Tax Tip 116: The cost of owning assets while having non-deductible debt

The cost of owning assets while having non-deductible debt

If a person has $100,000 in income producing assets but $100,000 owing on their non-deductible home loan it doesn’t really make sense to be in a situation like this. They could sell the income producing assets and pay down the home loan and then re-borrow to buy the income producing assets. They would end up paying the same interest but with a $5,000 tax deduction for the interest paid that year (assuming 5% pa interest rate).

Selling the income producing assets would result in CGT being triggered and there is a chance that the income producing assets could jump in price and they may have to pay more for it to buy it back. There is also a chance of the ATO applying Part IVA and denying the deduction. Stamp duty may also be applicable.

Where the income producing assets are shares advice should be sought from a licenced financial advisor.

Example
Bart owns a bobcat worth $50,000. He is a sole trader trading in the name “Bart R Sing Around”. Bart also has some money owing on his non-deductible PPOR loan.
Bart decides he needs a new model Bobcat so this would be the ideal time for Bart to restructure. The Bobcat is going to cost about the same price as the one he has at the moment. Assuming he stays a sole trade (which he probably shouldn’t), but could sell the original Bobcat, pay down the home loan, set up a new split, and reborrow.

Bart does that. He first contacts his mortgage broker and splits the loan so that there is a $50,000 split and a split for the rest. He sells the existing one for $50,000, pays down the $50,000 split and the next day uses redraw to pay $50,000 (using a bank cheque) for the new Bobcat.

Bart goes home and cracks open a beer and lays back and calculates how smart he is. His Home loan is lower and at 5% pa he will save $2500 per year on this. He has also incurred $2500 extra per year on the other split as his net borrowings are the same. Bart feels disappointed and tries to put the top back on his beer so he can drink it another day when he realises that the $2500 interest is now deductible. His marginal tax rate is 37% so he will actually be saving $2500 x 37% = $925 per year, every year until he pays off the loan.

 

Just wondering.... "Bart feels disappointed", is that just incidental to the story? Just trying to figure out if there's a reason behind why you wrote that in the story.

 

lol, no hidden meaning behind it. Bart just thinks, temporarily, that he hasn't saved any money doing this, but he has.

 

Ok ta

 

Why didn't Bart lease the bobcat in the first place if he had too much debt ?

If Bart is happy with the bobcat and doesn't need a new one then he could sell it to a finance company under a sale and leaseback agreement and use the funds to pay down his private mortgage. If the bobcat has not depreciated much he might even get a further deduction if the lease company pays less than the depreciated value.

What if Bart had a chattel mortgage ? He already has deductible debt, although likely at a much higher rate than a first mortgage over a residential property.

Possibilities are wider if planned ahead.

 

There are plenty of Barts out there and they do all sorts of things without thinking ahead.

Another one is owning shares, without borrowings, while they still have nondeductible debt.