Interest In Advance

Hi all,

My wife and I are expecting our first child in July of this year.
We each currently earn around $100k gross in wages.
She'll be taking 6 months off to look after the baby and is expecting to return part time in the new year.

Given she'll be on a much lower taxable income next financial year, would it be wise to pay 12 months of interest on our investment property upfront in June of this year?
We have two investment property loans (one is IO and the other is P&I) which are both variable.
The properties are owned as joint tenants, and there's not as much benefit for me paying interest up-front as my wage next year isn't likely to change.

P.S: I had a quick look through Terry's tax tips to find information on this, but couldn't see it

Thanks

Frosty

 

Do the sums. If she owned property on her own she might have been better off because she could have capitalised interest too perhaps.

 

Prepaid interest will double the interest in the 2019 year and leave nil interest deduction in the 2020 year. The benefit should be assessed based on both years to determine what benefit may occur from bringing the amount forward.

There can be issues with a prepaid interest arrangement:

• Must be organised well in advance
• Facility needs to be approved - May be easier to do this now while she is working ?
• If the property use changes it may be a problem. eg the rental is sold prior to June 2020 or it becomes your home. Then the prepaid benefit is cancelled and an assessable amount may occur.
• Consider a 2019 PAYG withholding variation as well. This can assist you to start reduced PAYG tax withholding from salary now or soon perhaps?
• Consider Centrelink / Family Tax Benefits and paid mat leave etc too. Without interest deductions its possible she may have a 50% share of a positive rental income.

Then there is the issue of capitalising interest raised by Terry. Normally capitalising interest doesnt pass the ATO sniff test. However ONCE your wife commences leave it is tolerated to make the IP loan repayments from another new loan split (or addition to the existing loan). The ATO have issued rulings on this concerning a cashflow issue vs a scheme to capitalise. So its often OK. This may enhance debt subject to interest deductions but the merits are very long term. eg if $20K of repayments were paid using new borrowings then extra annual interest of $1K max occur for the forseeable future. A long term payoff and at the expenses of higher debt which means less equity. But it may be possible to funnel the $20K of cashflow into your own home loan instead. Its important such an arrangement only be temporary and not a full blown scheme to recycle debt.

 

It might not depending on the level of interest. If your prepaid interest takes your taxable income under 87k you will probably have the same tax rate as your wife will next year - the tax rates between 37k and 87k is the same.

So a 13k reduction of income should be good. More than that? Maybe not maybe?

 

Perhaps this may be an opportunity to consider a spousal transfer strategy too.

 

A basic question. If you have an standard IP loan, do most banks have a mechanism to allow you to prepay interest for next FY?

 

Yes.

It must be fixed though.

 

Its an IP and Vic ? The CGT and duty may be concern.

 

One thing I missed. Enhancing neg gearing wont reduce adjusted taxable income as a consequence of prepaid interest. I have encountered some who believe it may pull income down so Centrelink or other benefits eg Family Tax Benefits or mat leave payments improve. The use of adjusted taxable income averts that and its no issue. And maternity leave may be assessed on the prior year taxable income and provide a benefit if it pulls the 2019 year spouse income down v's 2020.

 

And just so I understand, you get a full tax deduction this FY for (up to) 12 months interest prepaid this FY.

 

yes - potentially.

 

definitely a concern. But paying duty can be worth it sometimes, depending on the circumstances. CGT could be minimised, to a degree, by the low income (+ interest in advance perhaps).

However, it might be hard to get a loan now.

 

And if they go through a certain northern state lender will be like extracting teeth

 

I have clients who physically prepay interest rather than just being charged the interest in advance and despite this they still take forever....Westpac / STG required real early application in March or April. Once you could apply in mid June. Physically prepaying also provides a small compounding benefit.

The danger is if they miss the cut off they face a positive geared property rental income issue.