Debt Recycling Using Shares

I occasionally encounter those who use borrowed $$ to buy shares. There is a debt recycling strategy that can be maintained in some cases that can be easily overlooked.

1. Only use borrowed $$$ to buy income producing shares / LIC, ETF, managed funds etc Otherwise if the acquisition is to buy and hold to resell for profit NO interest deduction is allowed. The interest becomes a CGT cost.

2. Track each parcel acquired.

3. When you sell a parcel that is at a profit ONLY repay the loan by the amount PURCHASED not the amount sold for.
4. When you sell a parcel that is at a loss repay the full sale proceeds only (not the original cost of the parcel)

**Note that when shares are sold the originating loan MUST be repaid using either 4 or 5. Leaving the loan unpaid results in a blended loan (part deductible and part non-deductible).

5. Any $$$ of profit can be banked to the PPOR loan NOT the loan for shares. This leaves the deductible loan at its optimum balance and allows profits to repay the non-deductible debt

 

Repaying the profit will also leave you short at tax time at you'd need to get those $$ back from the loan or stump up cash.

 

Would that include contributions to an smsf using borrowed funds or is that a form of double dipping?

 

The comment was made strictly about individuals who use borrowed $$ to buy shares.

Borrowing to make a contribution to any form of super is not deductible.

 

I assumed likewise but best to ask just in case

 

What about dividends. Reinvested or paid out? I would like to comment but am fearful..

 

Dividends and share income could be banked to the PPOR home loan NOT the shares loan. There is no obligation or requirement to repay a loan using investment income....Only issue is when shares are sold the right to deduct ends so repayment as previously noted avoids a tainted loan

This principal is seen with IPs. The ATO doesnt care where the rent gets banked. Can be banked into the parents bank account (a gift ?) and it has no impact that the legal owners will share income and expenses for tax purposes. You cant argue you didnt receive income. The right to dispose of the income is constructive as receipt.

 

I know this thread is abit outdated, jist wondering if no ppor debt is present and a home equity split was organised to invest in shares lics etfs for example wouldnt it be better to have divs streamed back into the loan split and then accessible though redraw at will instead of accounting for all little divs from different shareholdings?

Also can these equity release loans against the ppor be open ended or with no time frame so payed back at will??????

Cheers.

 

dividends paid into the loan have to be accounting for the same as if they were paid to a savings account or reinvested.

Some LOC type loans have open ended terms - but they are at call and I would never recommend one other than as a temporary measure.

 

Thank you Paul for the above informative post.

Would you mind expanding a little further on Number 4?

I am having trouble understanding how one could continue to claim interest once the the shares have been sold at a loss and no further income is expected to be produced.

For example say, Line of Credit against home with $100K Limit and $0 starting balance - with no mixing or contamination - interest paid monthly from personal savings account.

1. $50K was borrowed to buy NAB Shares and a further $50K was borrowed to buy CBA Shares.
1.a $100K loan outstanding used to purchase income producing shares.

2. 3 years down the track NAB Shares sold for $30K = $20K loss.
2.a Proceeds of NAB Share sales of $30K repaid to the loan - outstanding balance now $70K.

3. 5 years down the track CBA Shares sold for $100K = $50K gain.
3.a $50K of CBA Shares sales repaid to the loan - outstanding balance now $20K (which is result of NAB Shares loss)
3.b $50K of CBA Shares sales proceeds kept in personal savings account.

4. What happens to the remaining $20K loan - can interest continue to be claimed even though no income producing shares remain? If so, for how long?

5. 6 years down the track - borrow a further $50K to buy ANZ Shares - outstanding loan balance now $70K - on what balance can one claim interest?

Or perhaps if you could provide a link which explains the above?

Many thanks.

 

The ATO accepts that interest can be claimed on a loan used to acquire shares where the shares are sold and the loan is still outstanding because the sale proceeds were less than the shares.

In Willy's example it could be possible to keep claimaing the interest on the $20k. Interest could potentially be claimed for the remaining term of the loan.

Ideally when buying the ANZ shares you start a new loan split. but you could potentially claim the interest on $70k

 

Its important for those who do c/fwd the loan that they avoid tainting it by later reuse of the same loan. It then has similarities to blended loans and it can be difficult to demonstrate the nexus to the original borrowing and the later reduction (in part) leaving a debt balance. If the loan is a LOC style facility its often a poor choice. Ditto margin scheme loans require all sale proceeds to be applied and the buyer must payout the residual debt. But a clear and clean loan split to make good that loss would be a refinance if its done neatly.

I usually recommend one split for those losses

 

and split the loan well before the sale of the shares.

 

It sounds to me like it would be best practise to have one loan split per share parcel/tranche then?

 

depends on how many different parcels of shares you will have at any one time. if just 3 or 4 then it would be ok, but if 10 or so it may be impractical.

 

You could also split a loan that is mixed before the actual sale of hte shares which triggers the loss.

 

I find that if you diligently follow my rules for using borrowed funds to buy shares you cant go wrong.

1. Only draw the cost of each parcel
2. If sales occur at a profit only repay the original COST and not the sale proceeds on the date the settlement occurs
3. If a sale occurs at a loss only repay the proceeds received on the date the settlement occurs.
4. If a partial sale occurs then follow 2 and 3 and pro-rata based on the qty of shares.

Follow this and it will never be blended. Any number of trades or parcels.

 

The loan would be blended if the one account is used for more than one parcel of shares.
But where the owner of the shares is the same it won't matter as all of the interest would be deductible anyway and it can be easily apportioned by the use of a spreadsheet.

 

One way that a blended loan for shares can be a concern....

If you buy shares that dont pay income but they are acquired for a hold to resell for profit. That part of the interest would be on capital account and offset a future profit.

I'm often asked about buying ETFs or trusts that pay distributions that include large tax deferred income or capital gains in the annual income amounts. Does that affect the deduction ?. No. It is still classified as income even though the tax deferred or CGT amounts, foreign income etc seemingly may impact deductions.

The key concern is buying shares that have never paid income. eg Buying A2 Milk shares. Bellamy's....etc

 

Would payments need to be made at the date of sale? That is, if the loan was interest only, would an additional re-payment of the capital need to be made to account for the sale thereby reducing the overall balance?