Tax Tip 3: Mixing Loans - Don’t do it

Mixing Loans - Don’t do it


It is common to see loan structuring mistakes with about 90% of the clients I see. One of the most common is mixing loans. This occurs where one loan account has been used for more than 1 purpose. Often happens when redraw is used.


An example. Tom has an $80,000 loan with ANZ on a $100,000 property. He has paid the loan down to $60,000 but still has $20,000 available in redraw. The original loan was used to purchase his owner occupied property. Tom goes and buys an investment property and has the good sense not to use his cash but borrows the $20,000 from the original loan by redrawing it and using it as deposit.


Tom now has a mixed purpose loan. No real problem so far.


Problem 1

But if Tom’s loan is PI then he will be paying down the investment portion with every deposit he makes. being one pool of debt he cannot segregate the repayments so they come off the non deductible portion first. So every deposit he makes causes him to reduce his tax deductions which means he is losing money by paying more tax. he is essentially throwing money away.


Solution - split before using.


Problem 2

It will also be very difficult to calculate the portions of the loan. Each deposit made would come off both portions of the loan in relation to the percentage at the time of the portions at the date of deposit.


20/80 = 25%. So 25% of the loan relates to investment and 75% to private purposes. If the deposit into the loan is $100 then $25 must come off the investment portion and $75 off the private portion. Simple for the first deposit, but what if $328.77 in interest is charged for the month. 25% of this relates to the investment portion ….


It would be very difficult to work out over a short period. But with some people this has gone on for many years and it would be very difficult to work out.

Solution - split before using.


Problem 3

Another problem is the offset account. Since it is one big loan Tom would be offsetting the investment portion too. Say Tom had $60,000 cash. He would still be paying interest on $20k yet 75% of this would be private interest.


Solution - split the loan before you use it. Tom could have had 2 splits of $20,000 and $60,000 he could set up the offset on the $60,000 loan and pay no non-deductible interest at all.


Problem 4

Sale Time. If Tom were to sell either property he would then need to do some readjusting. If he sold the main residence he would have to be careful about paying out the investment portion (topic of a future tax tip). Paying this out would be necessary because the loan is secured by the main residence. But this would cause Tom to lose deductions and also to have less cash available for his new main residence. Fortunately there may be a way around it in most cases. This issue would occur whether the loan was mixed or not. But it is only possible to rectify this if the loan is split before it is paid off.



There are also issues with mixed loans where all portions of the loan relate to investments, albeit different investments. See my thread “An issue with mixed purpose loans where both portions are investment.” at

https://propertychat.com.au/communi...loans-where-both-portions-are-investment.902/



So what to do if you have mixed loans?
Fortunately the ATO allows mixed loans to be unmixed. Rolf says you cannot unscramble an egg, but the ATO allows you to notionally unscramble a mixed loan.


You must work out the relevant portions on a reasonable basis and the loan can then be split. Splitting means each loan portion will end up with a separate account number so they can be distinguished from each other.

 

Hi Terry, is there a minimum that banks will generally allow you to split? Let's say I wanted to redraw $15k from my PPOR with intentions to one day make my PPOR an IP, would most banks facilitate this? Or are they after $30 or $40k before a split will be considered?

 

Yes each bank has a minimum. Varies a lot.

 

Hi Terry,

thanks heaps for your posts. I keep having the 'ah' moment everytime I read one.

I however have to ask for a clarification as I could not find any clear answers. Hope this post is the best to bounce on...
What is the best loan structure that suites the ATO and gives flexibility?

For example I have 2 IPs, one loan for each and a LOC from the equity of my PPOR.

I see two options:


Option 1

The deposits for IP1 and IP2 are taken from the LOC.
The rent of IP1 and IP2 go to the LOC.
Repayments of loan1 and loan2 are made from the LOC.
The repayments of the LOC are made from a personal account.

Pros:
Only the combined loss (sum of Rents minus sum of Repayments) has to be compensated from my personal account.
Cashflow is easier to monitor.

