Why use a LOC?

[BigAJ]

I've been reading information from a few web sites about "line of credit". Im struggling a bit to understand alot of the information so im hoping a few people here might be able to explain it a bit simpler.

I read a few threads on this board also of people using their LOC to pay for bills and maintenance for their IP's. Also using it to "capitalise interest".

I just have a few random questions in regards to LOC.

1. What are the benefits of using a LOC to pay for all the bills and maintenance of an IP? And does that make the interest you pay on your LOC account tax deductible as its expenses your paying for your investment?

2. What does capitalising interest mean in relation to a LOC account?

3. Some people use their credit card to buy everyday things and then use their LOC to pay off their credit card. What is the reason for this? It just seems your paying debts with debts and getting deeper into debt?

4. Does having a LOC account make work for your accountant easier as you have statements showing your incoming and outgoing funds for each IP??

Thanks for your time!

AJ

 

[jroth]

Hi AJ, I'll have at answering your questions:

1. What are the benefits of using a LOC to pay for all the bills and maintenance of an IP? And does that make the interest you pay on your LOC account tax deductible as its expenses your paying for your investment?

The main reason is your own cash flow. You're using pre-tax equity to maintain the property without having to dip into your own post-tax savings. It should make the interest on the LOC deductible if you haven't used it for non-IP expenses (I'm not an accountant).

2. What does capitalising interest mean in relation to a LOC account?

It means you're not making the interest repayment, instead it increases the LOC balance.

3. Some people use their credit card to buy everyday things and then use their LOC to pay off their credit card. What is the reason for this? It just seems your paying debts with debts and getting deeper into debt?

If the aim is to keep tax deductibility this seems like a bad idea to me as usually a credit card is used for personal expenses? However if its just to keep you afloat the LOC interest rate is usually much less than a credit card.

4. Does having a LOC account make work for your accountant easier as you have statements showing your incoming and outgoing funds for each IP??

I suppose it would, but it's not much more effort maintaining a spreadsheet of expenses.

Cheers,
jroth

 

[Terryw]

Just to add to Jroth's post.

1. This increases tax deductions and frees up cash which can pay down non deductible debt faster.

2. becareful

3. Also many aim to get reward points by using a card and to get the 45 days interest free thereby leaving money in your account longer and saving more interest.

You do have to be careful when using this strategy if you will be mixing private and investment purchases on the card. If you pay it off in full every month then there would be no interest so no problem apportioning. But a credit card is also a loan, so you would be refinancing the loan with the LOC loan. If it is a split loan you should be very careful not to refinance the private portion too. There is also a tax ruling which states ATO will allow a split purpose loan to be refinanced to separate the two and they will accept this if done on a reasonable basis.

4. maybe

 

[BigAJ]

Thanks for the speedy informative posts guys.

Your responses have helped alot.

 

[Rolf Latham]

Hi BAJ



There are very limited instances where a LOC is useable without some risk of tax contamination

LOCs should (in general) be reserved for

1. Capitalising investment debt on a Separate facility
2. Capitalise Investment expensee
3. Sometimes pull an equity loan out of a PPOR ir an IP where a redraw loan is not possible


Dont use a LOC for

1. The use that most lenders promote, ie, pay your house off faster. Its admirable to want to pay your home off faster, and the products can help u do that, but you are then stuck with a tax mess if u ever turn the place into an IP

2. On an investment property using it as a savings or operating acccount. Every time you make a redraw for private purposes you will further contaminate the loan

3. High risk stuff where the loan may be called and you get stuck............quite a few locs have annual reviews and/ or repayable on demand clauses.


having said all that a LOC properly applied can be a GREAT tool

ta
rolf

 

[Murphy69]

Hi Rolf,

I've recently established a LOC, and my plan was to use it as an operating account, but only for investment related costs, so for example, have all rent paid into it, make loan payments (IPs only) out of it, rates etc, solicitors costs for new purchases etc.

I'm accumulating now, so any CF+ rentals will go into paying down LOC, or offsetting an CF- properties, so I don't anticipate using rent for personal purposes.

As long as none of the above are for a private purposes, is there a problem?
My thought was that as long as the expense would normally be a deductible, then interest associated with it would also be deductible?

Cheers
Murphy

 

[Rolf Latham]

Hi Rolf,

I've recently established a LOC, and my plan was to use it as an operating account, but only for investment related costs, so for example, have all rent paid into it, make loan payments (IPs only) out of it, rates etc, solicitors costs for new purchases etc.

I'm accumulating now, so any CF+ rentals will go into paying down LOC, or offsetting an CF- properties, so I don't anticipate using rent for personal purposes.

