Tax Tip 1: Parking borrowed money in an offset account

Thought I would start some tax tips so I don't have to keep repeat typing the same thing over and over again.

Many people borrow money and deposit that borrowed money into a savings account (including offset accounts) and later use that money to invest. Will the interest be deductible? The answer is "Maybe" !

In relation to investing, under s8-1 ITAA97 an expense is deductible if it is incurred in gaining or producing assessable income. Interest is generally deductible under this section. But problems arise where the incurring is not directly connected with the investing.

In a case from around 2004 Mrs Domjan borrowed money, put it from the loan and into a savings account to write a cheque. The savings account contained other money. So when she wrote the cheque to purchase an item for her investment property it could not be said that she used the borrowed money. The connection between the borrowing and investing was broken.

Some have argued that where the savings account is empty then there will be no co-mingling of borrowed and non borrowed funds if the loan is drawn down into this account. This is true, but where interest is incurred on the borrowed funds it cannot be deducted as there is no income, or commercial income generated. However where the savings account is an offset account there is no interest incurred at all as the borrowed money is in the offset offsetting the loan. If this borrowed money is later used for investment then the interest will start to be charged on the loan. I think this interest can be traced to the investing and the interest should be deductible (assuming no mixing).

However as far is I know there is no legal or ATO authority to say this is correct, except for one private ruling see Private Ruling Authorisation Number 57920. Question 1. Note the answer to Question 2 is a 'no', but I cannot understand the situation here. Also note that the circumstances to this question differ from our scenario of 'topping up a loan' as this situation involves the taxpayer borrowing extra at the purchase, similar but slightly different.

This private ruling cannot be relied upon by anyone other than the person who applied for it - within the dates listed.

So in summary

1. Borrowing money to part in a savings account will probably result in the interest being NOT deductible.
2. Borrowing to park in an offset account may result in the interest being NOT deductible where the offset contains other non borrowed money. The interest could possibly be deductible in part.
3. Borrowing to park in an offset account may result in the interest PROBABLY being deductible when the offset funds are used to invest at a later date.

Where an offset account is involved it is very easy to get mixed up or confused with account numbers etc and to inadvertently deposit non borrowed money into the account. This is harder to do with a loan account and the effect is less as any deposit can be left there without contaminating the loan. Where borrowed money is in the offset and non borrowed money is deposited it will be impossible to rectify. It would be like putting a drop of urine into a cup of tea.

To avoid the risks of ruining deductability I suggest a better way to proceed would be to use an Interest Only loan where you can draw down the funds at settlement and put them straight back into the loan. The funds can then be reborrowed from the loan at the time of investing.

Alternatively use a LOC product. These allow a credit limit with funds drawable (ie borrowed) when needed. The disadvantage is the higher interest rate and these loans are often (but not always) without a fixed term and can be called in by the lender at short notice. However, once the money is actually used the LOC could also be converted to a term IO loan. This way you get the best of both worlds.

See
Private Ruling Authorisation Number 57920
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/57920.htm

Domjan v Commissioner of Taxation [2004] AATA 815

 

My tip to avoid the loan contamination is:

1. Ensure the loan has a redraw facility
2. If the bank puts the $ into a offset which contains ANY other savings before you want to use them, re-bank the loan drawing to the loan AFTER checking with bank / broker that this is OK.
3. Redraw when actual proceeds are needed and draw a bank cheque or directly EFT to the solicitor etc...

Banks seem to have a thing about a new loan being "advanced" and so they draw down new loans and dump proceeds somewhere so that the loan satisfies the condition of being advanced.

Terry : Do mortgage brokers still get fees if the $ sit in a offset ?? Would the suggestion at 2. above affect future fees for a MB ?

 

Some banks refuse or cannot draw the funds down back into the loan account itself =e.g. ANZ. So another account must be nominated.

Paul - brokers don't trails on the loan less the offset. So a loan fully offset would mean no trails. But on a LOC product the upfront is just 75% (usually) of the usual upfront commission. Another reason why some don't recommend the LOC product.

I agree with your tip - 2nd list paragraph above.

 

Hi Terry,
Great info thanks, can I ask a question ( or 2 ).
I'm doing a Reno at the moment. I have money sitting in a loan account. Can you tell me how best to pay for things?
I have put what I can on credit card and transferred the exact amount over from the loan account onto the credit card, Is this ok? How do I pay for the things that I need cash for if I can't transfer the money into my account and withdraw? Can I go into the bank and withdraw the cash straight from the loan account thereby not transferring it and not mixing money?
Thanks for your help.

 

If your credit card contained other debt then it would be a mixed purpose loan and you would run into issues. not sure how an ATO auditor would look at this though.

if no other transactions then the credit card is just a loan which can be refinanced with another loan without changing deductibility of interest. If you need to pay cash then you could borrow it from the loan and pay. Just use a separate wallet to avoid mixing (joke). best to try to leave a paper trail if you can.