Cons:
Very hard to compute the interests on the LOC that relate to each properties.
Will the ATO be ok with the claim of the interests on the LOC?
Could be tricky when one of the property is sold (although Tax Tip 54 indicates it could be OK)

Option 2

The deposits for IP1 and IP2 are taken from the LOC.
The rent of IP1 goes onto loan1, rent of IP2 goes onto loan2.
In case the rent does not cover the minimum repayment for each mortgage, funds are used from the LOC.
The repayments of the LOC are made from a personal account.

Pros:
The interests paid on the LOC can easily be linked to IP1 and IP2 (the 10% deposit)

Cons:
Repayments are fully paid from the personal account even if both properties are cash flow positive (see your post about not reimbursing yourself, if I got it right).
Still the issue when selling one of the IP.

Which option do you recommend: 1, 2 or other?

To make things even more fun what if IP1 belongs to me and IP2 to my wife?
How do we claim the interests of the LOC?

Cheers.

 

neither

Option 3
LOC split into 2, A and B
A used for property IP1
B used for property IP2

Rents and wages deposited into PPOR offset account.
Interest on IO loan for each of IP 1 and IP 2 and each of the LOC from IP 1 and IP 2 come from the PPOR offset.

Loan agreement should be used where LOC is in a different name to owner of the property it is used for IP1 or IP2.

 

ahh..
Ok got it.

Thanks!

 

Hi Terry

Thanks for these fantastic tips. I am so glad I am reading these prior to buying the first IP.

I have a question - the loan for our PPOR mortgage has been redrawn and paid back a fewtimes, and with the occasional accidental payment of a bill from it. This is the loan itself not the offset. At the time I wasn't considering property investment and had no idea this would affect anything. Anyway I presume this will cause me problems if we ever were to rent the place out? Is it possible to fix?

 

Yes it will only cause problems if the property ever becomes rent producing as you could claim any interest which was associated with the loan used to acquire the property. If money has gone in and out then not all your loan will be associated with the purchase of the property.

There is no way to fix this. You just have to work out the relevant portions and see how bad it is and then consider strategies such as spousal sales or outright sales or just wearing it.

 

Terry thanks for these tax tips! Great resource, I often go into the list looking for one thing and end up reading a bunch of other stuff too.

I fairly recently created a mixed purpose loan, original loan against ppor, IO payments amount $135k.

I payed $78k off that loan and have been redrawing it in stages to pay for my GF construction. So from reading your post, to fix this I should go and split this loan now $78k/$57k?

Additionally I need a bit more cash to pay final expenses on the GF, say another $7k. Not sure how to handle that and gain deductibility for the extra $7k. I understand that if I just pay into the loan now it would come off the ppor portion and the new GF portion.

Do I need to do 3 splits $78,$7,$50? Or, can I just set up an $85k and $50k split now and then pay it into the $85k portion?

 

I can't comment on the amounts, but it appears you have a mixed purpose loan.

If the purpose relates to an owner occ use and the granny flat use you need to work out the proportions, then split it. It may not be the portions you suggest.

Don't pay anything further into the loan until you split.

No need for a 3rd split if 2 and 3 relate to the same thing - they can be ccombined.

Get specific tax advice before implementing.

 

Thanks Terry, the GF is on the back of another investment property, I just put the cash into the PPOR account to try and "Debt recycle". I underestimated how much I would need when I put the initial $78k in.

You raise another good point/mistake I've made wrt another GF, on the back of our PPOR. We did this years ago but never even though to split the loan. We had just been claiming a portion of the interest, worked out with the accountant using floor space/land ratios. I hadn't even thought to try and preserve the GF amount.

 

Hi Terry,

I have 2 split loans that I rolled into my main offset account. This is against an IP with the highest interest rate (I have no PPOR) but is also the same account where my personal savings\salary etc reside and most of my spending comes from.

