Tax Tip 228: Break even points with Using Offset Accounts to Invest

Tax Tip 228: Break even points with Using Offset Accounts to Invest


A $100,000 loan with $100,000 in an offset account results in no interest being charged

If the interest rate on the loan is 4% p.a. and the $100,000 is removed there would be $4,000 in interest charged per year, assuming an interest only loan.


Where the offset is attached to a loan that is not deductible, the extra interest incurred in this situation would not be deductible.

Where the loan relates to an investment income generating use the extra interest incurred would be deductible.

Assuming a 39% tax rate:

$4,000 / (1-39%) = $6,557

This means a person incurring interest of $4,000 which is not deductible would need to generate a return of at least $6,557 to break even. This is because if they invested the $100,000 they would incur an extra $4,000 in non-deductible interest so to pay this they would need to make at least $6,557 to end up with $4,000 after tax.

This means they would need to make a return of 6.56% at least to break even.


On the other hand where the interest is deductible a much lower return is needed to break even this is because they only have to earn enough to pay the interest after the tax deduction.

$4,000 in interest would result in tax savings of

4000/39% = $1,025

This means they only have to make $2,975 to break even, or 2.98%


Keep in mind that there is also the possibility of using the debt recycling strategy of paying the money that will be invested into the loan first and then reborrowing it. This is something worth considering for both deductible and non-deductible investing, but is a tip for another day.

 

I often have this conversation and the general principle always fall to this :

1. If the offset relates to newly borrowed funds intended for future deductible use then the offset should always be applied to the same loan. No other money should be added until that offset is exhausted;

2. If the taxpayer is accumulating savings in a offset then this principal applies:
A. Always offset a non-deductible loan first (To access the 6.56% benefit Terry describes); if that is not possible then
B Offset the deductible debt
Also consider BOTH taxpayers ownership of the relevant properties in B. If the taxpayers had two IPs and there are different ownership % it may be a benefit to favour a different tax outcome for one taxpayer v's another. You want to think inversely and seek the lowest tax impact on the higher income earner. This may mean that the impact of the 2.98% above does not occur or is reduced.

 

There is a rare case where it may be better to offset a deductible loan and a not a non-deductible and that is when the main residence is subject to tax from being a former investment property etc.

 

Ah yes. 3rd element costs. Arguably only where the taxpayer knows what the CGT impact may be. Its often reduced by 50%. But for a non-resident who wants to keep cash here and not be stung with withholding tax etc its a strategy with some effect.

 

I was just at the calcs in this old example and was thinking the last part should be:
$4,000 x 39% = $1,560 tax return

Requiring an additional $2,440 or 2.44% to break even

Hopefully I'm not mistaken

 

I am no mathematician so could have the figures mucked up