Tax Tip 1: Parking borrowed money in an offset account

Below is something I just wrote on another thread. Some people want to borrow and park in an offset but don't realise depositing rent in the offset will contaminate the loan. This is another reason why you should avoid parking:

Even depositing rent in an offset containing nothing but borrowed money will contaminate the loan. If the offset contains the borrowed money only you can trace it back to the borrowings so the interest will PROBABLY be deductible (see tax tip 1). But as soon as you mix non borrowed money in an offset containing only borrowed money it will be contaminated and AT BEST you will have to apportion the interest. Doesn't matter what the source of the money is.

 

After reading this my understanding is :
Either:

1. Park Borrowed money in an offset account created for this borrowed money only. Do not deposit any other money into this account.

OR

2. Return / pay off the borrowed money back to the source but don't pay 100%, as bank might close the account off. For Eg. if borrowed money is $100,000. Return $99,999? Have a redraw facility ready so that can draw the money when needed.


is this correct?

 

No. 1 May be ok, but avoid it if you can and go for 2.
Alternatively a LOC.

 

ok thanks terry.

Will do No.2 for this short term.
Haven't worked out what is LOC yet .. too many things to learn!!

 

I am confused now. I have one IP loan, no PPOR. One offset account linked to the loan. All money from salary and rent go into this offset account. Is this wrong?

 

Nope.

Unless you had borrowed money and put into the offset?

 

No I haven't and before doing something like that I will ask you

 

In that case you should be fine then

 

Hello @Terry_w ,

I have been speaking to some tax accountants and I have been given some advice which seems contrary to your writings on the deductibility of interest and the use of offset accounts. I just want to know who is right in with regard to this principle. Just to make sure I have understood what you have written in this article, you are saying that both the purpose and source of the finds determines deductibility of the interest for the loan. What I have been told is that as long you do not use the money in your offset account for mixed purposes, that is, to use that money to buy a car and an investment property, then you should be fine to mix borrowed and non borrowed funds. They say that the 'urine' analogy only applies to the purpose of the funds rather than their source which means you only contaminate the deductibility if you spent the money for personal needs, even if it was one single dollar.

Let's say there is a scenario where you have a investment home loan (IP1) of $50,000 on a property worth $100,000 structured with a simple offset account against the home loan. Every year you can claim the interest charged to you against the loan as it is used for investment purposes.

The property then increases in value by $100,000 taking it to a new value of $200,000. Let's say that the bank is willing to lend you another $40,000 based on this increase in value and deposits the money straight into the former empty offset account. Assuming you did not form a 'loan split' you now have $40,000 in an offset account offsetting a $90,000 loan, so essentially you are still paying interest on an $50,000 loan, so at the end of the financial year you would claim the interest charged.

Then say you take that $40,000 sitting in the offset account and you wish to purchase a property. You calculate that it requires $50,000 (including deposit and all purchase costs) to purchase another property, this leaves you with a shortfall of $10,000 to complete the transaction. So you decide to place $10,000 of salary worth of savings from your normal transactional account into the offset account to bring the total amount in your offset account up to $50,000. You then take this $50,000 and purchase another $100,000 property (IP2) which allows you to obtain a $60,000 loan, where the equity in the property is $40,000 ($10,000 used on purchase costs). You then claim the interest charged by the bank on the $90,000 loan from IP1 and also claim the interest charged by the bank of $60,000 on IP2.

In this scenario I have been told you can still claim the interest on the $60,000 loan against IP2, AND also the $90,000 loan against IP1. I have been told that it is the purpose of the funds which is the most important thing, that even though you mixed borrowed funds together with non borrowed funds, you are still using the combined amount for investment purposes. Furthermore, I was advised that because you are depositing extra money into the offset account, you are in fact paying less interest on the loan due to the offset facility and therefore are overall able to claim less interest as a deduction in any case. This argument seemed to make sense in any case as there is an existing offset account with $40,000 of borrowed money offsetting a $90,000 loan, so you are paying interest on $50,000 and claiming interest on $50,000. If you put an extra $10,000 of your salary into that offset account with the aim of purchasing another property, you are essentially temporarily only paying and therefore only able to claim interest on $40,000 of that loan for that period of time.

Is this all true or completely off the mark?

 

I think in your example all the cash in the offset account was used for the investment. This cash was part borrowed and part cash deposits. Since all the money was used the interest on the loan used to borrow to park in tthe offset should all be deductiblle.

But if only half of the cash in the offset was used then you cannot say you chose to use the borrowed part of the offset. This is the urine analogy part. Domjan case paragraph 44.

All this cann be avoided by not borrowin to park. Never park in an offset is my advice.

 

Incorrect Hotmail

1. The only deduction to be claimed against IP1 will be the original loan interest on $50K. The other loan interest on $40K is deductible against IP2. ie IP2 has a $100K deductible loan. You are confusing loan security with loan purpose. Where different ownership interests are involved this can make a huge difference. (ie one taxpayer +ve geared and spouse neg geared)

2. You haven't blended money in the offset example given. Taxpayer borrowed $40K and combined this with $10k savings and used all of it to settle. 100% of the funds were used to acquire. No issues. The problem is more evident when a taxpayer has $30K of savings in a offset then borrows $40K placed in same offset and then uses the $40K to settle. That's where the urine principle operates. You cant put $40K in and then take it out without being tainted. Arguably in the example I cite the deduction may be limited to 57.14% (40/70) of $40K = $22.8K

 

I just spoke to someone today about this issue and my suggestion was when the loan proceeds are drawn down have the bank credit the lawyers trust account pending settlement. A perfectly clean answer for all those who have banks that demand funds go to a savings or offset account -

 

Yes good idea Paul. saves potentially contaminating loans.

