Tax Tip 263: Multi-generational Debt Recycling Strategy

Death allows for many strategies to be employed. Instead of paying off loans on properties they can be left in place to allow for debt recycling to happen after you are gone.


Example

Dad has a fully offset his main residence loan. That is, he has a loan of $1mil and $1mil cash in the offset account.



Dad dies and leaves his house to his son. For the son to transfer the house to himself someone would need to pay out the loan on dad’s property. Depending on the terms of the will this may be

a) The estate

b) The recipient of the house, or

c) Someone else (by other assets being used to pay out the loan thus reducing their share)

Where the will is silent the loan basically must come out of the asset is it secured by.

This means the son in this example.

The son is also going to receive the $1mil in the offset account. He could just use this money to pay out the loan on Dad’s house.

Instead the son borrows $1mil from a bank and using these funds to pay out the loan of the estate and the property is transferred over. The interest on this loan would now be deductible once dad’s former main residence is paid out.



Son uses the $1mil cash he receives to pay off his own home loan – or fully offset it so that his daughter could employ the same strategy when he dies.


Other incidental advantages

- The house was the main residence of the dad at his death doesn’t change anything

- Dad could have used the original $1mil loan to buy shares or go on a dream cruise around the world

- If dad’s property was a former investment property which would have attached a huge capital gains bill had dad sold it – that could have disappeared if the property was the main residence of dad at his death.

- Dad could have left the property to a TDT – Testamentary Discretionary Trust – and the son could have employed the strategy, with the trust claiming the interest.

Thanks to @ChrisP73 for prompting this strategy.


See

Legal Tip 74: Loans Death and Inheritance Legal Tip 74: Loans Death and Inheritance


Legal Tip 237: Using to Loans as an Estate Planning Strategy for Death Legal Tip 237: Using to Loans as an Estate Planning Strategy for Death


Tax Tip 220: Strategy to Avoid CGT for generations to come (forever?) Tax Tip 220: Strategy to Avoid CGT for generations to come (forever?)


Tax Tip 65: Deductibility of Interest for paying out a loan of a deceased estate Tax Tip 65: Deductibility of Interest for paying out a loan of a deceased estate


Tax Tip 171: An example of how Testamentary Trusts can Save Heaps of Tax
Tax Tip 171: An example of how Testamentary Trusts can Save Heaps of Tax

Tax Tip 241: Leave your children 2 properties CGT free on death Tax Tip 241: Leave your children 2 properties CGT free on death

 

Has there been any cases of banks closing people's offset facility and paying off their loans if they have $1mil in offset and a $1mil loan? I've read before that it's best to not have it at fully offset like that (or over) because the bank could just close down the facility as they get no benefits, meaning no interest payments to them. Best to always have it slightly under being fully offset.

 

Never heard of it happening. Not even sure if could happen if there has been no default.

 

Does dad's property have to be leased out (after the loan is paid out) for the interest to be deductible?

 

If the legal owner borrows to acquire some or all of the property then interest will generally be deductible

 

Thanks Terry. So to clarify, the property would have to be used in an "income-producing" capacity (i.e. IP) for the interest to be deductible?
Simply paying off the loan and then occupying the place as a PPOR would not afford the same benefits.

 

My non-bank lender (RateBusters) sent me a letter demanding that I either close my account or reduce my offset balance after it had been sitting fully offset for a while. There was nothing in the loan contract to say I had to, but I was very unhappy with the lender anyway, so I did close my account.

 

An offset is not permitted to exceed a loan under ATO guidance issued to lenders a long long time ago in TR 93/6. That ruling explains that offsets are limited to lender software and raises the issue of Nil offset arrangements. This is really at the mercy of the lender.

So what about a $0 offset ? Many lenders have a concern that then there is no loan.... So then a minimum balance is needed, right ?

Lenders cant also leave $10 unpaid on the loan without requiring some sort of minimum repayment. So there can be real problems with a "fully repaid"offset being kept alive.

A strategy used by several clients is to bring the offset down toa token balance of say net $3 and then withdraw and later deposit $100 a month (ensuring its many days) and keep doing that so that a token balance always exists eg $2 but during the month there is some interest albeit very token in nature. eg $100 drawn 12 days = $13cents

 

What makes the borrowing deductible ? Hasnt the son been left a property in the will ? The borrowing wasnt incurred to acquire an asset. It was used to discharge a liability (of the estate) so that the asset transfer could be effected. I would want to see a private ruling on this arrangement.

 

Think of it this way. If I give you my property valued at $300,0000 on the condition of you paying out my loan, would the interest be deductible to you? The property is being acquired and the borrowing is incurred in relation to this.

 

If I pay out your loan its not a borrowing. If I financed a new loan it would potentially give rise to a deductible nexus as a new loan (not a refinance since we arent the same persons) if my intent was to produce rental income and my new loan was given to your lender at settlement. Yes.

I can see some holes in a will shaped like this ie the silence part. And its completely unnecessary if the beneficicary seeks to reside in the property.

The refinance principle Roberts & Smith works yet again. However the ATO could attack the basis using Haydens case where the borrowed funds are objectively used to pay other persons their entitlement.

 

If you pay off my loan it is essentially you giving me money so I can pay off the loan.

There is at least one positive ruling along the lines of this post, and I think I have linked it before.

But anyone contemplating this strategy should seek tax and legal advice before implementation

 

@Terry_w, presume dad has a property with a valuation of $1.2M but no loan when he dies. What strategies could an executor of the estate use to establish a $1M loan secured against the property to enable this strategy? Estate has no other assets/income.

 

Actually, if the son had 20%, he could get a bank loan for the 80%, and purchase the property from the estate. The estate would then distribute the cash to the son as the sole beneficiary which could be used by the son to paydown non deductable debt. Does this work?

 

That might work but would generally result in both stamp duty and CGT being triggered.