Tax Tip 11: Further Borrowing against property deductible against the

Further Borrowing against property will be deductible against the income it generates


I often come across people who say things like “My property is slightly positive geared, i don’t want to borrow against it any further as it will cause the property to be negative geared.”

This is not correct because it is the purpose and use of the borrowed money that determines deductibility. The security for the loan doesn’t matter.


So if I owned 123 Smith Street and had a 50% LVR and increased my loan to 90%, to buy 456 Jones Street, this won’t affect the cash flow for 123 Smith Street because the extra money will be deductible against the new property at 456 Jones Street which I used the money for.


On tax returns the interest has to be claimed against the correct property.


It is also important to split the loans because when the property that it relates to is no longer income producing the interest will no longer be deductible.

 

Another example

Imagine Tom has a $500,000 loan used to purchase property A. Property A has increased in value and the loan is increased to $600,000 with the extra $100,000 used for the purchase of property B. Both A and B are investment properties.


It is important to realise that the interest on the $100,000 loan is deductible against property B not A. If Tom had one big loan, which he shouldn’t if he has been following my tax tips, then he would have to apportion the interest.


You may wonder what the point is because it will all be the same in the end, and this may be the case but

• there would be a different tax situation if the owners of A and B were not 100% the same. e.g. a spouse’s involvement
  
  
• Sale of one house could mean interest being claimed on the other one would suddenly increase when you realise you can keep claiming interest on the correct property (assuming the problem of the security for the loans is solved) and this could trigger an audit.
  
  
• CGT issues if the interest is not claimed against income.
  

 

Hi Terry,

If the security property is for a different owner, which property should claim the interest?
For example, Abc Pty Ltd ATF Abc Trust uses 123 Abc St as a security for Def Pty Ltd ATF Def Trust to purchase 456 Def St, which property should claim the interest for 123 Abc St? The director and shareholder of the trustees are the same person.

Thank you.

 

who borrowed the money?

 

ABC Pty Ltd ATF ABC Trust is the borrower. Is the interest deductible against 123 Abc St?
If DEF is the borrow, would that be 456 Def St which claims the interest?
Thank you.

 

If X borrows money and Y uses it the interest is deductible to neither of them as X has no income and Y hasn't incurred the interest. There must be a connection between the expense and the income.

A simple solution may be for X to onlend the money it borrows to Y.

Seek legal advice.

 

Thank you Terry. What if 123 Abc St is an IP, can ABC Pty Ltd claims the interest of it is the borrower?

 

It is really irrelevant what the security is. Is ABC generating income from the borrowings? is the question to answer. (There may be more questions too)

 

No. Not unless the borrowing is for improvements to, repairs to or outgoings (except loan payments) for the same property. Always deduct interest against the income the borrowing is used to produce .

1. Borrow against IP to buiy a speedboat for fun, NOn-deductible use of borrowed funds is private
2. Borrow against IP1 to build a GF for further rental income. Deductible against IP1.
3. Borrow against IP1 to assist to buy IP2. Deductible against IP 2
4. Borrow against IP to buy CBA shares. Deductible against dividend income

 

If a trustee of a trust bought an IP for $300k outright, the money is borrowed from one of the beneficiaires interest free.

Later on, the IP use as a security to borrow $200k from a bank and the 200k is to repay part of the $300k interest free loan.

Is the interest for the $200k from the bank deductible?

Thank you.

 

Under s8-1 it would be deductible if it is just a refinance. But the ATO may look at it as schemey. was there a written loan agreement contemporaneously done with the loan? If not it would appear to be a gift.

 

So if there was a loan agreement, ATO would not treat it as a scheme?

 

I wouldn't say that!

 

If there was a written loan agreement entered into when the loan was taken out, or before, it would help. Without a written agreement it could be argued that the money transferred was a gift and that you are now trying to gain a tax deduction by pretending that gift was a loan.

 

And if the proceed were advanced by Mr Fred Flintstone to Mr Rock the solicitor's trust account this may even pose a concern the trustee didnt borrow. But if the loan was advanced to the trust which then paid it from its account to Mr Rock it may better support the view contained in the written agreement. I have also seen poorly drafted agreements which come date stamped on the documnet that it was created months after the loan was advanced. But a copy of settled loan agreemt between the two parties by email may show it existed at the time. But the terms of the laon must still be complied with....eg was there a repaymnet and interest accounted for ? These are factors after the event that better support a intention to repay ie a loan.... And then if the trustee and the lender are the same person it could mean the agreement has legal defects. You cant lend to yourself.

 

Hi Terry,

If our current loan for Investment Property A is $260,000 (P&I $1300 - Rental Income $2,340) and want to refinance to 80% LVR ($800k - conservative valuation of $1m) Usable equity is $540k on a split to purchase Investment Property B (est. $1m) :

IP A: Split 1. $260,000 - (P&I $1300 - Rental Income $2,340) Split 2. $540,000 (P&I $2,250 - correct me if math is not accurate - calculated at 5%)
IP B: $460,000 (P&I $1,916 - Rental Income $2,600)

Although it is not negatively geared for IP A - Split 1, wouldn't it be negative for IP A Split 2 + IP B? (2,250 +1,916 = 4,166 - 2600) by about $1,566 per month?

 

I don't practice the art of mathematics, but you seem to be taking the principal part of the repayments into account when you are talking 'negative gearing'

If you borrow against IPA and use it for IPB the interest on that loan would be deductible against the rent on B not A (if you have done it right)

 

Many taxpayers confuse borrowing security v use and repayments v interest. Both are not ensured deductibility

 

451 tips later I wrote this
Tax Tip 462: Lending Interest Free to a Trust with the Trust later borrowing to it Pay Back Tax Tip 462: Lending Interest Free to a Trust with the Trust later borrowing to it Pay Back