Strategy: 50% Spousal Transfer Strategy to Increase Deductions

50% Spousal Transfer Strategy to Increase Deductions

I have mentioned the 'Spousal Transfer Strategy' in a few threads in the past but I don’t think I have outlined this strategy in detail with an example.


The strategy works by Spouse A selling a property, or part of a property they own to Spouse B. Spouse B borrows to acquire the property or part property and claims the interest on the loan, while the funds released from the sale are used to pay off the non-deductible main residence.


The stamp duty laws need to be carefully considered as an exemption is generally only available where the property is the main residence at the time of the transfer and the property is going from one name into 2 names either as joint tenants or tenants in common in equal shares. In some states the exemption is not available if the share of the property is purchased, as is the case in Queensland or Victoria. To be able to claim interest on the loan there must be ‘consideration’ given as you cannot borrow to make a gift and expect to claim the interest. On this see:

Tax Tip 15: Transfers for No Consideration and Deductibility of Interest Tax Tip 15: Transfers for No Consideration and Deductibility of Interest


Example
Homer and Marge have owned their home for about 20 years now. It is just in Marge’s name as she bought it before their marriage and the loan has long been paid off. The property is located in NSW and is worth approximately $1mil.


They want to buy a new home (House 2) to live in, but they don’t want to sell the existing home (House 1) just yet, because of the subdivision potential it has.


However if they don’t sell it they will need to pay a lot of interest on the loan used to acquire House 2. They estimate they will need to spend about $1.5mil but only have $700,000 as a deposit. That means they would need to borrow about $800,000 and pay about $40,000 in interest (at 5% pa) per year which would not be deductible.


Instead they decide to utilise the 'Spousal Transfer Strategy, after seeking appropriate legal advice, where Marg would sell 50% of House 1 to Homer for $500,000. If they do this while still living in the property there may be no stamp duty at all. There would also be no CGT because the property has always been the main residence.



Marg and Homer go to the ABC Bank and borrow $500,000 so that Homer can pay Marg for her 50% share. Both names will need to be on the loan as they will be joint owners and joint mortgagors.


Marg will receive $500,000 from Homer from the sale. This $500,000 will sit in the offset account of the loan from ABC Bank until they need to use the money for the new purchase of House 2. No interest will be incurred while this happens as the offset account balance equals the loan balance.


After the transfer they would remain living in House 1 for a few months and then move out and into a new property, House 2, which will be purchased.


When they find House 2 they will arrange their finances so that $300,000 is borrowed, say from DEF Bank, and $1.2mil of cash is used for the remainder of the purchase monies (the $700,000 cash they have plus the $500,000 from Marg’s 50% sale to Homer).



After House 1 is available for rent Homer is able to claim the interest on the $500,000 loan.


Comparison: Strategy v No Strategy for Homer and Marg

Without using this strategy

Homer and Marg would have a loan of $800,000 on House 2 as they only have a $700,000 deposit on a $1.5mil purchase.

At 5% per year interest rate this would be approximately $40,000 in interest with none of it being deductible.


Using the Strategy

They will still have a debt of $800,000 in total, but as $500,000 of this relates to the purchase of House 1, the interest on this loan will be deductible to Homer.

At 5%pa interest rate this amount $25,000 p.a. in deductible interest.

They will also have $300,000 in non-deductible debt because this was used to acquire the new property which will be their main residence and therefore non-deductible.

Total $25,000 plus $15,000 = $40,000 in interest

But because Homer is on the top marginal tax rate his tax will reduce by 47% of $25,000 which is $11,750


So they will be better off, as a family, by $11,750 per year by doing this strategy. This extra money saved can be used to pay down the main residence and debt recycle into investments – saving even more interest and making ever more income.

Over the course of a life time these savings could add up to be hundreds of thousands of dollars.


Cost of implementing is very cheap because the only costs would be

a) Legal advice;
b) Taxation advice (on deductibility of interest and Part IVA)
c) Conveyancing;
d) Loan exit and entry fees.

All up it should come in at less than $3,000.

Note - Please do Not try this without legal advice as I have seen at least one person do the conveyance for no consideration which meant that none of the interest is deductible at all. They were left in a worse position than before doing it.

Do Not try this without tax advice as the loans need to be made to pay out the other party, and payment should be made. Also the Commissioner of the ATO can also deny the deductions, under Part IVA, if the sole and dominant purpose in doing this is to increase tax deductions.

 

great post
@Terry_w thank you

 

If a couple has 2 investment properties in seperate names could they potentially do this twice?

 

Yes, but various tax and duty consequences to be considered.

 

@Terry_w, does a variation of this strategy exist where its a JOINTLY own PPR and one partner wants to buy the remaining half (with the aim of achieving an increased tax deduction)?

Eg John and Jane jointly own a property. This property has been a PPR since it was purchased jointly.

John and Jane have now purchased a new property which they plan to move into (once it settles). The existing PPR will become an IP.

Can John borrow money buy Jane's half of their original PPR (that is becoming an IP), thus John will now become the sole owner and therefore gets a larger tax deduction.

And then Jane can park the funds from the proceeds of the sale of her portion in the new PPR to reduce interest cost?

 

Yes that can work, but no stamp duty concession in NSW.

 

Laws in Victoria changed in the past 18 months or so. Used to be “easier” to do this. Now much stricter in terms of stamp duty concessions.

 

This can still work in VIC, but stamp duty would be payable.

Tax Tip 161: The new Duty on Spousal Transfers in VIC Tax Tip 161: The new Duty on Spousal Transfers in VIC

 

Hi Terry,

I have been reading up on your posts. They are very informative and have opened my eyes. Thank you!

