prudent to increase the LVR on the debt to be secured against the IP to greater than 80% and ensure that LMI premium is 100% deductible.

Hope this helps!
 
Hi Richard,

Thanks for your input. My original thoughts on the setup were that it was going to be difficult to do and I was hoping to get some feedback to substantiate this.

I would have thought it would simply be easier to create a second account for the equity and draw that down as required and therefore be able to show its use for investment purposes.

Hutch.
 
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