interest deduction on loan security substitute

Discussion in 'Accounting & Tax' started by melbourne171, 2nd Jun, 2022.

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  1. melbourne171

    melbourne171 Well-Known Member

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    This is an example. I have 2 IPs:

    Property A : Value: $1,000,000, loan 1: $200,000
    Property B : Value: $1,200,000, loan 2: $600,000

    Currently, I can claim a tax deduction on the interest for both loans because of loans against rental properties.

    Now I change the loan security as follows:

    Property A : Value: $1,000,000, loan 1: $200,000, loan 2: $600,000 (Note loan 1 + loan 2 = 80% value)
    Property B : Value: $1,200,000, No loan

    Will both loans' interest still be deductible?
     
  2. Terry_w

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

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    interest deductibility is not affected by security. If you substitute security or borrow another $600,000 secured by Property A and pay out Loan 2 it would generally not change deductibility
     
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  3. melbourne171

    melbourne171 Well-Known Member

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    Thanks Terry. It makes sense

    So, I go the next step

    After 6 months, I sell property B. is interest on both loans still deductible?
     
  4. Terry_w

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

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    what was Loan B used for?
     
  5. Terry_w

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

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    I guess that would be the $600,000 loan
     
  6. melbourne171

    melbourne171 Well-Known Member

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    Loan 2 remains still open secured by property A. Property B is sold without any mortgage.

    Property A : Value: $1,000,000, loan 1: $200,000, loan 2: $600,000 (Note loan 1 + loan 2 = 80% value)
    Property B : Sold
     
  7. Terry_w

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

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    what was Loan 2 used for?
     
  8. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I read that the second property is unecumbered as the new loan discharges the former loan on P2. ie It is a refinance.

    Wise to discuss with a broker as these could be crossing issues eg Lender may want to keep holding the security for P2.

    ""After 6 months, I sell property B. is interest on both loans still deductible?""
    No. When P2 is sold any interest deduction ceases with the disposal of the asset.
     
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  9. Ruby Tuesday

    Ruby Tuesday Well-Known Member

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    I read it is the same loan with different security, not a refinance. You cant answer no, unless you know the purpose of the loan. It is the purpose of the loan that determines tax deductibility.
     
  10. Terry_w

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

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    No, I disagree. It is the use to which the borrowed funds are put that determines deductibility.
     
  11. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I can actually answer "NO"". It is fundamental tax law. s8-1 ITAA97. Its the first basic element of tax law.
    INCOME TAX ASSESSMENT ACT 1997 - SECT 8.1 General deductions

    If a loan was used for any deductible purpose and the asset (P2) is sold without discharge of the debt then interest deductions cease under the principles in s8-1 which ties deductions to receipt of income. No income, no deduction. And if the use of the borrowing was not a deductible purpose it is also going to remain the case so the issue is a sale will mean the loan deductbility ends on sale of the asset. Future interest would be not deductible.

    There is a exception to this. If a loan is deductible and the proceeds are insufficient to discharge the whole debt then after sale the interest may continue to be deductible on the residual loan balance.
     
  12. Sanka

    Sanka Well-Known Member

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    Understood interest deductibility is not affected by security for tax purposes. However for lending purposes how do banks look at it.

    Ie lets say you currently have 1m ppor debt which you then reduce to 200k by doing 800k security swap from ppor to ip. I am guessing if you then go to a different bank for another loan will they presume all loans secured against IP are deductible. Or do they ask what is deductible and what is not?
     
  13. Terry_w

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

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    They ask
     
  14. Lacrim

    Lacrim Well-Known Member

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    @Terry_w

    can I just get clarification on something per this example. So let's say after the succeeding going from:

    This

    Property A : Value: $1,000,000 Loan 1: $200,000
    Property B : Value: $1,200,000 Loan 2: $600,000

    to This:

    Property A : Value: $1,000,000, loan 1: $200,000, loan 2: $600,000 (Note loan 1 + loan 2 = 80% value)
    Property B : Value: $1,200,000, No loan

    Will the OP be able to sell Property B after a couple of months (?) without the Bank doing serviceability checks etc given the debt has not changed, but the income from Property B has disappeared?


    And in terms of deductibility of the remaining loan, what if you use the proceeds of $1.2 million (sale of Property B) and purchase shares with it? Will that make the original loan of Property B deductible?
     
  15. Terry_w

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

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    what was loan 1 and 2 used for?

    Changing security for a loan won't affect deductibility.

    If a property is unencumbered or not being used as security for a loan given by that bank then it will not have any say over what is done with that property.

    No. Sale proceeds are cash and not related to loan B.

    You should look at my tips on loan recycling
     
  16. Lacrim

    Lacrim Well-Known Member

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    Well in context, loan 1 and 2 were for two separate IPs.

    Yeah re: property 2 being sold, I guess what I was implying was whether the bank would take issue with the fact that the loan for property 2 was still 100% intact (albeit attached to property 1) but the rent for property 2 would no longer be coming in (bc it was sold).
     
  17. Terry_w

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

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    Your wording is a bit vague. There is only use and security that you have to worry about

    if the property securing a loan is sold the lender, who is the mortgagee, will only allow the sale if the debt is gone. Which means either paying out the loan or changing security for the loan.

    If you can substitute security the lender cannot do a reassessment for servicing if you are selling a property that they don’t have a mortgage over.

    if the investment a loan was used for is gone then the interest on that loan is no longer deductible (limited exception of loss)
     
  18. Lacrim

    Lacrim Well-Known Member

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    OK so in my case what I want to do is to shift the debt from one property to another (both IPs with same lender):

    From this

    IP 1 = value $1 mill, debt $400K (40% LVR)
    IP 2 = value $1 mill, debt $300K (30% LVR)

    to this

    IP 1 = value $ 1m mill, debt $700K (now 70% LVR)
    IP 2 = no debt

    And in due course, sell IP 2 unencumbered to maximise cash received on sale. Is this possible?
     
  19. Terry_w

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

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    If you mean shift the security for the loans this is possible. Once a property is unencumbered it could easily be sold
     
    Last edited: 28th Jan, 2023
  20. Never giveup

    Never giveup Well-Known Member

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    Have you considered tax implications ?
    Assuming you have held IP2 for over 12 months then post sale, after expenses 50% CGT discount and rest will be taxed !