Tax Tip 16: Capitalising Interest

Terry,

Just to expand on what has been asked of you in this thread: what if you have money that is the result of an equity release from another investment property that you have sitting in an offset account, linked to an investment property loan. That equity release cash is ear-marked to pay for investment property related expenses. If one were to use that equity release cash to make payments on a loan and thereby increase the loan, even if there was cash (not an equity release, just cash) sitting in another offset related to a principal place of residence: would the ATO consider that to be a scheme? Or would that be allowed, in your opinion?

Kind regards,

Leilah

 

This is essentially borrowing to pay a loan, assuming it is not contaminated. Why would someone do that if they had the cash to pay the loan?

 

I don't know, maybe want to keep the cash for a rainy day. But in any case, would the interest on the interest be claimable? Would the ATO allow it or do you think this is essentially a scheme?

 

And yes, it wouldn't be contaminated.

 

This is what the thread is about. Seek specific tax advice.

 

The tax office dont allow deductions. The ato follow laws and its own views plus common law. Self assessment imposes tge obligation for deductions on the taxpayer. Years later deductions can be cancelled and tax arrears due. One of those ato views is that capitalising interest may not be deductible esp when a scheme is evident.

Personal tax advice or a private ruling may provide a better view. Typically there needs to be a reason such as a temp cashflow issue. Choosing to use borrowed money while using earned money to fund private costs may be considered elements of a scheme if the outcome is a enhanced tax deduction.

Spending borrowed funds on improvements that may enhance rent are less subjective than using cashflow from borrowed funds to pay the loan while using salary and rents to accelerate paying off your own home in a scheme

 

This situation is much clearer to me now. Thanks Paul and Terry, greatly appreciated.

Cheers

Leilah

 

A very interesting discussion.

I am in the process of being made redundant and rather than seek a new job I plan to start my own business. Realistically the new business would not make a profit in the short term and be mildly profitable in the medium term.

Clearly an issue of cash flow - but the severance package is not insignificant - in rough terms about 2 years after tax tax home pay.

I wonder what the thoughts are vis a vis cash flow to capitalise interest ... if based on a severance package I could realistically continue paying interest at least for the next 2 years?

 

if you had a large pay out then surely you could use this to fund the living expenses?

There may be opportunities though so best to seek tax advice on this and strategies for starting up a business relating to tax (and the legal side too).

 

Thanks. I believe so - a bit of pre-planning here correctly could make a substantial difference in the long term.

 

Hi All
First of all, thanks Terry for all the tax tips. It's truly a treasure throve!

Would like some advice from the knowledgeable members of this forum:

I currently have an investment property. It was my previous PPOR, loans payed down, so no interest.
I have opened a LOC, and have been paying ongoing expenses for the investment property (rates, strata fees etc) from the LOC.
The monthly interest is also charged to the same LOC. Reading this post, I understand this is capitalised interest.

Can I fix this by:
1. Transferring funds into the LOC to the tune of the total interest charged so far
2. Requesting my bank to pay future LOC interest from another account (savings)
3. Either cut the interest that would have been charged (if not capitalised) or cut my losses, and only only claim the interest deductions post "fixing" the mess.

Not sure if step1 would be likened to Urine/Wine mix analogy?

Thanks

 

perhaps there is not much to worry about. Is there a tax advantage being gained? you are not paying any interest, except for the LOC,

step 2 is not mixing but paying interest with cash which is standard practice.

 

Not significant tax advantage currently, but overtime as the borrowing to pay for the expenses increases, then yes.

My concern was step 1 actually.
Say my LOC has $100,000 limit.
I then use LOC to pay $5000 expenses (rates etc), reduce limit to $95,000
Monthly Interest calculated (@5%) would be $20.8 - charged to LOC

So Month two would be $5020x5%/12 = $21. So I would have $0.02 capitalised interest. (obviously nothing to be concerned about yet.. but in time this will become significant).

The LOC balance would $5041 at the end of Month 2.

If I transfer $41 to the LOC.... can I say that the $41 is paying the interest component? Or do i have to transfer $5041 to fully repay and start again?

 

So where is the tax advantage?

You are not diverting income to the payment of another non-deductible loan are you?
What happens to the $41 you have due to the capitalising of interest?

 

Hi Terry
I am diverting the rent to a savings account.
The LOC is used solely for paying expenses for the rental property.
My plan was to claim the interest against the rental income.
I understand this is acceptable.
However, as my LOC is currently capitalising interest, reading this thread, I understand the claim would be rejected (if ever audit).
Have I missed something?
Thanks again.

 

Hi Kay

Yes you have missed this from the first post:


The same rules for the deductibility of ordinary interest apply to capitalised interest. That is if the underlying interest is deductible then the interest on interest would be deductible. This was stated by Justice Hill on the High Court case of Hart a few years ago. It is also confirmed by the ATO in TD 2008/27 (paragraph 1).

 

Thanks Terry. Sorry, I totally missed that!

If i leave the interest to capitalise in the LOC, but keep the rent in a non-linked savings account (offset for PPOR loan). Would this be considered a "scheme"?

Apologies in advance, for repeating what I imagine is asked before.

 

The ATO seemed to be mainly concerned with people capitalising interest so that they could pay off their home loan sooner. You don't appear to be doing that and the amounts are small.

 

Terry,
What would be the ruling on the following:
Married couple:
Husband high income
Wife Low Income

Husband owns 3 IPs, wife 1 IP solely in each name
Rent from husbands diverted to pay down loan from wife's
Interest capitalised on husbands IP Loan via LOC with view to being deductable.

reason - Asset inbalance in relationship and correcting by paying wifes first and increasing asset base for wife.

Cheers
SMTY