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 Well-Known Member Business 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
    craigc, ChrisP73, meni and 1 other person like this.
  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 Well-Known Member Business 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 Well-Known Member Business 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 Well-Known Member Business Member

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