When purchasing my next IP, what do I need to do to ensure the split loans (remember now mixed with personal funds) can be used to purchase that IP and also be considered tax deductible.

The intent of those split loans was always to re-invest but it has been 9 months since splitting. Can I simply transfer the exact split amount out to an alternate account before using those funds for my next IP purchase so the funds are trackable?

Cheers
Andy

 

Andy

You have contaminated your loans and only part of the interest could be deductible.

You should work out the relevant splits then split and then pay off the non deductible split and then reborrow.

Next time avoid parking in offsets.

 

Hi Terry, reading all your Tax Tips... really valuable so thank you. Unfortunately this tip was too late for me but it may have ended up in my favor.. but I'll let you rule on this please

2009. Purchased my PPOR but lets call it P1 $600K (loan of $480K). Moved back with my folks in 2012 and rented out the property.
2013. Drew $60K equity out of P1 - loan amount grew to $490K. Purchased new H&L and it is now my PPOR (P2). P1 is now my IP and P2 is my PPOR.

Currently owe $468K on P1 (includes the $60K used to purchase P2) and $520K on P2.

So from where I am sitting I have increased my good debt (as you call it) and reduced my bad debt (PPOR). I have only recently moved P1 loan to IO and the extra cash all sits in my offset account for P2.

Interested in your thoughts...

 

You haven't increased your good debt because the redrawn $60k relates to the new PPOR.

see
Tax Tip 77: Redrawing Extra Repayments to Increase Deductions? https://propertychat.com.au/communi...extra-repayments-to-increase-deductions.5760/



You have created a mixed loan - $490k relates to two purposes.

 

It cant be corrected. If you repaid the original PPOR loan then its gone. Forever. The new borrowing needs review for the use of each new amount drawn. With LOC's this can be impossible to identify and correct where its blended multiple times and multiple purposes

 

The reference to $60K would only be valid if its a IO loan. A common mistake by takpayers is to think it remains a $60K deductible portion. When a loan has P&I repayments the repayments must be apportioned across all amounts... eg Two amounts are drawn $60K and $400K. Lets assume the $60K has a deductible use. Now just fwd three years. How much is deductible if the total debt is $410,000 ?

Answer = $53,478.26 of the balance produces deductible interest (assumes $60k was used to buy an IP)

Deductible % is 60,000 / (60,000+400,000) = 13.0434%
13.0434% x $410,000 = $53,478.26

Another way of looking at it is 13.0434% of the blended loan is deductible PROVIDED another drawdown doesnt occur. Each drawdown will dilute that % and complicate matters further.

 

It is IO now... I wont lie... totally confused.
All I know is I have 1 single loan for my IP - which actually includes the $60K I drew out to help fund my new property which is my PPOR.
When I provide the accountant all the costs including interest for IP I don't portion out the $60K interest component. So I assume it is being treated as a deductible i.e. assisting me with my negative gearing.

 

If you drew out $60k of the investment loan that means you borrowed to pay for the thing that $60k was used for - which is the main residence.

If you don't tell your tax agent this he would not know and would think the full interest on the loan reported will be deductible.

You might get away with it, but it is incorrect and you have to worry about an audit.

 

Naughty. The ATO did an exercise a couple of years back where it attacked borrowing expense deductions. They had data on recent borrowing fees and advances and used that data to identify those who added to their IP loans and claimed the new fees ie fees for equity release claimed on the existing IP.

I find the easiest sign of a error is in all your past tax returns. Look at interest deduction:
Example.
2012 $12,000
2013 $11,650
2014 $11,000
2015 $17,500
2016 $16500

Q : Why did interest go up in 2015 ? ATO reviews and queries. They dont care why. They see the issue as a likely error. They write and propose to amend down but more likely they dont have enough info so propose to deny 100% of the deduction unless you can convince them otherwise.

A : Now here is the nasty part. You then must find supporting evidence and convince them your calc. Do it badly and they amend after 28days to $0. + interest + penalty