Trying to get my head around investment portfolio structure

[newlywed1311]

Please bear with me as I explain our situation. I know it's pretty straightforward to some people but figures just aren't my forte.
We have just purchased our first investment property. We utilised equity in our PPOR to assist with this purchase.
We have three loans, our PPOR, the equity loan and the investment loan. Home loan is I & P and two investment loans are IO. We have an offset account attached to our home loan in which all of our income goes including rent, wages, etc.
We currently have around $10,000 in cash left over after the property settlements. Currently this is sitting in our offset account.
My mortgage broker suggested I should pay this money off our small investment loan (the one taken out against the equity in our PPOR) and then as payments related to our IP's are made from our offset account, transfer that money over. She believes this will make it easier to keep a record of expenditure against the IP.
However, I spoke with a lady from the mortgage centre from the bank we have the loans with and she said we are better off leaving this money in the offset account as it offsets our PPOR loan and would provide better value to us as this is non tax deductable interest.
Where should we leave these extra funds? Should we try to be paying the most interest on our IP loans as these are tax deductable?
Confused
Have added the diagram our mortgage broker drew for us in one of my further posts.

 

[josko]

Hi newlywed,

I think your banker is correct. Leave your 10k in the offset account to offset the non tax-deductable interest on your PPOR.

Stay very clear that PPOR Interest is not tax deductable. It sounds like you have your accounts set up correctly, well done.

As long as that particular offset account with the 10k in it is used solely for IP expenses then it is tax-deductable and quite clear to the ATO. Meanwhile leave your money in it to offset PPOR.

Regards JO

 

[newlywed1311]

Hi Jo,
Many thanks for your reply.
I'm fairly confident the accounts are set up correctly but I am still confused. The account were the $10,000 is sitting is our every day saving account - that is an offset account to our PPOR.

As long as that particular offset account with the 10k in it is used solely for IP expenses

It isn't! That offset account is our every day account where all of our money and expenses go into and come out of. Will that be a problem or do I just need to ensure that I keep good records of the income and expenditure on a separate spreadsheet?

 

[skater]

Your loan against your PPOR is not tax deductable, yet your loans for your IP are.

Your focus should be to pay down your non-deductable debt, as you are doing. If you need to draw funds out again for whatever reason you can. If you need to keep track of your IP expenses, then a simple Excel spreadsheet will do that for you.

 

[newlywed1311]

But going by that set up skater, couldn't I just borrow more 'tax deductable' money and put it into my PPOR line of credit? I mean, the money was borrowed for investment purposes, however, I'm then using it for other purposes (ie, to reduce interest on my PPOR). I'm just wondering how this is okay. I'll attach the loan set up diagram, as drawn by my broker, because it may just be that I'm not explaining it correctly.
Can you have a look?
Cheers,
Jacinta

 

[skater]

But going by that set up skater, couldn't I just borrow more 'tax deductable' money and put it into my PPOR line of credit? I mean, the money was borrowed for investment purposes, however, I'm then using it for other purposes (ie, to reduce interest on my PPOR). I'm just wondering how this is okay. I'll attach the loan set up diagram, as drawn by my broker, because it may just be that I'm not explaining it correctly.
Can you have a look?
Cheers,
Jacinta

I am a little confused. Your Investment LOC that is attached to your PPOR, is that fully drawn?

 

[Modal Harmony]

Hi Jacinta, might I suggest a chat with your Accountant as well? Do you have a property savvy one??

 

[newlywed1311]

Skater,
Do you mean the $55,000 loan? That is my investment line of credit attached to my home loan, isn't it? That loan was actually $44,000 after some changes to figures and currently it is fully drawn. Settlement was only at the end of June. The excess funds after both properties were settled is $10,000 and that is the money that is sitting in my offset account. That is the money that I'm not sure where to place.
MH, no accountant as yet but know I need one. Am asking around for an investment savvy one as I know he/she will be able to articulate the diagram for me and assist me in managing my IP finances. Just thought I'd ask here to see if someone can explain it in layman's terms for me

 

[skater]

OK, just to be clear with the $10k, was that drawn to fund the IP, or the PPOR? If it was drawn for the PPOR, then you should probably put it into the offset account, as it is private funds. If it was drawn as part of the funds for the new IP, then you should probably put it into the IP LOC and you can draw out IP expenses from this account until it is fully drawn.