 

Hey I should offer a wonderful free service. I will willingly help any PC member avoid such a concern and accept $ to my account. Any takers ?

 

Hi Paul,

1) You raise an interesting point in the first part of your post. I'm a bit confused as to what this means though. So you are saying that you can claim the interest charges on the $50k loan from IP1 and can claim $100k from IP2 ($40k loan and $60k loan) which makes sense, but in practice the bank charges you interest based on the $90k loan from IP1 and $60k loan from IP2 right? So are saying on the tax return you need to have the accountant manually rearrange the claim so that you are claiming $100k's interest from IP2 plus $50k's interest from IP1 INSTEAD of what the bank charges you with $60k's interest from IP2 plus $90k's interest from IP1. Is this what you are saying?

2) It's still hard for me to see the difference between using all the mixed money in the offset account and having it be fine versus only using a portion of the mixed money in the offset and it being contaminated. Could you explain why this is?

I was reading the Domjan paragraph and it seems that she mixed borrowed funds into an account which contained personal funds. I assume by what is meant by personal funds is that she was using the money in that account to spend on non investment purposes. What is the definition of personal funds? For example if I use all of my salary for investment purposes, is that still considered personal funds? In my example, what if in that particular offset account, the funds exiting the account were always used for investment purposes?

Interesting you suggest never parking borrowed money into an offset account. How do people usually borrowing from their existing properties to fund new purchases. What would be the optimal product types to do this (besides LOC)?

 

To answer your question to Paul - yes you need to apportion interest in this case. Interest is deductible against the income it is borrowed to produce.

for the second part any cash in the account that is not borrowed money is personal fundsl It has ne bearin on what you use personal funds for. It doesn't change anyhting if all the withdrawals from the account were used for investment purposes - it would still be a mixed loan if the offset hadd any personal funds in it and you would have to apportion the interest.

use a LOC or pay back into the loan and reborrow when needed.

 

I have done this. I have borrowed against an existing property, to part fund a new property purchase. I have done this on three separate times just using a standard home loan, not a line of credit. Each time, I organised for the funds to be disbursed directly from the loan account to the vendor using a bank cheque each time. This can be organised as part of settlement.

For my most recent loan, I thought I would try the offset thing. It has not worked out and I have to reset and start again. Lucky I have not invested any of the money yet, so there is still time to fix it.

 

Hi everyone,

I have been frequenting accountants again and it seems there are a range of opinions on this matter. There are four basic positions accountants seem to take for this deductibility of interest issue when spending a combination of borrowed and non borrowed money from offset accounts:

1) Some accountants have said that as long as the money from the offset account is used for investment purposes, it doesn't matter how you mix and match borrowed and non borrowed funds, all the interest produced from removing the money from the offset in any combination is always tax deductible

2) Some accountants suggest to seek a private ruling and wanting to charge close to $2500 dollars to work together with a tax lawyer to set up an application and go through tax law etc.

3) Some accountants suggest that as long as you are not overclaiming IN TOTAL, i.e. even if you contaminated funds in offset accounts and you still claimed the interest generated when they were spent, you will never be overclaiming interest deductions compared with someone who had 100% perfect structures. I have calculated this as per the example above and it is technically true.

4) Some agree with your position presented on this forum

Given that there are property investors who use accountants with opinions similar or identical to positions 1), 2) and 3) and obviously they themselves are none the wiser, then who is to blame when the ATO comes knocking with an audit looking at decades worth of incorrect interest deductibility claims. Surely there must be thousands of average joe clients (people who invest and don't know about such tax rules in such detail as we do) who may be mixing funds inappropriately and neither them nor the accountant know about the rules. If an audit does occur, does the accountant with the incorrect understanding of the tax rules have to pay the penalties for the client? To me it would seem unfair for a client to have such indepth understanding of the rules when even the tax professionals can't seem to come to a concensus.

What do you guys think about this?

 

Personally, I don't really care what the tax pros do and don't claim. If I get audited it would be me who walks the auditor through my paperwork and calcuations, not my accountant. I simply would not be comfortable trying to justify claiming interest on a loan where the funds were transferred to an offset account, mixed with non-borrowed funds and then invested. As such, I only invest borrowed funds in such a way that the invested funds can be clearly traced back to the original loan. I don't mix borrowed funds and non-borrowed funds in any account and then invest from that account.

 

Some accountants do not understand this concept. No doubt about it.

The taxpayer is solely responsible for their own tax so if they claim something incorrect on the advice of a tax lawyer or tax agent then they will wear any penalties. They may then be able to make a claim against the adviser for breach of contract and/or negligence.

Much easier to get it right from the beginning though as suing someone is stressful and risky. You will be dealiing with their insurers too not the advisor. e.g. if someone sued me for bad advice, I could not defend myself personally - it would be my insurer that would either pay up or fight without my input.