Repaying LOC with partial investment sale proceeds

Scenario: 100k LOC, used to buy 2 separate income-producing managed funds at 50k each. 100% of the interest is tax deductible.

1) When one of the managed funds is sold, am I correct in assuming that the original 50k borrowing for the sold fund must be repaid, since that 50k borrowing is no longer for an income-producing purpose?

2) If so, since this 50k repayment is associated with the sale of an asset, does it cleanly restore the LOC back down to 50k of fully deductible debt? Rather than 25k coming off each part, resulting in only 25k of deductible debt associated with the unsold fund?

3) Will the repayment always equal the original borrowing for that fund (50k) regardless of whether that investment increased or decreased in value?

 

1 - doesn't have to be repaid, but the interest would no longer be deductible.

2- see tax tip 55
Tax Tip 55: An Exception to the rule about splitting before Repaying a Mixed Loan

3. No

 

Thanks Terry, could you please clarify point 3?

Assuming that one wants to pay the LOC back down (to save apportioning interest)...

Say the fund is sold for 60k. Only 50k is put towards the LOC because the next 10k would come off all other parts of the borrowing equally (as per examples in TT55)

What if the fund is sold for 40k? Would one have to stump up another 10k of their own cash? (or is it preferable to not repay the LOC in this situation?)

 

Generally it would be worth splitting the loan prior to repayment to clearly show which borrowing is for which asset.

 

So say the borrowing for the sold fund is split off to its own 50k loc. The fund sells for 40k and the interest on that 50k loc is no longer tax-deductible.

In order to reset the purpose of the loc for future investment, the whole 50k needs to be paid down to 0. This means stumping up an additional 10k.

Hence I'm wondering if the same thinking applies to an unsplit loc...

 

1. Either repay some your recouped expenditure (i.e.the first $50k) or reinvest all of the proceeds to earn assessable income
See TR 2000/2 paragraph 37, and example 4.

2. Yes. The Commissioner considers repayment of a recouped expense as a targeted repayment.
See TR 2000/2 paragraph 45

3. If there is a shortfall from the sale of the investment then provided all proceeds have been used to repay that respective loan portion, all interest should remain deductible

Note that TR 2000/2 example 5 is a contentious view and perhaps should be read down to the specific circumstances of a LOC. This is a rolling monthly refinancing arrangement and seems to get an unusually severe treatment by the ATO.

Case law on other types of investment loans has supported ongoing deductibility.

If you have a shortfall on a LOC then seek legal advice regarding whether to apply for a pbr, followed by an objection.

Cheers,

Rob

 

TR 2000/2 has examples of situations like this. I think I copied these into my post too.

You could pay $60k into the LOC, but as only $50k relates to that debt the extra $10k would reduce other debt of the LOC

If there is just $40k this can be paid into the LOC and this will come off the $50k relating to the purchase of those shares. There will still be $10k owing for these shares and the interest on this may be able to be still claimed under certain circumstances.

 

Thanks guys, interesting to know how to handle the opposite of repaying too much. Although I wonder if one was to sell an asset for 40k and then repay 50k (to be safe and fully reset it) would still be matched up as a repayment relating to the sale of an asset, since the amounts are different?

 

You would be repaying $50k off the money you borrowed for those shares that you just sold.

 

So TR2000/2 p45 will undoubtedly apply if the repayment matches the original borrowing amount?

 

Not necessarily. Only for the proceeds of sale. If u sell for $40k and then chop in another $10 cash then the cash will come off the mixed loan portions

 

That's quite a sticky situation... glad I'm asking here first!

1) So the cleanest way to do it after the sale would be to split 40+10+50, use sale proceeds to pay off the 40 (resetting it), leaving an unpaid 10 split and uncontaminated 50 split?

2) If split before the sale, would 50+50 be sufficient to isolate each investment from each other? i.e. just going off the amounts borrowed since there are no sale amounts to go off?

3) If the sale proceeds are larger than the amount borrowed, must the entirety of the sale proceeds be paid into the LOC? Paragraph 69 details why the extra/profit will be split amongst the loan portions, but doesn't seem to imply that it is compulsory to pay it into the loc.

 

ot sure what you mean here. How much did you borrow to buy these shares and what is the sale amount?

3. no. Just pay off the amount borrowed. The surplus can go into your offset account or into the main residence loan.

 

For 1., 100k loc, 50k borrowed for asset A and held, 50k borrowed for asset B which sold for 40k. If that 40k is paid into the 100k loc, then the remaining borrowing is 60k, which is 50k for asset A (deductible) and 10k incurred as loss on B, which may or may not be deductible.

To reduce the uncertainty, in 1. I'm asking if the loc can be split 50k+50k to avoid contaminating the 50k for asset A (my original 50+10+40 split was overcomplicated)

 

Yes you would end up with a mixed loan. You could keep as is, or you could split before paying back. That would be clear cut.

 

Cheers. Thanks for putting up with my long-winded questions