Debt recycling and capital gains

So, question about capital gains within a debt recycling.

Saw we paydown a loan, then redraw to use it to buy some equities.

The equities goes up in value.

Thoughts on selling these equities then rebuying similar ones in order to maximize the deductible loan for these shares periodically?

Two main issues i see
- will have to pay capital gains tax
- might be a wash sale?

My feeling is that the CGT will probably generally outweight the tax advantages, although if we do this in a trust we might be able to distribute at minimal CGT cost.

 

1. yes
2. potentially

still be worth it though

 

Is it possible to sell and then buy directly something else without paying into loan?

E.g. Borrowed money $200K and inveated different splits into direct shares, etfs, lics and managed funds.

Now want to sell couple of direct shares (as they sky rocketed) and want to invest in something else ETF/Managed funds/alICs (new ones).

 

Yes you can. You’ll still need to pay CGT. If within the context of debt recycling, you’d probably be better off doing something like;

1. Selling the investment
2. Paying down the investment loan amount you borrowed to buy those shares
3. Put money aside for CGT
4. Paying down your non deductible debt with the left over
5. Adjust your loan splits
6. Draw down on your investment loan to re-invest in the ETFs.

Regards,

Jason

 

I would advise that you not do that - if you were a client of mine.
It would be better to repay the loan and reborrow. If you don't could you show that you used borrowed money to buy the new lot of shares?

 

Let say I used $15K of borrowed money to buy ABC and now that is worth $20K.

I have another option where I think investing $20K is tge best option compare to current option hence I sell abc and transfer money to buy XYZ.

Now I have used the initially borrowed $15K +$5K growth to buy XYZ and at tax time I will capture CG of $5K

@Terry_w - does this show the link with borrowes money?

 

I have seen not one ATO source document that suggests either way.
I would argue it doesn't because you have sold an asset and the proceeds are just cash. You need to pay off the loan and reborrow for them to be borrowings.

 

I would agree.I wouldnt assume but would present the matter to the ATO and seek a binding ruling that is likely conditional on several matters eg
- There is no withdrawal of funds for any non-investment use
- The whole of the funds (or greater) have been used to acquire eligible investments (is leaving in cash acceptable ?)
- The investments are the type which permit interest to be deductible (ie they produce income)

I have seen people in this poistion and they cant demonstrate to me the nexus between the borrowed funds and what they own. Sure they can show that 2 years ago they borrowed $100K and dropped it into Commsec. But then every subsequent transaction and transfer can be a issue. A few I have seen then drew out "$X of profit" which in my view broke the nexus and would mean a diminished deduction. And failing to demonstrate how that deduction was then adjusted means the ATO could deny the whole amount. They assumed you can draw out "profit". You cant.

Margin loans are a strong alternative. They only allow approved income producing investments and are a perpetual loan for each individual purchase that is discharged on sale and then a new loan is given for a further purchase.

We also see issues when offshore shares are acquired. eg Tesla. Facebook etc. Non-income producing and also foreign income. - Or Nil to be accurate. Interest is then non-deductible. A CGT costbase element. Messy blended loan issues.

 

Thank you @Terry_w and @Paul@PFI

I think better leaving it as its considered cash after sale.

On a different note:-

If using borrowed money (equity pull from an IP) for investment and then refinance that loan with another bank and merge into other investment loan belong to same property from where equity was pulled to make one single loan. Does it establish the nexus as no sale of actual shares only refinancing.

 

changing security for a loan doesn't change deductibility and neither does refinancing.
You can merge different loans for the same use together but merging loans for different uses would create a mixed purpose loan.

 

And would also need to apportion that and be abvle to demonstrate evidence of the refinancing. messy. Best left apart as unusual consequences can occur. Eg sell down shares WILL reduce deductions on the property. X% will be propertya nd Y% shares but with portgfolio changes to shares it may be impossible to apportion.

 

Could I pose a follow up question here please. What are the general rules around partial asset sales (i.e. a part of share holdings) in a debt recycling strategy and under what circumstances do you need to repay the debt?

e.g. Invest 100k from a new loan. Share value increases to 120k. I'm selling 20k. Do I need to repay?

What about the same 100k paying 3k in dividends? What if I have a DRP plan? Is it different if the distribution (e.g. from an ETF) includes a capital gains component?

I tried to find some guidance on this, but couldn't locate anything on this specific topic.

 

This is not a partial asset sale - you are selling 20k worth of shares. You must work out the cost base of each share.

If you sell an asset that you have borrowed for you could no longer claim the interest on a loan for that asset (except in limited circumstances). You might still be able to keep the loan open though.

see
Tax Tip 148: CGT and Different Parcels of the Same Shares Tax Tip 148: CGT and Different Parcels of the Same Shares


Tax Tip 272: Borrowing to buy shares and then selling those shares and deductibility of interest Tax Tip 272: Borrowing to buy shares and then selling those shares and deductibility of interest

 

Thanks. So bascially i need to look it as an collection of small loans for each share.
If I sell a share, i need to repay the loans associated with the initial purchase price, i.e. the cost base. Key for that is to identify the correct parcel and keep records.

But simply putting it back into the mortgage, is it clear to the ATO that I am repaying the part of the loan which has no longer interest deductiblity?

 

If you bought 10 shares for $10 each that amounts to $100.
If you had borrowed this and the shares pay dividends the interest on the $100 should be deductible in full.
If you sold 2 shares though you could only claim interest on $80 going forward.

 

But if you bought 4 more shares costing $80 (they went up in price) your original loan of $80 + new loan of $80 means interest on $160 can now be claimed. Blending loans in this exampe is very easy and it is wise to have a strictly dedictated "shares" loan.

Of course all shares must be income producing and not speculative for profit. Othrwise the interest isnt deductible and is a CGT costbase element.

 

Paul, that was what i highlighted. You mentioned the starting point of having an $80 loan after selling the shares.

But after I sell $20 worth of shares, i have $20 cash and a $80 deductible loan and a $20 non-deductible loan. I drop the $20 back into my mortage. Following the pro-rata principle, i now have a $64 deductible loan and $16 non-deductible loan. Or can I pay the $20 and simply assume it is repaying the non-deductible part of the loan which was orignally associated with the sold assets?

On the comment that shares must be income producing (i.e. the facebook example). ATO says that:
"If you borrowed money to buy shares, you will be able to claim a deduction for the interest incurred on the loan, provided it is reasonable to expect that assessable dividends will be derived from your investment in the shares. " Why not reasonably expect that facebook will pay dividends eventually?

 

If u paid $20 off a $100 loan you would have $80

 

Some of my rules for loans and shares

1. If you sell for a profit repay no more than the cost of the shares
2. If you sell for a loss repay the sale proceeds not the cost of shares
3. Only use borrowed funds to buy shares that pay income. Otherwise its a blended loan and the non deductible part may lose 50% of its deductible benefit

These tips will ensure your deductibility is always maximised in tiny increments. Until you lose money that is....Whn you sell for a loss you will always create negative equity as the loan will exceed the value on that parcel...
4. Using borrowed money to invest can create negative equity. Markets rise and fall.

 

or more precisly - only repay what you borrowed to acquire those shares.

So if you borrowed $100 to buy $200 worth of shares and sell 40% of those shares only repay $40 even if that $40 parcel is now worth $60.