Debt Recycling Strategy - Critique

Firstly thank you to @Terry_w for all the threads although I must say these discussions can be quite complex.

My Scenario:

PPOR Total Value: 1m
Current Equity: 700k
P&I Mortgage Facility (with offset) 300k @ 3%
IO Loan Facility (with offset) capacity 300k @ 3.75%

The IO Facility is currently unused.

If I was to take 150k from the loan facility and purchase shares (buy and hold ETF's), my understanding is that the income/dividends should be paid into the P&I Mortgage offset account to reduce the non deductible debt.

Questions:

1. My plan was to service the interest costs on the IO Loan facility by just drawing on my IO Loan Facility. Is this acceptable? Based on my readings on this forum I understand this to be 'capitalizing the interest and is possibly not allowed in the eyes of the tax man?

2. If I chose to actively trade shares as opposed to having them in a buy and hold portfolio generating income, does this impact my ability to use any profits to pay down my Mortgage Facility?

 

1. Yes you would be borrowing to pay interest which is essentially capitalising interest. It is allowed, but you have to consider Part IVA

2. If you are making a profit you could use the profits to pay down your non-deductible debt.

 

Thanks Terry,

Adjusted example:

What if instead of having all the dividends hit the PPOR loan account I direct those funds into the IO offset account. In effect I keep the 2 loans (and any subsequent income) completely separate.

How do I manage the timing differences between receiving dividends (quarterly/half yearly) vs the monthly interest payments on the IO loan? There will still be times where the interest is capitalised due to timing differences (or whether the portfolio is positively or negatively geared)

I guess putting my question another way - from which account should the interest payments on the IO loan be coming from to ensure there are no issues with the tax man?

 

The related problem is if you use borrowed $$ to make interest payments that could be a scheme and a concern. The timing difference issue with capitalising is not likely a concern however. When we mention capitalised interest concerns we are generally talking about an arrangement when the interest continually accumulates and compounds.

 

Without tax advice you should be paying the interest with cash. You should not have an offset account on the investment debt as if you had money in here it would be costing you non-deductible interest so interest repayments for both loans should really be coming from the PPOR offset.

 

Thanks Paul - Yes agree, my goal isn't to 'wash' a huge amount of non deductible debt into deductible debt, it is more just doing everything in my power to keep it separate

Hmm, this is interesting, in effect you are suggesting the offset account for the IO loan is redundant. This is news to me as I always thought the rule was 'keep everything separate, including repayments' so its easy to identify deductible vs non deductible debt.

I agree that I'm giving some tax advantage by paying dividends into the IO offset account however I was ok with this given it ensured I kept everything separate and clean from a tax perspective. Given I am actually 'capitalising interest' due to the timing differences by doing this, maybe I should just have do as you suggest and have interest for both accounts come out of my PPOR Offset account.

Practically speaking then, come tax time I will have a statement for my offset account where I am paying interest to 2 accounts, I assume I just identify which interest relates to the investment loan and declare accordingly - this will keep the tax man happy?

Paul, Terry,

This is incredible feedback and your time is much appreciated, your help could indirectly have huge implications for myself - thank you.

 

There is no tax reason to segregate cash and doing so will actually be harmful because you are diverting interest savings from the non-deductible debt.

 

Thank you gents - Fantastic help. PS terry your website is great but can't you pay an internet whizz to spruce it up a bit!

 

ha ha. I can, but what for, I have too many clients now!

 

Well that's a good thing then!

Terry - I'm going to have a similar discussion with my brother tonight using the example below - can you run your eyes over the below picture to make sure I have everything understood (feel free to adjust as needed)

 

It doesnt show the historical use of teach borrowing used and maintained solely for a deductible purpose. Thats the key issue.

 

Yes fair point - segregation is key.

Take 2?

 

Whats the bottom offset for?

 

A bottom offset is what I sit on

 

In that example we have capacity to borrow 600k however say we don't want to use all of the funds immediately, this allows us to purchase sporadically (when comfortable) without paying interest on the entire 600k if it's not in use.

Unless I have my wires crossed?

 

Are you saying you will borrow and deposit into the offset?
Tax Tip 1: Parking borrowed money in an offset account Tax Tip 1: Parking borrowed money in an offset account

 

Terry,

I will be starting a new loan (the 600k in the pic) and the funds drawn down will be used solely to buy shares. I can't see what this would be a problem?

 

All explained in tax tip 1

 

Thanks Terry,

So to summarise where I'm at.

1. I've learned that you can't capitalise interest (aka use interest to pay interest). As such dividend payments and interest costs will all be linked to the PPOR offset.
2. I've learned that my IO with offset set up is not ideal and I better be pretty bloody careful how I operate. I'm another one of these mugs who have set it up in this manner as opposed to having a redraw/LOC facility. Most importantly, No mixing of loans and no accidental payments into the investment offset.
3. To put (2.) another way, the balance I am paying interest on should exactly match the purchase cost of my shares. To the cent.

Now to speak with my broker.

Thanks for your help Terry - invaluable

 

Terry,

The bank has released the funds into the wrong account initially.

Can I move these funds back into the loan account and then from there use the funds to purchase investment and still have the interest be tax deductible or am I stuffed?

EDIT: The account where they have put the funds has other monies in there.