Taxable Interest Question

[gad]

G'day

I was wondering if any of you know the answer to this non-property related question. I think I'm on the right track but I'm not absolutely sure & I would appreciate your input, thanks.

If I was to borrow (refinance IP, which I am in the process of) funds to invest in a managed fund & elected to reinvest the distributions into additional units in the fund, what effect would that make to the claim ability of the interest rates if I, at some stage, sold an amount of units to purchase something personal?

I'm thinking that even though I would only be selling some of those "additional" units, that the ATO would consider that the "additional" units were payments off the principle & the selling of those units would be treated as a loan for personal use, which would reduce the amount that I would be able to claim tax on. Would that be right?

Would I be better off having the distributions paid into an offset account of another loan?
I could then use those funds as I see fit:
i.e. buy shares, personal use or even to re-invest in the same fund in my spouses name, etc

I hope to be able to make the interest payments without selling any of those units but it may turn out that at some stage I will need to sell some, so I just want to be clear of the consequences before hand.

Hope that's clear & thanks very much in advance.

 

[DaleGG]

Hi Gad

Reinvesting the distributions has absolutely no affect on claiming the interest.

Once you sell some of the units though and use the funds for personal purposes, the use of the money has changed and the interest should then be apportioned between investment related and private use.

Dale

 

[gad]

G'day Dale

Thank you for your wisdom, which by the way, I would not doubt, but I am having trouble understanding this.

I am totally aware that if you make extra payments on an investment loan & then re-draw some of those funds for personal use then that would make that portion of the loan non-tax deductible
As would
having a LOC that your wages were going into & you lived off a credit card. If you pay the credit card from the LOC then that portion would then become non-tax deductible
But, in this situation
the loan is IO for the first 5 years. The purpose of the loan is for investment purposes, in this case, to invest the total X amount of $'s in a managed fund.
So even if I was re-investing the distributions into even more units & then later on selling some of those units, I can't understand how that portion would then be non tax deductible as the original X amount of dollars is still invested in the fund. The purpose of the loan is to invest to produce income. Hypothetically, all I want to do is spend some of that income (I may not but just in case). How would that change the purpose of the loan?
If I'd bought another property, I could do as I like with the rent (income) coming in, without affecting the tax status of the interest on the loan.
The original loan is still there; I'm just making interest payments every month. None of the loan has been repaid & the total amount of that loan is still invested in that fund.

If I chose to have the distributions paid to me rather than re-invested in the fund, I can do as I like with them but you are saying if I do re-invest & then sell some it changes the tax deductibility even though the loan has not changed at all. Is that right?

Sorry if I come across as a bit of a stubborn bastard, I don't mean to be. I'm about to make a big investment decision & just want to be sure I get this aspect of it right before I do.

I really do appreciate your help, thanks.

 

[Brenda Irwin]

Sorry, I don't have an answer to the question, but I am trying to understand how all this would be set out in a tax return in the first place.

Since I only have IP's, each one has its own income and expenses schedule for each year. If an IP was sold though the year, then a Capital gains schedule is filled out and the amount of Capital gains, plus a tally of all income vrs expenses, is then offset against any wages to see if any tax is payable, or refundable.

In Gad's case, would he not just construct an income vrs expenses type schedule for the managed investments similar to IP schedules, with borrowing costs apportioned over 5yrs? Then, if some of the units were sold off through the year, a Capital gains schedule on that portion of the units as a % be filled to obtain a profit or loss plus an amendment be made of the % of borrowing costs over 5yrs on the income expenses bit.

This is then offset over to the wages to see if tax is payable or refundable. Wouldn't what you spend any profits on be irrelevent or are things never that simple?

 

[handyandy]

Hi Gad

I would think as long as you don't encroach into the original investment units ie, started with 1000 units and only cash in down to the 1000 units, then the tax man should be happy as the interest deductions are still valid.

As you correctly state any additional units are either all ready tax paid ( by you seperatly) or have a capital gain component which you will need to pay on cashing them in.

The current investment I am proceeding with will require me to cash in units to pay the tax and/or interest in the case where the distribution is insufficient to cover either.

I have check this out with my accountant and he gave me the thumbs up.

Cheers

 

[gad]

G'day

Thanks for the input.
Brenda, as far as etax goes the fund sends you a Tax statement that tells you where to put all the amounts in the tax return, these amounts include interest, dividends, CG's etc. Etax also askes you if you incurred any expenses in earning that income which would be the interest you have paid on the loan. Not quiet like a PI.

handyandy,
my thinking is the same as yours & we do appear to be doing the same thing, although I hope to be able to make the interest payments without selling any re-invested distributions. The question I need to be clear on is what would be the tax status down the track if I sold some of those re-invested units to buy something for personal use.

As I would already have funds in an offset account I guess I could sell some units to pay some monthly interest bills & use the money I would have paid that interest with (from the offset account), to buy that personal item! How would the ATO have a problem with that, I'd be doing as you are going to do, sell some units to pay the interest.

I'll wait till Dale clarifies his earlier reply if he kindly does so.

Thanks again.

 

[DaleGG]

Hi

OK, let's throw some numbers into the ring and see if we're talking about the same issues...

Assume you borrow $100k and invest all of that into the ABC managed fund. At the end of year 1 you invest all incomes into buying more units in the ABC fund. This goes on for a little while.

At a point in time you still have a $100k loan and the fund is now worth $120k.

If you withdraw the $20k and spend it on personal matters, the loan interest on the loan would still be tax deductible in full.

However, if you withdraw $30k we may have to apportion the loan between investment purposes and personal purposes as the use of the funds has changed.

Of course, the tax office will blindly accept whatever is entered on the return. It is only in an audit situation will the issue be put to any test. So, plan for an audit and be sure to pass the "sniff test" when one comes along.

Dale

 

[gad]

Thanks Dale

That clarifies it for me.

Thanks.