Is that a little more clear?

 

[newlywed1311]

Hi Skater,
Technically that money was drawn down to fund the IP, not the PPOR. It's not like we had $10,000 in cash sitting in our bank account prior to settling our PPOR (refinanced loan) and IP. This money is definitely left over after settlement - meant for a buffer for IP costs after all other IP purchase costs have been expended. Your suggestiong about putting it back into my LOC is exactly what my mortgage broker was suggesting. This makes sense to me, else I feel we'd be using the funds for PPOR benefits when the purpose of the loan was for our new IP. My gut feeling was the the Tax office wouldn't be happy with us using those funds for PPOR benefits when it was drawn down for IP expenses. I'll go see an accountant and see what he/she suggests and just leave the money where it is until then.
Thanks so much for your advice, greatly appreciated.
Jacinta

 

[Gordon Farkus]

OK, just to be clear with the $10k, was that drawn to fund the IP, or the PPOR? If it was drawn for the PPOR, then you should probably put it into the offset account, as it is private funds. If it was drawn as part of the funds for the new IP, then you should probably put it into the IP LOC and you can draw out IP expenses from this account until it is fully drawn.

Is that a little more clear?

Disagree. The funds might have originally been drawn for the purpose of the IP but that wasn't how they were eventually used. They came from the equity held in the PPOR so can be returned there (ie. to the offset a/c).

I say leave it in the offset account so as to reduce the interest on the PPOR loan (even if by only a small amount) and maximise the interest on the LOC. Then, when expenses on the IP are required, transfer it from the offset to the LOC and pay those expenses from the LOC. Why put it in the LOC now when it's not yet needed?

 

[skater]

Disagree. The funds might have originally been drawn for the purpose of the IP but that wasn't how they were eventually used. They came from the equity held in the PPOR so can be returned there (ie. to the offset a/c).

I say leave it in the offset account so as to reduce the interest on the PPOR loan (even if by only a small amount) and maximise the interest on the LOC. Then, when expenses on the IP are required, transfer it from the offset to the LOC and pay those expenses from the LOC. Why put it in the LOC now when it's not yet needed?

I am positive that if you ask any reputable Accountant, or, for that matter, the ATO, you will find that all of the money drawn must be used for IP purposes. As it stands the interest on $45k is deductable, while the interest on the other $10k isn't. By doing what you suggest, you will muddy the waters and create an accounting nightmare.

 

[Perth Investor]

I sleep with an accountant

And I'm with Skater. If the money wasn't used for investment it's not tax deductible, which means you should put it back where it came from, which is the $55K Investment Loan, as per your "structure example"

Noel

 

[Perth Investor]

And if you want to talk about structure, I would have had the $55K loan a Line of Credit, and had all the rent going in there and all the rental expenses coming out of there, and let that build up over time.

This would mean all your personal income can go to paying your PPOR loan, whereas now, some part of your personal income will be used to help offset the net loss for your investment property.

I.e. my way in a couple of years you would owe $10K less on your home loan and $10K more on your investment loan, which is more tax effective.

Noel

 

[Peter_Tersteeg]

If the $10k came for a loan account set up for investment purposes, it should go back onto that account.

If you save money or have money from a source where you've paid tax on it (such as income or capital gains), then this is your money, not investment money. This can go onto the non tax deductible loan - that is your PPOR loan or the offset account.

I'd say your broker has done an excellent job structuring your accounts.

Noel your suggestion could be seen as tax avoidance. There are cases where it's been allowed and cases where the ATO has come down hard on it. I'd get very specific tax advice before implementing it. Personally I prefer the existing structure because it would be fine with the ATO.