 

Thanks, maybe a dumb question but if I draw out funds from the loan and I find I don't need it all, can I pay the excess back in with no problems?
I think I've already screwed it up though with the credit card. I have a paper trail, kept all the receipts ( nice and tidy in a zip lock bag, somewhere ) how does the ato treat misinformed and dim if we get audited

 

As long as all withdrawals are for the same property there should be no issue paying the money back in the loan.

99% chance you won't be audited. Even if you are they may not pick it up, even if they pick it up they may not worry too much. A penalty, if any, would be small.

 

Thanks so much, that's a huge load off.
Appreciate all you do on these boards.

 

Great post Terry! It's really got me thinking.

If someone had an offset account for their mortgage where their rent went into and where their repayments were made from, but they put an extra amount into that offset account each week from their PAYG job, would that be contaminating the loan? Would the interest still be deductible? I've confused myself from reading.

 

If the offset didn't have any 'parked' money which was borrowed then there would be no tax issues.

 

Bravo! Brilliant post Terry.
I know I have probably helped contribute to this with endless "contamination" questions but this just lays it all our perfect.
Now to find the rest of your tip posts.

 

I still prefer Terry's anaology of a glass with urine mixed with another drink. You cant choose to unmix it later.

If everyone thought of an offset as a drink or recipe that cant be unblended they would not mix and contaminate.

 

Lol me too don't drink and toilet at the same time

 

How do you deal with this when it comes with refinancing and accessing equity?

For example, property is worth $1,000,000.
Current loan is $600,000 (60% LVR).
Broker recommends a refinance and pull out equity at the same time.

In theory, it should be easy, have Loan 1 as $600,000 and Loan 2 as $200,000.

In reality, the $600,000 is never $600,000, its either a little higher (accrued interest + fees) or a little lower (its a P&I loan where the regular payment occurred just before the loan finalisation).

And the $200,000 equity loan is drawn down and paid into the nominated bank account.

I've noticed the paper work only allows for the "surplus" funds from loan #1 and loan #2 to be paid into a single account, you don't seem to get the option to have the surplus of Loan #1 to paid into account #1, and surplus of Loan #2 paid into account #2.

How does one get around this without taking out a Line of Credit (due to higher interest rates)?

 

See my first post above.

You could borrow under a new split, paid into a clean offset account. Immediately pay back into the new loan split, carefullly avoiding paying it off. Then borrow it using redraw when needed.

 

I think this may be the answer that I was looking for ... but can I ask the question just to be sure? In the process of refinancing at the moment. Have 1 loan of 15k for home loan, and another loan of 318k for IP1. Using home as security to borrow 189k with new lender, and 252k using IP1 as security.

189k has 3 splits, 1 split has an offset. I believe at settlement after paying off old loans, surplus funds get parked somewhere. I've nominated offset account (which may or may not have some rent money in it by the time settlement occurs). We also plan to pay rent into offset and some money from salary.

From what I read, I should split the suplus funds as evenly as possible back into the loans as originally intended...? We want 35k surplus for private redraw after paying out 15k, so loan 1 is set as 50k. Second split is 71k which will probably have surplus funds. I was going to leave it in the offset but this will contaminate the 71k loan interest tax-deductibility?? I should put it back into the 71k loan, am I correct?

Does it matter if there's money in the offset before the settlement?

If I redraw for investment (eg pay rates), the money will go into the offset account. This is acceptable as long as I can show that amount went to pay rates?

It's just a tad confusing

 

I can't understand you question so I better no answer it.

But from what I can gather you will be parking money in an offset account and this offset account will contain other money. If this happens your loan interest will not be deductible in full and the loan will end up a mixed purpose loan.

Don't do it!

 

Lol ok I'm just so confused as to what I've been told will happen at settlement. The whole loan amount (even though split) will be used to firstly pay off refinanced loans. Then any surplus are deposited as one whole lump sump somewhere.

What happens if one of the split amounts is for a deposit for a new IP which I am yet to buy? If I transfer the whole loan amount back in, does that mean the loan is cleared???

"Immediately pay back into the new loan split, carefullly avoiding paying it off. Then borrow it using redraw when needed."

 

If you pay a loan off and then redraw the money again it will be a new loan for tax purposes and deductibility will mainly depend on what the funds are used for. If paid off completely and borrowed for one purpose then no mixing either.

 

Hi Terry, Great write up!

If I was to draw down funds from a loan and have it sit in an empty savings (transaction) account which does not pay any savings interest at all, and then transfer funds to pay for an investment purchasing costs. Would all interest be tax deductible in this scenario?