As long as none of the above are for a private purposes, is there a problem?
My thought was that as long as the expense would normally be a deductible, then interest associated with it would also be deductible?

Cheers
Murphy

Hi Murphy

Thanks for pointing that out.


I think the idea is ok......................here are a couple of things to think about i where your cash actually ends up.

1. Do u currrently have a PPOR and/ or associated debt ?

2. Will you ever make a purchase using borrowed funds for private/ non deductible purposes ?

ta
rolf

 

[BMan]

Hi Murphy

Thanks for pointing that out.


I think the idea is ok......................here are a couple of things to think about i where your cash actually ends up.

1. Do u currently have a PPOR and/ or associated debt ?

2. Will you ever make a purchase using borrowed funds for private/ non deductible purposes ?

ta
rolf

Could you set it up like Murphy but instead of having the rent go into the LOC you put the rent money into your personal account (say a PPOR offset) and just transfer it into the LOC yourself?

that way if you want the LOC to be self sustaining you keep putting the rent into it (or a % of it)
-you get the benefit of tax deductions of borrowed money to pay your IP expenses (that are tax deductible of course) and maybe slight capitalization of interest but the LOC is self sustainable
-if you only put a % of rent your still keeping the LOC sustainable or at least last alot longer than no rent, and that bit of rent money your keeping is going into your PPOR offset to help pay that off

if your looking to MAX the capitalization of interest you can stop putting the rent in there?
maybe you buy a new PPOR with debt you put the rent money into the PPOR offset to help pay that off alot quicker

 

[Rolf Latham]

Could you set it up like Murphy but instead of having the rent go into the LOC you put the rent money into your personal account (say a PPOR offset) and just transfer it into the LOC yourself?

Sure, thats doable.

I was headed down the path of keeping all positive cashflow in an offset account, either against PPOR or IP.

Thus, when the borrower ever wants to make a non ded purchase, they are using their cash, not borrowings.

ta

rolf

 

[Murphy69]

Sure, thats doable.

I was headed down the path of keeping all positive cashflow in an offset account, either against PPOR or IP.

Thus, when the borrower ever wants to make a non ded purchase, they are using their cash, not borrowings.

ta

rolf

Rolf, thats the way I want to set up my accounts in the longer term, with an 'incoming' account, ideally the offset against the most CF- property, and then a LOC, with payments made out of the LOC, and funds transferred between the two.

The advantage being that if there is excess funds in the Offset account I can use it how I see fit, but if there isn't sufficient funds in the offset and a payment is due,it doesn't matter as the payment will come out of the LOC.

I've been thinking about purchasing some CF+ properties such that the CF+ component completely covers the LOC interest payments (at the LOCs max draw).

This would allow me to use my salary to generate my next purchase, while the CF+ pays my other operating costs.

Murphy.

 

[BMan]

yeah i know what you were saying and its a good idea
cheers

i was asking if it could be done this way as then you could still have a LOC with capitalization of interest but without it getting out of control (by putting some money back in if you wanted)

obviously it would be better to have all the money going into the PPOR offset but then you getting more and more debt building up in the LOC that can get out of control if you dont know what your doing

or if you have a small LOC then you can keep it running so to speak without it running out in a short space in time and no equity to top it up

 

[BMan]

Murphy do you have any non deductible debt eg PPOR car loan etc?
if you do or plan on it yes putting all your cash into income account would be good but rather than use it against the most -VE property use it for personal debt

if you dont have any personal debt then yes it sounds like a good strategy

your CF+ properties must be good ones to cover the cost of your operating costs

 

[Murphy69]

Murphy do you have any non deductible debt eg PPOR car loan etc?
your CF+ properties must be good ones to cover the cost of your operating costs

No non-deductible debt. I don't have any CF+ IPs yet.

I only have on IP and its CF neutral at the moment, with a LOC against it (and some re-draw available as well).

I've only just established the LOC and am now looking around for the right property(s), so this thread caught my eye.

My plan is to get several IPs that are CF+. I realise that on acquisition even a good CF+ property isn't going to earn a fortune, so I'm prepared to put in a bit of my own cash to do so.

Reason being I may have the opportunity to be offered a voluntary redundancy in about 5 years time. Not counting on it, but its a possibility, so I want to balance out CF+, LOC and CF- such that if I decided to take 12 months off, it would balance out.

Murphy

 

[Terryw]

My thought was that as long as the expense would normally be a deductible, then interest associated with it would also be deductible?

Cheers
Murphy

There is a tax ruling which says that if the underlying interest is deductible then the capitalised interest would normally be deductible.

Then the ATO put out a more recent ruling saying they could still apply Part IVA if people are using this as a scheme to pay down a private home loan quciker.