Tax Tip 285: Redrawing money is borrowing

Taking money out of a loan is considered new borrowings for tax purposes. A deposit into a loan is a repayment.

This creates a few issues when redraw is used because:

a) The loan will be mixed

Once redraw is used the loan will now have 2 uses. The original use – usually to buy that property and the second use – which will depend on how the redrawn money is applied. Where the redrawn money is used to repair or improve the property it won’t be mixed though as both uses will be the same.


Example

Homer has a main residence loan with $20,000 available in redraw. The loan was used to buy the main residence originally and has never been redrawn.

Homer redraws this money and uses it as deposit on an investment property.

The loan is now mixed as part of it relates to the purchase of the main residence and part to the investment property.


b) Deductibility of Interest

Interest on loans used to purchase income producing assets will be deductible (under s8-1 ITAA97). Where a mixed loan relates to part deductible and part non-deducible it should be split before the paying anything extra into the loan other than the minimum repayment. This is because you would want to reduce the non-deductible portion before reducing the deductible. This is not possible where the loan is mixed.


Example

Homer has his loan mixed as above. Let’s say he hah $80,000 owing and $20,000 was redrawn to invest in the investment propriety. Homer inherits $50,000 and deposits it into the loan. This deposit will reduce the $80,000 portion to $40,000 and the $20,000 to $10,000.

It would have been far better for Homer to split first and then reduce the $80,000 to $30,000 and keep the $20,000 as is because this would have kept his tax deductions higher and saved him non-deductible interest

 

I'm often asked questions concerning debt reduction and using borrowed funds for paying investment outgoings, redraw etc. I find it worthwhile to remind all borrowers that any loan drawdown reduces equity dollar for dollar. Chasing a deduction is a minor element of the transaction and under 2% of the amount borrowed will reflect in a full year as a return of cash through an enhanced deduction. You are eating equity with trivial payback and even debt recycling may take a long term cycle to outweight a benefit v cost. As the property is already owned no additional capital growth can occur through the new funds drawn.

Using borrowings to leverage an entitely new asset is a different matter as a $100K loan could be used as the deposit funds to acquire a new investment with potential to create additional growth through a new leveraged asset. Provided market conditions are right of course. A market price correction would magnify losses.

New borrowings are not always the same.

 

Wouldn't it be better to debt recycle say $100 and save say $4 than give it to the ATO if that $104 can come off your home loan - as long as the effort needed is minimal.

 

So if you were to redraw from PPOR loan to pay costs for investment e.g council rates and strata fees. Is that then tax deductible generally speaking?

 

Your wording is vague - I assume you are asking if the interest on borrowed funds to pay these expenses is deductible? The deductibility of rates etc doesn't change if it is cash or borrowed money that is used to pay for it. But if borrowed the interest may also be deducitble.

Tax Tip 4: Borrowing to Pay investment expenses Tax Tip 4: Borrowing to Pay investment expenses

 

Yeah I worded that horribly but you managed to answer my question so thank you!

 

Hi Terry thanks for the information on recycling debt. I have just refinanced to get equity out of PPOR.
Loan 1 167K PI redraw/offset
Loan 2 97K PI redraw/offset
Have 30K in savings.

going to invest 97K that's the easy part, now should I pay 30K into loan 2 and redraw to invest? as loan 2 interest is 100% deductable and only being used for investments.

If I pay into loan 1 then redraw would that be mixed? Thanks

 

Seek specific tax advice as that wouldn't appear to make sense.

 

Have a quick question here. As redraw is new borrowing, does this means hypothetically, the same loan redraw can be used multiple times? Eg below:

Loan A split 2 ways:

Split A - $100K
Split B - $20K

$100K loan is for IP
$20K split has no purpose yet.

Can I fully repay into split B, redraw full amount and pay for IP A expenses?

1 week later, I fully repay into split B, redraw full amount and invest in shares?

Does this mean that as long as i continue to repay into split B, redraw, and invest, in theory I have $40k of deductible loan interest from the example above?

 

Uesy

 

Depends if the investment is a deductible purpose. Interest is not deductible just because you buy something to invest

 

Sorry the others may have missed it - but from my understanding aren’t you saying you have repaid the split B for a second time after one week?

If you’ve repaid the loan after 1 week at that point there’s no longer any interest to deduct.

If you then redraw (Reborrow) correctly as per Terry’s tips for deductible purposes such as dividend paying shares, then the new $20k redraw could be deductible.

You can’t claim interest on $40k when the loan amount is only $20k.

If this is not what you intended from your question I apologise and please disregard above.

 

i think you are right @craigc. It should be 20k coz like you said for me to "redraw" again, i have to pay it first. so if the 2nd redraw is still for income producing purpose, then it is deductible.

Spot on - i myself have overlook that point.

 

Mlee17 said ...
Have a quick question here. As redraw is new borrowing, does this means hypothetically, the same loan redraw can be used multiple times? Eg below:
Loan A split 2 ways:

Split A - $100K
Split B - $20K

$100K loan is for IP
$20K split has no purpose yet.

Can I fully repay into split B, redraw full amount and pay for IP A expenses?
1 week later, I fully repay into split B, redraw full amount and invest in shares?

Does this mean that as long as i continue to repay into split B, redraw, and invest, in theory I have $40k of deductible loan interest from the example above?

Split B isnt a loan. Its an undrawn facility. It cant be repaid as the balance is $0. There cant be a redraw. Only a original use for the funds. If that is then repaid the deductible reduced eg You repay $10K. Only 410K is now deductible. You reborrow $10K for shares. Now its $10K property A and $10K shares.

In the proposed scenarion B would be come belnded between shares and property A expenses. Given many shares are bought, sold etc I would argue the ATO could easily find B blended and question the deductible %

New Tax` Tip Terry - The maximum deductible value of all loans is limited to a maximum of 100% of all facilities drawn. Deductible % can only ever reduce on redraw, blending or use of borrowed funds. It can never increase above 100%.

 

Hi @Terry_w and @Paul@PFI

The tax tips are an incredible resource! Thank you!

Given your initial statement suggests a redraw is considered a new loan, therefore I cannot deposit and redraw personal use funds into/out of an investment loan?

Investment loan $150k
Personal cash $100k
Put cash into investment loan to reduce balance, then redraw that same $100k for personal use in 2 years time.
No other funny business.

Does that make it a mixed loan after the redraw? Even though it's purely there for the investment only? And the personal cash has gone in and out dollar for dollar?

Cheers and have a great weekend!

 

It will make it a mixed loan as the $100k relates to non-deductible use.
Don't do it, use an offset account.

 

Thanks @Terry_w
The more you read on this the more the case law makes sense. So clearly an easy thing to mess up, especially those (non tax professional) who think they know what they are doing.

 

Many elements of tax law are like that. Its very easy to overclaim or underclaim.

 

Why we would need 2 loan split? Can't we just borrow 120k as investment loan and lets say pay down 20k into 120k loan and reborrow again to invest!! Will it be tax deductible that way or has to be Paid full b4 reborrowing??

 

If you pay down a loan in part and redraw again you will be creating a mixed loan.