Margin Loans Avoiding contamination of loans used for share purchases

Discussion in 'Sharemarket Investing Platforms, Tools & Services' started by Harry30, 27th Feb, 2018.

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  1. Harry30

    Harry30 Well-Known Member

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    If you purchase $100 worth of shares via a margin loan, and sell the shares for $150, the proceeds are immediately put against (reduce) the margin loan. So, how do you extract the $50 profit without contaminating the margin loan (ie having a loan with deductible and non deductible amounts). If I take out $50 from the margin loan, isn’t $50 of the margin loan now not deductible. Ie. the $50 ‘loan’ was not used for income producing purposes. Have I not contaminated the loan? How do you get around this?
     
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  2. Terry_w

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

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    I have never used a margin loan myself, but I can see the issue potentially if that is how it happens. If you sell all the shares it won't be a problem, but if you sell part it could be.
     
  3. Harry30

    Harry30 Well-Known Member

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    Appears all margin loans are set up this way. The shares are held as security, so the margin provider requires any funds from sales (which reduces the lender’s security) to be put against (reduce) the outstanding balance. Interested whether anyone knows of a way to address this.
     
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  4. Harry30

    Harry30 Well-Known Member

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    Selling all your shares would address this but clearly not optimal given many sales would attract capital gains tax (the easiest tax to avoid, just don’t sell).
     
  5. Harry30

    Harry30 Well-Known Member

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    I suspect there is only two ways to address this (extract ‘equity’ from margin loan/share holding without contamination), and it is only a partial solution (but can be turned on and off as needed). First, ensure dividends are paid into a separate account and don’t go against (reduce) the margin loan balance. These options are all permissible. Second, capitalise the interest on the margin loan (assume tax office is ok with this, have not checked Terry’s Tips on this). So, you effectively get the dividends, and the savings from not paying the interest. Each strategy will reduce (effectively extract) available equity from the margin loan/share holding without contamination. Interested in getting the thoughts of others.
     
  6. Terry_w

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

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    But Harry, that is something else - it won't help if you sell part of the shares and all the proceeds are paid into the loan.
     
  7. Harry30

    Harry30 Well-Known Member

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    But, if 100% of the proceeds (that includes a profit on sale) are paid into the loan account, there is no contamination. 100% of the remaining balance in the margin loan remains tax deductible.
     
  8. Terry_w

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

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    imagine
    $100,000 worth of shares with a $50,000 loan. Shares now worth $200,000. You decide to sell $20,000 worth and $10,000 of the loan relates to these shares. if the lender pays the proceeds into the loan the loan will now be $30,000 and you won't have any cash, but you could possibly redraw from the loan, but this has tax consequences.

    Instead you let the loan capitalise back to $40,000. This is good, but you are still out of pocket in the debt recycling arena for a while.
     
  9. Harry30

    Harry30 Well-Known Member

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    Yes, spot on. Good example. As I said before, no perfect solutions, but at least you don’t contaminate the loan. So to summarise, 1) Never make withdrawals from the margin loan, 2) capitalise interest to reduce/erode equity, 3) Don’t pay dividends into the margin loan (just bank into a separate account), 4) Don’t use dividend reinvestment plans, 5) Don’t pay tax cheque (assuming they are negative geared) into margin account. All these strategies will effectively allow you to extract equity gradually without contaminating loan.
     
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  10. Harry30

    Harry30 Well-Known Member

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    A further complication, if you buy shares at $100 using a margin loan, and sell at a loss (say at $50), with proceeds going back to the margin loan, I assume the $50 remaining in the margin Account remains tax deductible. Of course the $50 remaining debt is not supporting any income (shares are all sold), but guess it gets down to purpose at time of acquisition.
     
  11. mita

    mita New Member

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    How about the following query - any thoughts on option 2 (ie transferring a parcel of shares out to another non-margin account work or would this just contaminate the original margin loan for tax deduction purposes?)

    Consider a margin loan that has been around many years. All costs and proceeds of each share transaction have been deposited or withdrawn to the account as you would expect. Interest was charged to a different account and claimed as a deduction over the years as is the common practice.

    All the original shares used as security for the original account have been sold and proceeds gone back into the account, so all current shares have been bought via the loan facility. The current debt is a small part of the portfolio value and most of the portfolio has significant gains (100%+). A small value of recent purchases have small gains.

    The aim is to realize some of the value of those shares for private use but maintain a similar value portfolio and full deductibility of outstanding debt

    One option (I assume is fine) might be to sell enough shares to bring the account into credit, draw the funds needed for private use from the funds in credit, and buy back different shares to bring the portfolio (and debt) back up. The issue there is the capital gains bill. Selling a small packet of shares is fine, but to sell enough to bring it into credit would require shares to be sold that are up a lot, incurring a big bill.

