Tax query re: P&I loans on investment property

Hi all,

In the process of refinancing our first investment property, we've run into a small hurdle with the 80% LVR cap on investment interest only loans (both CBA and NAB are enforcing this) and have a tax query.

Property 1
Loan: 491k
Valued: 660k
LVR: 74%
Refinanced to NAB who offer LMI waiver up to 90% for Children of NAB staff.
Issue is that they will no longer offer interest only on investment loans above the 80% LVR.
We are currently renting and have no non-deductible debts.

We are looking to purchase our 2nd Investment property and our options are:
1- Increase LVR to 80% on first loan: frees up $37k in equity to use for investment purposes.
2- Increase LVR up to 90% on first loan: frees up up to $103k equity to use for investment purposes, but it would be P&I.

If we choose to pay P&I on the $103k equity, how are the principle payments treated by the ATO in the future if we wish to withdraw the equity again and buy a 3rd investment property?

 

In a principal and interest loan, the interest component is tax deductible, the principal is not. You don't get any tax breaks for paying down principal.

 

As Peter said - The interest charged to the loan is the deduction not the repayts. In addition if you draw equity and buy a new IP its wise to split the equity loan so the new portion is a separate loan and it will be deductible v's IP3 NOT the property it is secured agaisnt. Otherwise you have a blended loan and it can become a problem to apportion and trace it through to each property etc. Your broker can address a split for the loan.

The borrowing costs for the refinance may likely fall onto IP3 over 60mths

 

If your parents lend you money to help in paying the principal you will owe your parents an amount of money. This debt to your parents is wholly connected to the borrowings on the investment properties.

If you later on refinance to repay your debt to your parents the interest on the subsequent refinanced amount is tax deductible.

Documentation and loan agreements are critical. And the application and ongoing management is critical. Estate planning matters come into play as well.

And the debt to your parents must be real. If this is all a tax dodge it will not work.

It does not have to be your parents. It could be somebody else. But the management is critical otherwise it will fall over.

This is not a problem if it is interest only. You could simply use offsets to effectively pay down the debt and have flexibility later on to use the offset monies for other uses.

 

I wrote something similar to Ross's point here
Tax Tip 46: Want to Pay IO on a PI loan? https://propertychat.com.au/community/threads/tax-tip-46-want-to-pay-io-on-a-pi-loan.4438/

I think borrowing from related entities to pay the principal can work.

 

If the total deductible debt rises and the parents are used to implement an interest capitalisation arrangement Part IVA could apply. Real and effective payments also need to match the formal agreements too. Parents who lend for a temporary basis may seem applicable but an escalating debt seems highly unusual. ATO always looks skeptically at loans that rise

 

Hi all,
Thanks the replies, some good suggestions. I am aware that the principle payments are not tax deductible, but my question was regarding what happens to the interest deductions after equity (principle) is redrawn.
I did a bit more reading on the ATO website and I believe I will need to use loan splits as per your suggestions above.
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)

If my understanding of the link above is correct, then interest on the redrawn amount is deductible as long as it is used for investment purposes. If the redrawn amount is used for personal use, then it is not deductible. Is this correct?

Eg. P&I loan for Investment property 2 of 103k. Over 3 years we pay P&I (10k principle paid of as an example).
I understand that the Interest against this loan is deductible against IP2, the 10k paid Principle is not.
In the future if we wish to redraw the 10k principle paid on this loan for the purpose of another investment (IP3), we would need to split the $103k loan into $93k (IP2) + $10k (IP3).

 

If borrowing to invest the interest will be deductible whether loan is pi or io

 

Take care if two different investment purposes exist for the loan. eg originally for a IP and now $15K is for shares or even a new IP. This is still a blended loan and not ideal.

I strongly recommend shares always have a distinct loan account. There are sound reasons to use margin lending rather than a home loan style account also but thats a whole thread in itself.

 

thanks all for the advice!