Tax Tip 301: The need to Apportion Borrowing expenses in the 1st and 6th Years

Discussion in 'Accounting & Tax' started by Terry_w, 24th Aug, 2020.

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  1. Terry_w

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

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    Where a loan relates to the generation of assessable income the interest can be deductible and also so can the borrowing expenses such as loan application fees and Lenders Mortgage Insurance or LMI.

    Borrowing expenses are deductible under a specific section – 25-25 ITAA97 which states, basically, that they are only deductible over 5 years or the life on the loan if shorter. But in the first and last year of these 5 years the costs will need to be apportioned to take into account part years – unless your loan settled on 1 July perhaps.


    Example

    On 15 March Smithers takes out a 30 year loan and incurs $10,000 in LMI. The loan related solely to the purchase of an investment property so the $10k will be deductible over 5 years. But as there are only 107 days left to the end of the financial year Smithers will need to apportion the first year’s claim

    Year 1 5.31% (being 107/1826 days)

    Year 2 20%

    Year 3 20%

    Year 4 20%

    Year 5 20%

    Year 6 14.69% (whatever is left)
     
  2. Paul@PAS

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

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    The words five years dont appear in s25-25 for the calculation method statement s25-25(4). And neither does 20%. I avoid using these words as it misrepresents the eligible deduction. I am astounded how many tax agents think its 20% per annum. See Steps 3 & 4

    Example

    Maximum deduction for an income year
    25-25(4) You work out as follows the maximum amount that you can deduct for the expenditure for an income year:

    Method statement

    Step 1. Work out the remaining expenditure as follows:

    • For the income year in which the *period of the loan begins, it is the amount of the expenditure.
    • For a later income year, it is the amount of the expenditure reduced by the maximum amount that you can deduct for the expenditure for each earlier income year.
    Step 2. Work out the remaining loan period as follows:
    • For the income year in which the *period of the loan begins, it is the period of the loan (as determined at the end of the income year).
    • For a later income year, it is the period from the start of the income year until the end of the period of the loan (as determined at the end of the income year).
    Step 3. Divide the remaining expenditure by the number of days in the remaining loan period.

    Step 4. Multiply the result from Step 3 by the number of days in the remaining loan period that are in the income year.

    s25-25 (5) refers to the period of the loan and is where the 5 years arises. s25-25(5)
    (c) 5 years starting on the first day on which the money was borrowed.

    Using the rules in 25-25 deductions will usually be spread over 6 tax years in almost all cases. In the very rare case of a 1 July borrowing it would only be exactly 20% pa
     
  3. Terry_w

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

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    upload_2020-8-24_11-8-4.png
     
  4. Paul@PAS

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

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    And 25-25(5) answers a common question I am asked

    Fred borrows $200,000 and incurs LMI of $8,000 to assist purchase of a new investmnet property. The loan is a 3 year fixed rate term. Fred asks :

    Q. Can I write off borrowing expenses over 36months since the loan term is 3 years ?
    A : No. s25-25(3)(b) looks at the repayment term. A 3 year fixed term is generally reset to variable at the end of the 3 years and a 3 year loan wont generally allow lump sum repayments (without penalty). Hence the period of the loan for borrowing expesnes and deduction purposes is a 5 year (60 month) term.

    However, if Fred was proposing to repay P&I over three years so that at the end of 3 years the loan is repaid this may be correct. BUT in many cases it may be prudent for such a borrower to claim the deductions based on 5 years until the actual loan IS repaid and then claim the balance of undeducted borrowing expenses at that time.
     
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