    The other option is to transfer a small packet of shares out, and sell where proceeds go to a different account. The loan balance is not touched, but is the interest still fully deductible?
     
  12. Terry_w

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

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  13. Harry30

    Harry30 Well-Known Member

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    That has always been a problem with margin loans where buying and selling funds/proceeds goes directly against the margin loan. Is there a solution to Mita’s issue? Take this example. Let’s say you have $100 worth of shares with a margin loan of $50 (original equity = $50). The shares increase in value to $200. So, you now have equity of $150, and you want to access that equity. Taking Mita’s suggestion, you transfer (say) $40 of shares out of the margin loan into a separate account, and sell the $40 worth of shares. The $40 sale proceeds go into a separate account. However, you pay down the margin loan by $10 from the proceeds, and keep the remaining $30. As the $40 of shares had an effective liability of $10 (overall portfolio of $200 is geared to 25% with liability of $50) you must pay the margin loan down by $10 as $10 was the original money you borrowed to buy what is now the $40 of shares you just sold. In other words, provided you pay down the borrowed funds with sale proceeds equivalent to the original amount borrowed, 100% of remaining margin loan ($40 in this example, $50 - $10) remains tax deductible and there is no contamination. Unfortunately, I cannot see any way of accessing equity without selling some of the shares. If you simply draw money out of the margin account for personal use, the loan is contaminated and no longer wholly tax deductible.
     
  14. Terry_w

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

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    I have never used a margin loan, but can see where you are coming from now. It could potentially get messy

    But

    How would you transfer $40 worth of shares out of the margin loan?
    you need to distinguish security of the loan and the use of the borrowed funds.
    I assume if you transfer them out that means they are not being used as security for the loan any more. But if they were purchased with the loan then still part of the loan relates to those shares. So if they are sold the deductible interest on the loan may decrease - in your example 40/200 = 20% of the interest will relate to the $40 worth of shares which are sold so only 60% of any interest incurred on the remaining loan could be deductible.
     
  15. Harry30

    Harry30 Well-Known Member

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    I have a margin loan but have never withdrawn shares from the margin account, so don’t know the mechanics and whether this is permissible. You can certainly transfer securities into the margin account, but I have never withdrawn securities. I would think provided the overal LVR stays within the permissible range, then withdrawing shares is fine. Clearly, you cannot withdraw so many shares than the LVR margin loan trigger is breached and the account goes into the margin call zone. That all said, it may differ among margin loan providers, so a phone call to the provider is probably advisable.

    The key problem with margin loans is that when you sell shares, 100% of the proceeds automatically go against the outstanding balance. They are a bit like a LOC account where all ‘deposits’ reduce the loan balance automatically. This is arguably sub-optimal where you have purchased shares that have substantially increased in price.

    If I borrow $50, to buy shares worth $100 (have contributed $50), and they go up to $200, and I sell $40 worth of shares, then the margin loan will ordinarily just go down to $10 ($50 - $40). That is, 100% of proceeds just go against outstanding balance.

    Clearly, you want to avoid this. Ideally, you only want $10 to go against the outstanding balance (ie. original amount borrowed to buy what is now $40 of shares), and retain $40 of deductible debt ($50-$10).

    To achieve this, I think the only solution is to transfer $40 of shares out of the margin account ahead of the sale.

    Pretty messy situation as you say.
     
  16. Terry_w

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

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    Oh - not good for debt recycling then, unless you sell the lot.
     
  17. Harry30

    Harry30 Well-Known Member

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    To maximise deductible debt on margin loan, best to:

    1) Ensure dividends from shares go into separate account and not into the margin loan account, reducing balance;
    2) Always capitalise interest on the margin loan, so you progressively add to the balance of the loan (get tax advice first to ensure continued deductibility);
    3) Don’t use dividend reinvestment plans, take as cash.

    All of the above progressively reduce your margin loan equity, effectively achieving a progressive equity withdrawal, while not contaminating the loan.
     
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  18. Terry_w

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

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    I was thinking of the capital gain harvesting. Selling part of your holdings could create a mess.
     
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  19. Harry30

    Harry30 Well-Known Member

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    Do you mean harvesting capital gains without selling any shares? I can’t think of how that can be done. In the prior example, shares have $200 of value with $50 margin loan. No problem withdrawing money (say $50) from margin loan, but immediately you have margin loan with $50 deductible and $50 non deductible. Loan is contaminated.
     
  20. Terry_w

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

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    No, selling a few years, but not all.
     

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