Tax Tip 2: Debt Recycling

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

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  1. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Wash sales are generally a CGT concern and not a interest deduction concern. A wash sale may be undertaken to trigger a CGT loss on one parcel of shares that offsets a CGT gain on another. The ATO view is that the issue is a scheme. They can cancel the CGT loss and the sale / repurchase may be disregarded OR a different basis used for the CGT event (ie that specific parcel sold and repurchased would be the CGT event NOT the original acquisition). This is permitted under the specific identification method for CGT treatment.

    However wash sales can trigger a different but related income tax concern. If the predominant purpose of the wash sale was to engineer a (new) loan deduction by switching one parcel of unleveraged shares for a similiar risk using a new loan then the ATO may easily see a Part IVA scheme in operation. They could and most likely would see this as a form of evasion and have unlimited time to amend to remove the scheme benefit by cancelling the interest deduction and impose penalties.

    Scheme is the word the ATO use to described systematic processes. eg event one leads to event two etc....The key concern is when a scheme benefit produces a tax benefit. The Commissioner then looks at the predominant purpose a taxpayer may have to initiate such a arrangement. It may be difficult to argue anything other than a tax deduction benefit. Simply changing from say $100K of CBA shares to $100K of ANZ shares may still be a scheme. Instead if the taxpayer sought to change to say a margin lending facility and better utilise their capital for another purpose (even a private one) this may be a stronger defence than a buy / sell sale.
     
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  2. chylld

    chylld Well-Known Member

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  3. Kat

    Kat Well-Known Member

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    Is there any people out there doing debt recycling on one wage?

    Looking at this strategy myself and interested in the stories of others.


    My alternative strategy is to continue renting and add the extra into shares.
     
  4. inertia

    inertia Well-Known Member

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    Debt recycling is about converting non-deductible debt (eg loan on your PPOR) into deductible debt (eg used for income generating investment such as share or investment property). Having 1 or 2 wages does not change this - just the income and how it affects your serviceability.

    Cheers,
    Inertia
     
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  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Heaps
     
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  6. Harry30

    Harry30 Well-Known Member

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    I read with interest this commentary around borrowing to pay interest, and applicability of anti avoidance provisions. What about this example. The CBA margin product offers 2 quite distinct ways to pay interest - periodically via direct debit, or you can just let the interest capitalise - ie. Have it added to the outstanding balance. So, borrow via margin loan, buy shares, direct all dividends from shares to pay off your bad debt. And make zero repayments on margin loan, let it compound, further increasing deductible debt. Is this borrowing to pay interest? Sure looks like it.
     
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  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It is. But it is a strategy worth considering with a private ruling
     
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  8. Harry30

    Harry30 Well-Known Member

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    This is the case with a LOC as well. No requirement to make repayments. You can just let the interest compound. Again, buy shares with LOC, use dividends to reduce non deductible debt, and let deductible debt just increase. I am surprised there has not been a private ruling or case law on this point given how common these financial products are.
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Not all Loc are like that. Many require minimum repayments.

    There is a tax ruling on this which says if the purpose is to pay the home loan off sooner they can deny the deductions. They just don't specifically mention shares.
     
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  10. Rex

    Rex Well-Known Member

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    Ok, I just thought of a scenario. Two loans of same origination date & term:
    Loan 1: $200K P&I tax deductible
    Loan 2: $100K P&I non-deductible

    Loan 1 minimum monthly payment is $1,500/month, comprising $1000 interest & $500 principal repayment. Min payments on Loan 2 are half of this but not really relevant.

    The proposal: Make repayments to Loan 1 by redrawing from Loan 2, so as to progressively refinance Loan 1 and minimise the paying down of non-deductible debt.

