Tax Tip 219: Debt Recycling v Borrowing Extra to Invest

It might be an error

 

Hi Terry,

You've been nominated as the authority to settle an internet debate for us, congratulations. I hope you don't mind assisting.

The debate is essentially around the exact definition of debt recycling.

Definition A
Debt recycling includes converting deductible debt to non-deductible debt as well as using the equity in the home to increase deductible debt borrowings.

or

Definition B
Debt recycling is converting deductible debt to non-deductible debt but does not include additional borrowings against the equity in the home.

i.e. does debt recycling include increasing borrowings by using available equity?

Hope you can help

 

B

 

As above apart from the fact this is backwards!

Why would you want to recycle to convert debt from tax deductible to non-deductible?

 

debt recycling in reverse?

 

Taking an $80,000 plunge into debt recycling - HisHerMoneyGuide

Here is a link to a debt recycling article written by a blogger. They had a fully paid off loan and then redrew to invest and said it was debt recycling. I consider this to be just borrowing to invest because they had no non-deductible interest at the time (from how they explained it in the article at least).

 

If someone has a loan fully paid down and redraws to invest, are they borrowing to invest or are they debt recycling?

 

Many times debt rececling does involve a new loan but in the process there has been a reduction of a non-deductible loan which is repaid and then a new deductible purpose loan is drawn. Its a question of how you look at it. On the day of the new loan yes its a new loan but the recucling may be a element of the arrangements

eg Fred has a non-deductible home loan which has $100K balance. He also has a offset with $100K. He check with his lender who confirm that he can pay down the loan to $0 and the account wont close and he can use its redraw to draw a new loan of$100K . Technically yes its a new borrowing when he does that however over the term of the arrangements he will pay down the loan to $0 first. A perfect example of debt recycling.

However a general drawing of redraw will NOT be a debt recycle and is often just a new deductible loan. Over 6 years it may look like a recycling strategy but its really isnt.

Tip - If the redraw use is ever a different purpose to the originating loan (if there is a balance left) then splitting will avoid blending the loan purposes.

 

If someone had a $400k homeloan, paid it off in one go and redraw $400k for investment - that's just an extremely efficient way to DR? Opposed to doing it via smaller amounts with splits.

 

Is it debt recycling if it had a balance of $1 for say 3 years already?

not saying it is efficient or not

 

My question a few posts up is basically about the definition of debt recycling - not whether one should pay off a loan and redraw and invest - they probably should, but is it really debt recycling if there is no non-deductible interest?

 

I see, would you define whether or not it's DR based on what the intention is? So in my example if they pay down with the intention to redraw/recycle and invest - even though for a small time there would be no non deductible interest, the intention was there, but if it had been paid down for 3 years, there was probably no clear intention to DR so redrawing that would be more borrowing extra to invest

 

The intention doesn't really matter. If you have a $100,000 loan and pay it down to $1, you can essentially paid off the loan. If you then redraw you are not debt recycling, in my opinion, you are just borrowing money. This is because there is no non-deductible interest to begin with.

This doesn't matter though really. The definition of debt recycling doesn't change anything. But I see people classing this as debt recycling and therefore thinking it is 'good' when in fact they are just borrowing to buy shares - which they normally may not think they are doing.

 

It seems all relative - whether it's considered DR or further borrowing would depend on which reference point was used.

If that loan was paid to down to $1 and you consider there to be no non deductible debt (so naturally any redraws from this point would be viewed as further borrowing)

Then you could also view a more traditional DR strategy in the same way -

Start with 100k NDD

Create 20k split, pay down to $1, redraw

If I consider that at one point in time I had $80k debt, then I've just increased my debt by 20k, so further borrowing

 

Yes agree. another variation is someone with 100% of loan offset for years and then paying down loan and investing. It’s debt recycling by the common definition but there is no conversion of non deductible interest because there was no interest

 

Experience tells me that better to organise a split from ND loan before paying it down followed by
redrawing to the new split for investment etc.

Have run into situation before that after paying down ND loan it was closed down automatically but unintended so. When requesting redraw be re-instated lender re-assessed servicing etc and
redrawable amount (in actual fact a new loan to be exact) was less than before original ND loan was closed unexpectedly. What a pain.

 

ALWAYS ask the lender for their policy on redraws and closures. Paying down all but $1 is often used but some lenders dont auto-close. Some lenders wont split before its paid down too. Or a bank staff member may need to assist.

I am often asked if a trivial balance like $1 is a concern. No its not. Yes it is STILL BLENDED. However, the value may be immaterial and round out as $0
eg David and Sue have a loan for $111,000 that they pay down using their offset savings to $1. Then then redraw $110,999 for share investments

1/111,000 = .0009% so each year the non-deductible adjustmnet to the interest deduction is $0 eg Interest is $3330. Of this 3cents is non-deductible. Tax returns disregard cents so no problem. If the ATO ever query it you have done the calcs and can explain the issue.

 

I have even had the $1 balance in private ruling applications concerning debt recycling and the ATO hasn't even commented on that.

 

Check out my latest podcast on this topic:
Structuring Podcast Episode on the Distinction between Debt Recycling and Borrowing to Invest