Join Australia's most dynamic and respected property investment community

Tax deductability of equity extracted to fund IP purchase

Discussion in 'Accounting & Tax' started by Honeydew, 24th Nov, 2015.

  1. Honeydew

    Honeydew Well-Known Member

    Joined:
    20th Jun, 2015
    Posts:
    127
    Location:
    SYDNEY
    Say if an individual extracts 20K equity for the purpose of funding the purchase of a cash generating investment, i.e an IP, then the interest charged on this equity loan is tax deductible. Original and new equity loans are in separate accounts and both in the person's name.

    Does this tax deductability benefit only apply if this new IP is bought in this individual's name? What happens if a person pulls out equity to fund the deposit and purchase cost of an IP held in a discretionary trust with a company set up (i.e the IP is now owned by the trustee) but this person is the director and also the guarantor for the loan of this trust ? Will the interest on the 20K equity loan also become tax deductible ?
     
  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,970
    Location:
    Sydney
    Interest incurred in gaining an income can be deductible.

    With a discretionary trust it will not be deductible to you because any income generated will not be yours, but the trusts income.

    If you borrow and lend the money to the trust and have a written loan agreement at commercial rates you will be able to claim the interest. But you will also be receiving interest from the trust and this will match or exceed your interest being paid. The end result is the trust will incur the cost of the interest and it will be able to claim a deduction for the interest if it relates to the purchase of an investment property.

    It is irrelevant that you, the lender, are the director or a guarantor of another loan the trustee is taking out.
     
  3. Honeydew

    Honeydew Well-Known Member

    Joined:
    20th Jun, 2015
    Posts:
    127
    Location:
    SYDNEY
    Thank you so much Terry! :)

    For the written loan agreement, does the interest rate have to be equal or higher than the what the individual is paying the bank for the 20k equity extract ? or can it be less ?(i.e person pays bank 5% on interest for the 20k equity but charges trustee 3% for interest on the loan etc... resulting in a net loss etc ? )

    Does the loan agreement just have be a written document or will it need to be drafted and executed by a solicitor too ?

    Lastly if the net total cashflow is negative in the trust for the first year, then the company does not pay tax, is it possible for this loss to be carried forward in the following years ?

    i.e in year1, net cashflow is -1k,
    year2 , net cashflow is -1k
    year3 net cashflow is +2k.

    Will the trustee's company be taxed at 30% on the net +2k in the third year ? or is there a way the net losses from previous years get rolled across ?

    Many many thanks
     
  4. D.T.

    D.T. Adelaide Property Manager Business Member

    Joined:
    13th Jun, 2015
    Posts:
    5,576
    Location:
    Adelaide, SA
    Hi Honeydew,

    If the equity is extracted, it's usually then loaned or gifted to the company structure. The company structure then invests those funds you've loaned/gifted.

    If its loaned its tax deductible, if its gifted its not.

    To add another spanner to the works, you (personally) receive repayments on the above loan from your company structure. The interest portion of these needs to be declared as income. To fix this, usually the rate you obtain the funds at (say 5%) is the same as what the company structure pays you back at (say 5%)

    Check with your accountant which route you should go.
     
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,970
    Location:
    Sydney
    The interest you charge doesn't have to be more than you are paying, but you will not be able to claim all the interest you charge the trust. It will also not be a commercial agreement - who lends at a loss!! So the ATO may have issues.

    At law a contract can be verbal, but the ATO will not accept one that is not written. Only lawyers or parties could draft a loan agreement. A lawyer wouldn't execute it unless they are a party to the agreement.

    If it is a trust disregard the company. A loss incurred will be incurred by the trust and this can be carried forward to later years, but there are many rules about losses in trusts so get advice.

    The trust is not taxed at all. The company only acts as trustee so it doesn't have any income or pay any tax, just pretend it is not there.
     
  6. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,970
    Location:
    Sydney
    Sounds like it is a company acting as trustee.

    Paying the same rate - it may not be commercial especially where there is no security involved.
     
  7. Rob G

    Rob G Well-Known Member

    Joined:
    16th Oct, 2015
    Posts:
    167
    Location:
    Melbourne
    You borrow at a secured rate on a first mortgage over your residential property.

    You on-lend to a related party.

    If you make an unsecured loan to the related party at a rate either below your cost of funds or significantly below the market rate for unsecured loans then the Commissioner may infer the non-commercial arrangement is at least partially for another purpose.

    Non-commercial arrangements would encourage the Commissioner to search for any additional purpose. See Fletcher's case.

    It all depends upon the surrounding facts.
     
  8. Honeydew

    Honeydew Well-Known Member

    Joined:
    20th Jun, 2015
    Posts:
    127
    Location:
    SYDNEY
    Hi All, thank you so much for your responses and apologies for my late reply. Very much appreciate your advises !!! :)
     
  9. Serah

    Serah Well-Known Member

    Joined:
    12th Dec, 2015
    Posts:
    45
    Location:
    Sydney
    Hello,

    My name is Serah, i am new to purchase a property.
    Sorry, this thread is not for depreciation schedule but i ask anyway. Does anyone know where to get the depreciation schedule in sunnybank hills?

    Thanks heaps.
     
  10. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,358
    Location:
    Sydney
    BMT, Depreciator and many others.
     
  11. Serah

    Serah Well-Known Member

    Joined:
    12th Dec, 2015
    Posts:
    45
    Location:
    Sydney
    Thanks Paul.

    Do you know the standard schedule fee for the residential property in BRS?
     
  12. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,358
    Location:
    Sydney
    It varies.