    E.g. pay an extra $1500 salary into Loan 2 each month, above the Loan 2 minimum repayment. Redraw $1,500 from Loan 2 for the payment into Loan 1 at the end of each month. The $1,000 interest component is not deductible (don't capitalise interest) but the $500 principal repayment portion is a refinance. Therefore the deductible portion of Loan 2 balance increases by $500 every month, making up for the repayment of Loan 1 principal by a commensurate about. Yes, Loan 2 repayments pay down some of this deductible $500 each month, but only a fraction of it.

    Am I missing something here? Too good to be true? Obviously a simpler and more effective setup would be to have Loan 1 as IO, but it might not be worth the significant interest rate premium.
     
  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Sounds like the strategy that I wrote about in another tip . Called something ''paying io on a pi loan'.
     
  12. ChrisP73

    ChrisP73 Well-Known Member

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    Not following that at all. You sure you have all your 1s and 2s the right way around? Either way I can't see anything in here that's going to reduce your non deductable debt. Likely the reverse the way you've explained it!
     
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Borrowing to pay the loan with a payment into the borrowed funds of an amount equal to the Interest. Borrowing to pay principal.
     
  14. Peppas

    Peppas Well-Known Member

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    Can I ask, is there any issue with using the simple loan structure outlined in tax tip 13 and creating P&I splits to debt recycle rather than paying down the loan and opening a line of credit? I guess you would be continually paying down the principal rather than only paying interest, but are there any other advantages/disadvantages?
     
  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Yes non-issue. The simple loan structuring tip was with debt recycling in mind
     
  16. Peppas

    Peppas Well-Known Member

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    Great, thanks @Terry_w. I had been racking my brain trying to work out if I was missing something!
     
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  17. skinner84

    skinner84 Member

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    Hi @Terry_w,

    Made my way here via a Whirlpool post I made around DR. Read through all your articles and I think I have a pretty good understanding of how it works now. Like you say, it's actually pretty simple!

    I'm with NAB who as you mentioned on Whirlpool are a pain in the ass to arrange splits. The loan adviser I spoke to at NAB seemed like he'd never heard of debt recycling before! They agreed however, but it seems like I'll have to go through an application process. Not ideal. Anyway, just want some validation on my strategy.

    $500K owing on PPOR loan.
    $50K saved in offset
    Split $500K loan into two:
    Loan A - $475K (P&I)
    Loan B - $25K (P&I)
    Immediately pay down a portion of Loan B, say $5K initially.
    Redraw $5K on Loan B and invest into dividend based shares.
    Dividends and normal savings into offset until I've saved another $5K
    Pay $5K on Loan B and redraw same amount.
    Repeat until normal repayments on Loan B bring the balance down to $0 and create new split.

    I realise that I could just invest the $25K straight away, but I have a wife who doesn't like the idea of throwing $25K in one go, so will use DCA.

    The other query I have is around tax. I am in the 37% tax bracket, my wife 19% (soon to be 0% with second child on the way). Am I better to put the share investment in her name so she gets more benefit of franking credits? I.e. potentially an 11% refund or even 30% if she's not working. Flip side of that is the interest paid on Loan B (i.e. the deductible portion) will be claimable under her taxable income. Or can we claim interest paid under my income?
     
  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Only tax lawyers and tax agents can advise on debt recycling so not surprising your banker hadn't heard of it before.

    What you mention is possible in theory, but NAB do not allow you to pay directly from the loan, so the money must take a detour and this is where it can get murky as to whether the interest is deductible or not.
    see this
    Tax Tip 1: Parking borrowed money in an offset account Tax Tip 1: Parking borrowed money in an offset account

    Your second question is really a legal one because you are asking about ownership of an asset. From a purely tax perspective it might make sense have your wife buy the shares but there are other issues to consider such as control, asset protection and estate planning.

    It will be the owner of the shares that claims the interest, the non-owner won't be able to claim.
     
  19. skinner84

    skinner84 Member

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    I see. If I split the loan first, and then redraw, the funds redrawn will go into offset - hence the potential for contamination. Do any of the banks allow direct redraw from the loan account??
     
  20. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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