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Tax Tip 2: Debt Recycling

Discussion in 'Accounting & Tax' started by Terry_w, 16th Jul, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Tax Tip: Debt Recycling

    'Retirement’ can arrive sooner if you can pay off non deductible debt faster. Interest on a loan used to purchase the main residence is not deductible - some call this bad debt. While interest on loans used to purchase investment properties (shares, business etc too) is deductible.


    So wouldn’t it be good if you could change bad debt into good debt?


    Well, you can!!


    As an example, most people would be paying PI on their home loan. The balance would be slowly decreasing. Some are paying extra paying it down faster. If you could reborrow this money paying off the loan and then invest it you would be charged around 4.5% pa in interest. This interest would then be deductible against the income from the investment. If the investment earns more than 4.5% pa then you would be in front and the extra money received could then be used to pay down the bad debt even faster.


    Further reduction in bad debt would potentially mean more funds are available to be borrowed to invest. This in turn would potentially lead to more income to pay off the bad debt which could then be turned into good debt by borrowing again to invest.


    If all goes well this could enable the bad debt to be paid off much quicker.


    This could be done with property, but most property would end up negative cash flow. But it could also be done with this and just hanging on for a few years and then selling and using the proceeds to pay down the bad debt and then reborrowing.


    Or you could speak to a licenced financial planner about using shares to do this. Shares are much easier to buy and the costs in and out are very low. But they can also be very volatile and potentially dangerous. But there are relatively safe ways to do this..


    Carefully planned, debt recycling can get you where you want to go sooner.
     
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  2. Rixter

    Rixter Well-Known Member

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    Terry, what about directing rents to the PPOR loan thus reducing its debt and letting the Investment debt capitalise to the same rental amount directed to the PPOR ?
     
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  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Rixter - that deserves a whole new thread!
     
  4. Rixter

    Rixter Well-Known Member

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    Yes, it can be a very effective way to debt recycle.
     
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I am not sure of that. Could you give me an example of what you mean?
     
  6. kr11

    kr11 Well-Known Member

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    Nice one terry
    1.Could u also do this for seminar expenses, board regulaton fees, professional indemnity fees, income protection, life insurance, car insurance etc etc ... related to your career that u r freating income

    2.Is there any time limit on deducting these expenses. Eg 30yrs

    3.For property,eg buyers agent fees,depreciation schedules, travel allowance to inspect ips, body corporate fees, rates,water etc. Any time limit on these apart from when u sell the ip

    4. Is loc easier to do this compared to redraw
    Never used redraw b4 but can u do direct etf from redraw without transferring to another acct

    Obviously provided u m can pay ppor by the same amount your loan is increasing
    Thanks
     
  7. spludgey

    spludgey Well-Known Member

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    Here is what I do.

    (The percentages are obviously arbitrary)
    LOC question.png
     
  8. srirang

    srirang Well-Known Member

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    Hi Spludgey,

    Looks great and thanks for the diagram.

    Do you pay interest on IPs from the LoC as well?

    Do you claim the interest on the LoC (i.e. Interest on IP interest) at tax time?
     
  9. spludgey

    spludgey Well-Known Member

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    Yes and yes.
    In practice, it's a loan with an offset and I use the offset account for the interest payments, but the principle is the same.
     
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  10. srirang

    srirang Well-Known Member

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    Terry/Rick, are you able to elaborate on this a little bit.

    How about this example scenario.

    PPoR Balance - $500,000

    IP#1
    Interest - $12,000 per year
    Expenses - $4000 per year
    Rental Income - $12,000 per year

    LoC#1
    Funds available - $50,000

    Can I have the rental income sit in my offset account and pay the expenses for the IP from the LoC? So, at the end of the tax year, situation will be...

    PPoR Balance - $488,000 ($500k - $12k rental income)
    LoC: Funds available - $34,000 ($50k - $16k IP expenses)
    Interest paid on LoC - $800

    Can I then claim the $800 as a deduction?

    Please correct me if my understanding is wrong and thanks in advance.
     
  11. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    Paying interest from the LOC is where a lot of people get into trouble with debt recycling. There's instances where private tax rulings have been obtained to allow it, but I've seen people get into ATO trouble trying this.

    Better to have all your income go into an offset account (against your non deductible debt) and have your loan repayments come out of that same offset account. The LOC is used to fund other costs, interest on the LOC is also paid by the offset account.
     
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  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Hope you have sought tax advice
     
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  13. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Probably not. You are borrowing to pay interest.

    This is a different 'thing' than I was talking about above.
     
  14. spludgey

    spludgey Well-Known Member

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    I have. I talked to an accountant who said that this is a bit of a grey area and that the auditor general could rule against it, but that it was okay to claim unless I was told otherwise by the ATO.
     
  15. srirang

    srirang Well-Known Member

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    Thanks Peter and Terry. That's what I thought. Good to know that non-interest expenses can be paid from the LoC though and we can legitimately claim the interest on those as deductions. That adds up to about $20k sitting in offset for me rather than paying cash for these expenses.

    Good on you spludgey for getting it clarified for your situation.
     
  16. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I disagree with this.

    What is your purpose in borrowing to pay interest?
     
  17. srirang

    srirang Well-Known Member

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    I have had this suggested as a "strategy" to pay-off your PPoR debt faster by a BA a few years ago. But it sounded dodgy to me.
     
  18. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    ATO have clearly stated that they will apply Part IVA to deny deductions in this case. Not a grey area
     
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  19. spludgey

    spludgey Well-Known Member

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    I can only tell you what I've been told by the accountant, but thank you for pointing out that it might not be a valid deduction. I'll look into it further and might ask another accountant.
     
  20. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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