I have a question: would it be beneficial to use this strategy when there’s a loan balance and funds available in offset?

Eg:

Spouse A owns existing home (House 1) 100%

Property Value: 600k
Loan Balance: 300k
Available in offset: 300k

They want to buy a new home (House 2) to live in and turn House 1 into IP.

Spouse A sells 50% to Spouse B
Spouse B borrows 300k to acquire 50% of property

After House 1 is available for rent, are both Spouse A and B able to claim interest on their portions?

 

Yes it can work as long as there is equity available.

 

Thanks for this Terry.

How would your strategy work if;

IP is currently in joint names between husband and wife 50% each.

Husband would like to buy wife's 30%, such that ownership be;
husband 80/100
wife 20/100

we do have a $500k loan against this property too in joint names.

Is there any possibility for us to execute the above, and increase husband tax deductible amount, and put additional amount (that wife receives from sale of 30%) into our PPOR/ non-deductible loan?

EDIT 1 - IS IT as simple as I need to come up for funding to pay out my wife 30% of market value? and because its an IP, I have to pay stamp duty on that 30% acquistion?

EDIT 2 - our other IP are held in 80/20 splits also, I wonder if I buy 19% of all her ownerships in these properties as a means to reduce/repay our non-deductible debt. In other words this could be a debt recycling strategy.

Once above is achieved, can then leverage off the family home to give some tax breaks again in the wifes name?

 

Extra interest would not be deductible in that case as ATO considers it would be borrowing to pay themselves. A can borrow to buy B's share but A and B can't borrow to juggle shares.

 

Thanks Terry.

Is there any way for me to make it work above?

Sounds like your strategy only works if the given property is unencumbered...?

 

for joint owners rejigging the portions it may work if unencumbered. You will need to seek tax and legal advice - there is at least one private ruling on this.

 

Ok, please help me understand spousal transfers and attribution of deductibility a bit more. Sorry if it's a silly question.
Let's say for a hypothetical example, a husband/wife own a property 90%/10% and it has a single loan associated with the original purchase in both names (deductibility for tax purposes notionally split 90 /10 as per ownership interest). If the couple changed the property ownership to 50/50 without making any change to the loan (and there is no 'consideration' associated with the transfer), what happens to the apportionment of deductibility between each spouse? Does it become 50/10 and 40% is lost?

Let's ignore they potentially significant stamp duty implications.

 

enjoyed reading this, learn something new everyday!
thanks Terry

 

Deductibility would be lost. It would probably end up being the original loan less the portion sold.
so 50/10

 

The ATO adopt the view that on the date of a change of interest in a CGT asset that any associated borrowing loses its deductibility whether repaid or not. So repaying it avoids any concerns about apportioning for the deductible / non-deductible blended loan. Typically the original loan should be repaid to repay the 40% residual loan balance borrowing (not the proceeds on sale or the original loan amount !!)

The problem with spouse transfer is that its important a new refinance occurs. Ideally this is best settled by the soliictors just like when you buy on arms length terms. Skipping that step could create all sorts of issues. This can happen a few different ways. T

1. Lender approves a new loan by one spouse to another for the 40%. Lender will be instructed to disburse $X to repay the original loan and balance to spouse. From this point on the tax returns for the property will need to adjust the interest deductions since the original loan is split 40/10 and the new loan is 0/40. Loans are not 50/50 !!
2. Spouse has offset $ or savings. This is a area where creative tax a/ credit advice in advance may identfy a tax benefit. eg Use cash to repay a loan and redraw etc.
3. Anything else....We see this a bit ie. Loans are disregarded or the new borrowing isnt "settled" with the spouse correctly. eg Money borrowed from new loan are credited to a offset for the old loan and then transferred two days later to the spouse. The trail of all old and new finance is important and care must be taken to plan how the loans will be discharged and drawn down. Moving funds through a savings account for example may be a concern.

Tip : In the example of 1. above the money transferred to the spouse could be used to repay the PPOR. Essentially you have just debt recycled by converting non-deductible debt into deductible debt.

 

Thank you so much for a great article @Terry_w . This is very informative.
Sorry to ask a similar question as above, I know I need to seek professional advice but been struggling to find an accountant who is interested.
Basically, we own our home as follows:
Semi-detached home in Mascot value: $1.1K (owned by husband and wife 50/50 since purchased years ago)
Loan: 485K
Cash in offset: 350K

We desperately need to but another house for our growing family, however, don't want to sell our Mascot property due to potential future rent in a prime location (walking distance to the station).
We are looking at a new property for about 1.5K in which we would take 100K from the current property plus our 350K - so the new non-deductable loan would be around 1.1K (ouch!)

Husband pays a LOT of income taxes already and there wouldn't be much deductions in the Mascot house as we have too much equity there.

@Terry_w , do you think this spouse transfer strategy could work for us even though we would need to pay stamp duty?

So Basically husband would borrow maybe 400K to buy most of the wife share.
The original loan is in both husband and wife names but now it would be mostly in his name and will be deductible. Is that right?

The wife now has 400K (less stamp duty) to put towards the new house.
So instead of borrowing 1.1K for new house, the new loan would be $700K.

Is that correct?
Sorry not sure how properly do the calculations when there is already the existing loan.

Thank you

 

Yes it can work. Husband should consider borrowing about $600k to buy wife's share.

Another option is to sell to a fixed unit trust and get to claim the interest on the full $1.1mil plus stamp duty and costs. See
Strategy: 11 Strategies for when you move out of the PPOR and keep it Strategy: 11 Strategies for when you move out of the PPOR and keep it