Legal Tip 15: An issue with mixed purpose loans where both portions are investment.

Hi Terry

Would this also apply in a situation when you are demolishing an existing PPOR with a mortgage and building two townhouses on the block (one to rent, one to live in). If you refinance after subdivision are there still deductability issues?

 

Yes.

You can only deduct interest on loans related the land and construction component of the investment property.

 

Interesting. So assuming the land is subdivided in half, I could only claim half of the current loan amount, plus half the loan for the construction costs?

So I guess the simplest thing to do would be refinance to two separate loans for the same amount, and put cash into the offset against the ppor?

If I rented them both out at the end, would that change things?

 

If vacant land was cut exactly in half and both halves had same views etc then they would probably be each worth the same price so you could spilt the loan in 2 halves.

It is not essential do split, but you should because later when you sell one you won't be able to claim the interest on the loan associated with this property.

 

Terry, from your second Tom example, I just like to clarify my understanding on the solution.

Is he supposed to split the $200k & $400k on security B when he got substitution of security instead of getting 1 big chunk of $600k?

 

Yes

 

So long story short, this is would be the tax implication associated with loans being cross-collateralized right? Essentially they all become multi-purposed loans..Is my understanding there right?

 

Cross collateralising loans? Nope, security for loans is not really relevant to this topic.

 

No I mean, the purpose for which the funds has been used for. Say when I get a big home loan for both IPs or PPOR/IP (hence cross collaterilising both properties against the same loan), come the sell-off time, repayment of the sale proceeds will have to be proportioned between the two properties isn't it?

Or do you mean that cross securitilisation can even happen with split loans?

 

If you have one big loan for 2 purposes this will be a mixed loan and you will have problems.

 

@Terry_w let me offer a slightly alternative scenario.

Instead of buying properties with the money from this loan, you're buying and selling shares instead.

Over time you buy and sell different shares, in different amounts, with varying profits and losses. You even dabble in options and Forex.

Wouldn't this have the same problem? Does this imply that for each share purchase a separate split should be set up?

 

Strictly speaking yes. I am not sure how strict the ATO would be on this though. imagine you buy 100 telstra shares using a LOC and then another 100 telstra shares a week later. It should not pose a problem. But what if you bought 100 Telstra shares and then 100 ANZ shares. You then sold the ANZ shares - technically the loan is mixed purpose and any repayment would into the loan before splitting would come off both the Telstra loan and the ANZ loan.

A private ruling would be needed for this one.

 

... and therein lies the insanity of the ATOs approach to all this. It either treats asset classes differently (likely on some arbitrary assumption of the size of the transaction), or every individual who wants to borrow funds to trade shares needs to get a private ruling.

From there, an argument is created that this private ruling should also apply to other asset classes.

Whilst I appreciate the legal logic of this entire argument, in practical application the outcome of that argument is quite ridiculous.

This is definitely an interesting topic, it'll be worth discussing with my accountant and solicitor next time we meet.

 

I guess it comes down to the interpretation of the law which only says interest on borrowed money is deductible if used for investment purposes. When writing legislation all the practical implications are not always apparent until situations arise years later. If this wasn't the case there would be little need for courts!

 

Ok hypothetical question, please.
I have an equity release loan secured by my PPR.
I have bought IP#1 with the equity release loan.
I'm looking to buy IP#2 with remainder in equity release loan.
To solve the issues discussed in this thread, do I split the equity release loan before purchasing IP#2? Any other issues with splitting?

 

Ideally -yes. You could also split later.

 

Hi,

I am trying to unscramble a mixed standard variable loan into 2 new deductible / non-deductible loans.

Do I have to keep the 2 new partitions to pay off the old same loan type (i.e. standard variable) to comply to the ruling?

Can I turn one of the non-deductible partition to LOC instead for future purchase deposit and still comply?

Thanks

 

Hi Terry,

I found your post rather disturbing, especially considering these rules may apply different for different assets (property vs shares). A google search on the subject returned this ruling. Of course not a tax expert and this may be out of date, but my reading of paragraph 17 says that anything paid back into the loan "is to reduce only that part of the outstanding line of credit debt applied to the previous use of those funds". The previous use of the funds, not the all the funds.

TR 2000/2 - Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities (As at 1 March 2000)

See also 45 and 66-73, although I find the allocation of repayments in examples four and five usually here as there is deductible and non deductible mixed I would have expected both be reduced not just the "use of those funds" amounts. These examples really do just seem to "follow the money".

Have I not read this as intended (easy to do) or have the rules changed since this ruling?

 

See my tip on the exception to the rule when paying down a mixed loan. If it is proceeds of the sale of the asset the funds were borrowed for then you can pay fown one portion of a mixed loan.

Se rules for property and shares too

 

If I refinance an IP loan (secured by IP)!to increase the loan for debt recycling (IP expenses mainly but possibly shares also). Should I split the loan so the increase loan amount is seperate to the existing IP loan amount ? Or is this required for multiple IPs?