Tax Tip 219: Debt Recycling v Borrowing Extra to Invest

Discussion in 'Accounting & Tax' started by Terry_w, 27th Jun, 2019.

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  1. Terry_w

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

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    Strictly speaking, borrowing to invest is a different strategy to debt recycling.


    Borrowing to invest could incorporate debt recycling, but it is really about borrowing extra money to invest over and above what you have already borrowed.

    Debt recycling, on the other hand, is about converting existing non-deductible debt into deductible debt. It doesn’t involve any additional borrowings.


    Example

    Bart has a home worth $1mil and an owner-occupied debt of $400,000. Bart borrows an extra $200,000 to invest in income producing shares.

    Loan A $400,000 Non-deductible

    Changes to

    Loan A $400,000 Non-deductible = still the same

    Loan B $200,000 Deductible

    $600,000 total Debt



    Lisa, on the other hand, wants to debt recycle and she has a home worth $1mil with a loan of $400,000 which is non-deductible. She also has $150,000 in the offset account and wants to invest in shares.

    Loan A $400,000 Non-deductible with $150,000 in attached offset

    Changes to

    Loan A $300,000 Non-deductible with $100,000 in attached offset

    Loan B $100,0000 deductible when drawn down to buy shares

    $400,000 total Debt



    Of course, borrowing to invest and debt recycling can be combined, and this is what Maggie does. She has a $1mil main residence with $400,000 owing on it and $150,000 in an offset account. She also wants to buy shares but wants $200,000 worth

    Loan A $400,000 Non-deductible with $150,000 in attached offset

    Changes to

    Loan A $300,000 Non-deductible with $50,000 in attached offset

    Loan B $100,0000 deductible when drawn down to buy shares

    Loan C $100,0000

    $500,000 in total debt

    Maggie has used $100,000 to debt recycle as well as borrowing another $100,000 on top for further investments. She could potentially even combine loans B and C above.
     
    Last edited: 28th Jun, 2019
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  2. craigc

    craigc Well-Known Member

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    Terry,
    can Bart please check his calcs, he should ask Lisa for assistance.:)
    Thanks
     
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  3. Terry_w

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

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    ha ha. I am not very good at maths! Thanks Craig
     
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  4. craigc

    craigc Well-Known Member

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    That looks better - thanks Terry :)
     
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  5. FXD

    FXD Well-Known Member

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    If the equity is drawn and "on loaned" at higher rate than borrowed rate to my own company
    or trust that undertakes the actual investing activities, is this considered DR as there is more
    income flowing back my way for me to service original loan (deductible) plus paying down other
    non deductible debts.

    Is it legit to have such set up? Are there strict ATO criteria such as the borrowing company/trust
    must demonstrate it's profitable before/when/after borrowing at a higher rate from me?

    Thanks,
    FXD
     
  6. Terry_w

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

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    It would be debt recycling if you used the extra interest to pay down non-deductible debt.

    But there are a host of issues. I just had a client apply for a private ruling and the ATO denied a deduction for the interest because their loan agreement was not on commercial terms (loan agreement not drawn up by me)
     
  7. FXD

    FXD Well-Known Member

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    thanks terry. Do ATO need to verify the company/trust must be profitable to determine if the loan
    arrangement is legit and therefore allow or deny deductibility from the on-lender?
     
  8. Terry_w

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

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    if the person borrowing the money is using it for income production purposes the interest may be deductible
     
  9. Pash81

    Pash81 Well-Known Member

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    Hi Terry,

    Following on my post in another thread, if I borrow money to buy a block of land, to eventually build a rental property, will the interest still be deductible as there won't be any income produced from the block until I build a house on it and rent it out?

    Thanks.
     
  10. Rolf Latham

    Rolf Latham Inciteful (sic) Staff Member Business Plus Member

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    Im going to butt in here :)

    till recently, vacant land interest with intent to build an IP was deductible ( Steele V ATO).

    Im not a tax guy but I believe this is no longer the case - TW can confirm

    ta
    rolf
     
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  11. Mike A

    Mike A Accountant Business Member

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    thats's right.

    Peter and Jim acquire vacant land with an intention to construct a new residential property which they will rent out.

    Peter and Jim will not be able to claim a deduction for interest, council rates, land tax or maintenance costs until :

    - The construction of the residential investment property is complete

    - Approval has been granted to occupy the property ;

    AND

    - The property is genuinely available for rent.
     
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  12. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    But if you borrow and buy a completed dwelling then the interest on deposit etc is deductible where there is intention to produce future rental income. The non-deductibility rule for "vacant land" is the key wording. But its complex since land sometimes isnt vacant and its still non-deductible. Or it can be vacant land and is still deductible eg land already owned at 1 July 2019 and only now being built on.
     
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