Tax Tip 19: Avoid Using Redraw on an Owner Occupied Loan

Avoid Using Redraw on an Owner Occupied Loan


Many people use redraw facilities on loans and rarely think of the consequences - which could be costly if the property is ever rented out.


Borat has a $100,000 property with an $80,000 interest only loan. He pays the loan down to $50,000 and then decides to buy a new car for $30,000. The balance is now $80,000.


Later Borat moves out and rents the property. But he has a problem:

Only the interest on the $50,000 loan is deductible and,

He has created a mixed purpose loan.


Only $50,000 is deductible because this is the part of the loan that is associated with the original loan used to purchase the property. The other $30,000 relates to the purchase of a car which is a private expense.


Solution - none as it was too late once the loan was paid down.


But the situation could have been entirely avoided if Borat didn’t pay any extra into the loan but parked his extra cash into an offset account. He could have used this to buy the car and would still be able to claim the interest on the full $80,000 of the loan once the house was available for rent. Indirectly the interest on the private expense of a car is deductible in this case.

 

Hi Terry,
Thanks for the tips, they make interesting reading and certainly go towards expanding the knowledge base.
This is one that I learnt the hard way. I've got funds sitting in a redraw that I've not yet decided what to do with.
As a result I now lecture anyone who'll listen about avoiding redraws and going straight to the offset, when housing comes up. Throw in the IO approach too while I'm at it. Shame I didn't know this before taking out my first property loan.
Live and learn I guess!

 

What happened if Borat refinance his home loan and have a new loan amount of $90,000 will this solve this issue ?

 

If the loan started at $80k and was increased to $90k it would be a mixed purpose loan creating further issues unless it was split. Either way, whether split or just increased the interest on the extra $10k will not be deductible unless the money is used for income producing purposes.

 

What about re-drawing for income producing purposes. Let's say I paid off $50k and wanted to re-draw that for a deposit on an IP?

 

Hi Terry,

I have a PPOR which is to be turned into an IP in a couple of months..It is bought for IP purposes with the plan of subdividing at the rear next year or so. I am currently living in it to renovate the property. It has a redraw which I have not used. It is 50% fixed for one year (due in a month) and 50% variable. What should I do to fix this? Should I switch to another loan product with offset account?

I am hopeful that market movement and reno would increase the valuation by the time reno is done. Redraw is rather confusing and complicated than offset. Please advise. Many thanks

 

In that case the interest would be deductible, provided there is no detours of the cash. If the loan wasn't split it would be a mixed purpose loan too.

 

What do you want to fix?

 

Hi Terry,

I need a place to park my extra cash. It not advisable to pay down on PPOR since the redraw will complicate tax when it is turned into an IP. I have been parking it in another IP with offset account but it just not right ? Shouldn't extra cash be parked in PPOR which is a non income producing loan?

 

In that case setting up an offset on the loan while it is a main residence will assist you save interest and tax.

 

Im

Thanks Terry,

Because he has paid the loan down to 50K.

Can he refinance this loan back to 80K and park that 30K in the offset account?

Sounds like once the loan gone down to 50K there is no going back. Even he refinance.

 

Increasing a loan is new borrowings and parking in an offset is aa bad idea generally as it can destroy deductibility later even if the money is used for investments. Also creates a mixed purpose loan.

So he could do that but shouldn't.

 

Hi Terry,

I believe a lot people including myself already made this kind of mistakes.

Is there any way to fix this problem?

 

Some things can be fixed totally, others are unfixable. I will write a tip on this so stay tuned.

 

Most likely that a tainted loan cannot be fixed as such however if a loan is blended and the taxpayer can make reasonable endeavours to apportion the loan between the deductible and the non-deductible and only claim the deductible then if challenged by the ATO its possible that they may not deny the deductions. Sometimes its better to correct a mistake than just bury your head in sand and allow it to get worse.

There is no assurance that this works and each taxpayers position will be different. Without admitting to the issue and seeking the ATO guidance its a unchartered area...I wouldn't generally recommend taxpayers do that !!. After 2-4 years the taxpayer problem will pass the period for amendment (unless there is a chance its evasion). So the taxpayer ends up with a lesser risk for 2-4 years and then no risk thereafter in many instances.

If the loan blending can be identified it can be wise to get bank to split into two loans based on that calc. Again its doesn't "fix" any problem it just assists to support that the taxpayer identified a error and has attempted to avoiding it getting worse.

Personal tax advice may be required.

 

Thanks Terry.

 

if it's the extra funds paid to PPOR loan, then it should be free to redraw it and use it as deposit or other cost for IP, and the IP can be a new investment loan....

if it's the extra funds paid to an IP loan, then it might become a mixed purposes...but the IP loan is setup for 30 yrs, and repayment is fixed per month, if you are overpaying it to reduce the interest, then it should be free to redraw the money you've overpaid, leaving the IP loan as when it was established with the minimum repayment, any interest calculated on the minimum repayment should be deductible? isn't it?

 

No, this is incorrect.

 

I'm really lost.....and I'm going to see my banker tomorrow...but i don't think they know how to structure the loan to make sure the interest is deductible...I posted a thread before, but I'm more confused now, better ask here...

I'm having a $22K loan for PPOR which I've paid off (but loan is not closed just for using the surplus funds), so there is $18K surplus available for redraw, I want to buy an IP which costs $45K, I'm going to pay 10% deposit out of the $18K, then borrow the rest as a separate loan, so that it's my IP loan about $40K, it doesn't mix with my PPOR loan (is this the split loan concept?), so in the future, I can pay as much as I can to finish the PPOR loan ( which should have $5K owing), but let the rent to pay IP loan...in this case, i'm guessing the interest on the IP loan is deductible?

Will things get complicated if I decide to move into my IP in 2 yrs and let my PPOR become the new IP? Do I need to restructure the loan for tax purposes?

Please help! Thank you very much!

 

Don't take tax advice from a banker.

What is the balance of the $22k loan? ($220,000 loan?). If it is not zero, or very close, you will be combining borrowings for 2 different things = mixed loan. When you subsequently pay into this loan you will be reducing deductible debt.