Tax Tip 293: Deductibility of Interest Where Shares Sold and Borrowed Money Reused

Discussion in 'Accounting & Tax' started by Terry_w, 18th Jun, 2020.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I think some people inadvertently bugger up the deductions on loans used to buy shares. This might happen because shares are more fungible – they can easily be bought and sold whereas property is more chunky and you can’t buy and sell without duty and discharging mortgages etc.


    Some way that share investors can get into problems is to sell and then rebuy with the same money without repaying the loan. See why I think this might be a problem.


    Example

    Ned borrows $100,000 and invests in shares that pay dividends. He does this buy transferring $100,000 from a new loan split to his share trading account.

    The shares increase in value to $120,000 and then he sells.

    The $120,000 remains in the share trading account.

    Ned then uses this money to buy more shares.

    Can Ned claim the interest?


    I think Ned would have a good argument that he can trace the funds back to the loan. But my concerns are

    a) The proceeds are technically cash and not borrowed money

    b) The capital gains compounds this further

    c) There is a simple solution of paying down the loan and then redrawing

    What if Ned wanted to take the $120,000 gain out and keep the $100,000 in the share trading account to invest?

    This would make it worse; I think.

    When the shares are sold it is a mixed loan really, as the account contains borrowed and non-borrowed money. If Ned were to pull out $20,000 it would be reducing both portions. This is like mixing 100mls of water with 20ml of organ juice. You cannot pull out the orange juice separately.


    The best solution is to repay the loan and borrow again.
     
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  2. codebeard

    codebeard Member

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    What happens if Ned wants to sell half of the shares? Can he sell half for $60,000 and take $50,000 of the proceeds from his trading account to repay the loan?
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Ato allow for portion of a mixed loan to be repaid so they would only need to repay the percentage of the loan that related to the shares sold
     
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  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I had a client last week who had debt recycled into shares, then fixed the loan, but was now going to sell the shares and buy some other shares. Because the fixed rate was so low he wanted to not pay into the loan again, which would have resulted in breaking the fixed period and having the loan revert to variable.
     
  5. Calder&Scale

    Calder&Scale Well-Known Member

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    Hi Terry,

    Do you think there are any concerns with selling/transferring a share portfolio, purely to use the proceeds to pay down debt and redraw to purchase the exact same portfolio (now with tax deductible interest)?
     
  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Whats the purpose of doing that?
    I would be concerned about Part IVA
     
  7. Calder&Scale

    Calder&Scale Well-Known Member

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    Yes, my concern is part IV as well.
     
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  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    The only reason to do that would appear to be a tax reason.
    Any history of buying low and selling high and buying back again?
     
  9. Calder&Scale

    Calder&Scale Well-Known Member

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    No.
    But selling slowly to accumulate funds, then debt recycling in chunks may obfuscate the purpose.
     
  10. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Part IVA may not necessarily apply if the total invested sum was to increase. Then later sell down. This should be neither all at once or too soon after increasing. It may even be possible to sell the parcels that produce the lesser CGT outcome. HOWEVER to avoid losing interest deductibility sell the parcels that had no borrowings. While the CGT rules permit any parcels to be chosen the interest requirements are different and if the later parcels are sold then it will stop some/all interest deductions from that date.
     
    Last edited: 28th Nov, 2022
  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  12. Bruz

    Bruz Well-Known Member

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    I’ve debt recycled $140k of my PPOR loan buying etfs. We may upgrade the PPOR and the current one would become an IP. Is there a way to revert debt recycling? I want to sell the shares and use those funds as a deposit for the new PPOR however I would like that loan split to be deductible against current PPOR that will become an IP once we upgrade.
     
  13. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Was the borrowed money used to acquire income producing investments? No. It was originally. But then that stops when the shares are sold. If the shares are sold the interest deduction ends whether the loan is discharged or not. So not using the proceeds to discharge the loan is still non-deductible. You cant continue deductions if the investments are sold.

    The interest cannot ever be deductible v a future IP unless the loan proceeds are clearly used to refinance a existing loan to acquire that property OR make improvements etc. Many people ask if they can borrow against the home and it later becomes deductible when the property is rented. This doesnt work either. The PPOR is merely loan security. The USE of the borrowing is to buy something else.
     
  14. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You always get what you want, but if you plan ahead you might get what you need using related party loans