 

[Perth Investor]

Peter

Just want to make sure we're on the same page here: I propose an account where all the rent goes into, and all the investment costs come out of. I'm not proposing to bank the rent in the offset account and pay costs out of another account and hence build up a negative balance, that I would have a problem with.

I consider it the same as a business running an overdraft, only this goes for a slightly longer time scale. You could say (as a rough example) that for the first three years the investment property runs negative, so the Line of credit goes from zero to $20K, but after this the rent increases start having an effect and so for 4 years after that the $20K starts making it's way back to zero. The account is specifically and only used for the investment property/ies, so any negative balance on the account is tax deductible.

Please see attached my version of an investment property structure, with investment below the line and personal above the line. The "kitty" would be a line of credit. I don't see how you could say an account used in this fashion would be disallowed a deduction for it's own interest costs.

 

[inv99]

(sorry to steal this thread)

Perth investor. How would you change that diagram if you did not have a PPOR?

 

[Perth Investor]

Inv99

There's a few variables here, including whether you would ever end up with a PPOR loan. i.e. whether you rent now, or whether you have your dream house paid off already.

But I probably wouldn't change it that much, only the offset account that is above the line, would now be offset against one of your investment loans, to obviously reduce your interest bill as much as possible.

But I would still run the kitty for your investments, and build up the cash in your offset account as much as possible. For no other reason than cash is king.

You don't want to be in the position where you reduce your investment debt over some years, then borrow $50K to buy a car / caravan / aeroplane, or $500K to buy a PPOR, and pay interest on that.

But like I say, this isn't one size fits all...

Noel

 

[Peter_Tersteeg]

Hi Noel,

I think I understand what you're saying and I did have a bit of a misunderstanding of it. I certainly understand what you're getting at, but the cautious side of me wants to tread lightly.

My hesitation with this would still be that the amount owing in the kitty is still increasing with no concrete time frame for paying it off. I'd suggest this is a bit 'grey' in terms of ongoing tax deductibility.

I'm not saying it's wrong or it's right, just that specific tax advice would be needed to proceed. In the absence of properly qualified taxation advice I'd be more comfortable with Newlywed's existing structure.

Moving forward, as the balance in the offset account increases, Newlywed could easily 'recycle' the home and investment loan. This would be to reduce the limit on the non-deductible loan (at the expense of the redraw or offset facilities) and increase the limit on the investment loan.

The overall debt/equity ratios remain the same, but this would change the purpose of the debt in a controlled manner to move debt from non deductible to fully deductible.

 

[Perth Investor]

Hi Noel,

Moving forward, as the balance in the offset account increases, Newlywed could easily 'recycle' the home and investment loan. This would be to reduce the limit on the non-deductible loan (at the expense of the redraw or offset facilities) and increase the limit on the investment loan.

The overall debt/equity ratios remain the same, but this would change the purpose of the debt in a controlled manner to move debt from non deductible to fully deductible.

I agree with this part, and understand all you said previously, although clearly I'm not as anxious to tread lightly as yourself

The structure I suggested does this recycling a bit quicker is all. For someone who will pay their PPOR off in the next 3 - 4 years anyway, this is all probably a moot point, but for those who will have this debt for another 20 years, these differences can make a fair difference in tax paid over that time.

Once again I come back to the point that using an overdraft account that has both the income and expenses running through it for an investment, would be deductible. Some businesses have overdrafts running for years. A lot of successful businesses would actually increase their overdraft each year, to manage the cashflow in a growing business, so I don't buy your argument that because it has no end in sight it wouldn't be deductible.

But the real benefit of this account is the set and forget nature of investing with it. If clients have enough equity, you can set up an account with a $50K+ limit, and they shouldn't have to contribute any of their own money to running the IP's for a good 3-5 years (depending on IP cost, rental income, vacancy etc). They can concentrate on their own debts like they are now, and it's like they don't even own the property. Except hopefully they are a couple hundred grand richer after the 5 years...

But i'll keep saying it's not one size fits all, and I would definitely see a good broker and a good accountant to structure properly from day one.

Noel