10 years of interest to be paid (Tax deduction or added to capital base)

Discussion in 'Accounting & Tax' started by kaibo, 12th Oct, 2018.

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  1. kaibo

    kaibo Well-Known Member

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    A friend of mine purchased a property from parents about 10 years ago and used it as an IP. This was done so she could borrow from the house to fund her business.

    The parents and her came to agreement that interest would be calculated @ RBA cash rate + 3% and the cumulative interest and principle to be paid as a lump sum when property up for sale or any time up to 15 years. (Its been 10)

    On a 500K loan the interest itself has got to $380K. (compound interest/revers mortgage at its worst) She intends to sell now.

    Once she pays the 380K in interest is it an income tax deduction as it is still was an IP during the time that she pays her parents or is it added on to the cost base when calculating CGT if the tenants are already out during the sale process?

    She will seek accountants advice as is big amount but any help would be great
     
  2. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It will depend on the terms of the agreement. Interest is deductible when it is incurred not when paid. Most commonly interest is incurred daily and credited monthly. So it should be claimed yearly. Do they have a written agreement?
     
  3. kaibo

    kaibo Well-Known Member

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    yes there is a written agreement, terms are interest is due once house is put up for sale or 15 years whichever comes first or other mutually agreeable time
     
  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    But how is interest calculated?
     
  5. kaibo

    kaibo Well-Known Member

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    rba cash rate + 3% at a set and constant month each year
     
  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I don't know what that means. You will need to seek legal advice on the terms of the agreement.

    If interest was incurred at the point of sale none of it could be deductible and it might just be a cost base expense.
     
  7. luckyone

    luckyone Well-Known Member

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    Wow! Her parents ripped her off big time! That's a higher interest rate than most banks
     
  8. Scott No Mates

    Scott No Mates Well-Known Member

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    That's only 1% (or so) above bank rates but considering that the person may not have qualified for a loan at the time, may not have been able to afford a loan, didn't have a deposit, may have had a different set of circumstances etc it's a bit hard to make that call.

    Is it expensive compared to the overdraft rate, personal loan rate or credit card rate?
     
  9. Mike A

    Mike A Well-Known Member

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    Exactly. Maybe no bank would lend. The business might now be turning over 10m per annum. Who knows.

    As long as both parties understood the arrangement and sought independant legal advice at the time i dont think anyone was ripped off.
     
  10. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I would probably seek a ATO private ruling on the deductibility and when any eligible interest deduction should be claimed. Its unorthodox and non-commercial in the terms but seems to be documented and agreed by the parties. Interest could be disallowed and a binding private ruling could avoid the issue attracting attention and penalties.

    I have a feeling that the interest should have been claimed when it was incurred as it is an amount that can be ascertained and determined at each annual point of time and not claimed when it is paid. If so a large amount may be non-deductible (out of time to amend) and be a third element CGT cost.

    Loans like this are often given scrutiny and denied deductions by the ATO as these types of loans can be evident with tax (deferral or profit shifting) schemes. Also the party receiving interest may have a tax problem. The ATO would argue they are a money lender. Money lenders need not lend to the world at large but need to have a commercial like arrangement which yields a return which may be supported by the detailed loan agreement. And they should have paid tax on the interest accrued annually NOT on receipt.
     
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  11. Beano

    Beano Well-Known Member

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    Have the parents returned the interest income each year in their tax return ?