Capitalising PPOR expenses

When living in a property currently declared as PPOR but may in the future be an IP, is there any point in capitalising expenses (not interest) related to the property to increase the tax-deductible interest later?

If so, which expenses can be capitalised?
- repairs
- renovations
- council rates
- utility bills

 

You may want to borrow to pay such expenses to build up a bigger loan associated with the property - but could you argue that interest on money borrowed to pay rates when you were living in it is now deductible when the property is available for rent? I don't think so.

But renovations may be different.

Get tax advice on Party IVA too.

 

Thanks Terry, when you word it like that it's pretty obvious council rates and regular expenses shouldn't be capitalised. Will bounce off my accountant re repairs/renos.

 

Even repairs would be a private expense I think.

Renovations would be capital costs and relate to the building so it would be similar to borrowing to acquire the property and I think the interest on a loan used to fund a renovation would be deductible once the property is available for rent.

 

Not quite. Capitalisation is not a tax term as such but is often used when a cost has not been claimed as a tax deduction ie has been held on capital account rather than revenue. CGT law recognises a ownership cost not claimed as a tax deduction to be eligible as a 3rd element cost for the costbase for CGT.

However if the property is always the PPOR then the property is 100% exempt so the exercise is futile. The cost could be $1m and sold at a loss and its exempt. Wasted effort.

The key issue is if the use of the property changes. The capital costs will reduce future CGT so keep a record. If its needed. That said if its always been your home since acquisition, s118-192 would mean the exercise is futile. You are wasting your time and effort. The costbase for the property will be its market value on the date it first earns income. Costs prior to that date are excluded for CGT. No option. You would only then record capitalised costs after that date. Typically for an IP these are just going to be capital costs such as plant, building works etc, fencing etc. Deductibles would be claimed ?

So Tips are these :
1. If its always been your home stop wasting time and effort. However costs for capital works (eg a new driveway) may assist the QS later since these costs need to be based on your cost....OR
2. If its had mixed use prior to now (ie you did not move in as soon as practical or changed residences, spouses with different residences, non-resident etc) then continue retaining those records. Your method for working out CGT will need historical costs and ownership costs.

 

Capitalisation was the wrong word to use; I simply meant using a LOC to pay for major works on the house, and then claiming a tax deduction on the LOC's interest once the property becomes an IP. Only 1 repair paid out of the LOC so far and trivial to reset with cash; no wasted effort.

Was not concerned about the CGT side but thanks for the info.

 

Ok.. I start with the question...Why ? Is it to enhance a tax deduction ? The common answer relates to cashflow....That is the concern I have. If the available cashflow is then used to provide a tax benefit Part IVA could still apply. There is certainly no tax ruling that says - open ended capitalising of property ownership costs on a loan is OK. Go knock yourself out. My question is ...where is the line ?

Capitalising expenses to a loan may be a Part IVA concern where you are engineering a loan that provides a tax benefit. This isnt necessarily concrete as there are many reasons why taxpayers may use borrowed funds to pay deductibles or non-deductible costs. There is a tax ruling for loan interest but I'm in process of seeking a ruling in respect of other costs as the Commissioner certainly hasnt said its OK either. I suspect that the limitations are greater than most taxpayers believe.

There is a possibility that where you use borrowed funds to max out a deductible loan while at the same time utilise improved cashflow to paydown non-deductible debt or to enhance a offset that minimises non-deductible interest on a PPOR that Part IVA could be used to determine you have engineered a tax scheme. These issues are the scope of my proposed ruling request and its very simple but complex but close to being readied.

There are exceptions of course and each taxpayers arrangemenst are different. eg a taxpayers wife on maternity ;leave may need the use of borrowed money temporarily due to cashflow limits. But by and large I consider that if the concept is to max out deductions then there could be a problem.

 

Not all property ownership costs... after Terry's posts above I'm just thinking about using a LOC to pay for major works like renovations that would increase the property's value. I would not be seeking any tax deduction or cashflow benefit while the property is still a PPOR. The goal is to maximise the tax-deductible interest if/when the property becomes an IP.

I understand that debt recycling is a grey area, but I thought I was proposing something different... is it the same?

 

Would be well worth considering paying the interest on the LOC from an outside account as capitilsing interest in this manner could be considered a scheme.

 

I really should not have used the word capitalisation.... I am not proposing capitalising any interest whatsoever. All interest from all my loans is paid out of my offset.

 

Thats an interesting answer. In my draft ruling request one of the scheme elements is to use a offset linked to a IP in this manner....Personally I see no mischief but paying interest in this way has a similar tax outcome (ie tax benefit) to capitalising interest if the offset is linked to a deductible loan.

 

The timing issue of doing this before its an IP may be a feature of a engineered scheme. I dont know is the truthful answer.

 

PPOR offset, i.e. my transaction account. Non-deductible interest. Seems more boring to me than interesting

If it was an offset linked to an IP loan, then wouldn't that be allowed anyway since the purpose of the loan is income-producing in the first place?

 

Just heard back from my accountant, pretty much as @Terry_w said above.

Interest on borrowings for repairs are only deductible if the repairs were related to damage caused by a tenant.

Interest on borrowings for substantial renovation work intended to increase the value of the property and later assist in generating income MAY be deductible.

I suspect this substantial renovation work involves adding bedrooms, bathrooms, car spaces etc. Something like a new kitchen probably doesn't count as substantial as there was 1 kitchen before and 1 after; no extra income-generating ability was added.

 

I wouldn't say substantial is needed - you could replace the front door with a different type, or add an airconditioner and borrow to do so and to claim the interest once the place is available for rent.

 

Adding AC I can understand (as tenants would pay more for a property with AC than one without) but replacing the front door wouldn't really add any new utility, let alone help the property generate extra income?

 

I would rethink your tax adviser. See bold above.
What else were you told ?

 

@Paul@PFI do your posts in this thread take into account the premise I proposed in the first post? i.e. the property is currently my PPOR. The repairs/renovations are performed while the property is still my PPOR. Only at a later date might the property become an IP.

Obviously expenses incurred while the property is an IP can be paid with borrowings for which the interest is tax-deductible, income-enhancing or not.

But here I am talking about using a LOC to pay for repairs/renos while the property is still my PPOR.

 

You are relying on the logic of the argument that the balance of a mortgage on a PPOR becomes a deductible purpose loan when it becomes an IP.

This could well extend to capital costs of construction such as extensions to the property.

Let's perform an extremely simplistic and dangerous present value calculation.

Assume:
1. You wish to borrow $100,000 at 5% interest-only to build an extension
2. You intend to rent after 5 years
3. Your marginal tax rate is 40%

Once the property is an IP, the $5,000 pa interest expense is deductible, providing a tax saving of $2,000 pa. Treat this as a perpetuity starting in 5 years with the same 5% discount rate.

You will have 5 years of non-deductible interest at 5%. Use the same 5% discount rate.

Present value of future tax savings (i.e. 40% of $5,000) = ($2,000 pa / 5%) / (1+0.05)^5 = $31,341

Present value of non-deductible interest for 5 years = $21,648

You should probably assume that any capital appreciation is reflected only in land value when you sell. Buildings rarely appreciate in the long term.

You did not mention whether you actually had the funds but were aiming for a tax deduction by borrowing.

If you had a spare $100k then you could put it in your PPOR offset for 5 years and save $21,648 of non-deductible interest payments on the PPOR.

Given that rates for cash savings accounts are very low, the offset account could give a similar return to your risky borrowing plan, but without any risk whatsoever.

 

What about the depreciation on the reno's once it turns into an IP ?