Tax Tip 4: Borrowing to Pay investment expenses

What would be the general consensus on deductibility of interest when redrawing to pay council rates in this situation?

• I have two loans; Loan 1 for my IP (deductible), loan 2 (non deductible)
• I have negligible "cash"; all my income goes into extra repayment to Loan 2, which is redrawable.
• I have a small amount of redraw available in Loan 1 (which I intend only ever to redraw for deductible purposes)
• Council rates on my IP are due soon. I will need to redraw on a loan (either Loan 1 or Loan 2) to pay them.
• Should I redraw from Loan 1 and claim the interest? i.e. is it be reasonable to believe this does not fall foul of Part IVA.

Since the ATO clearly believes that money available in a redraw is NOT equivalent to having cash available in an offset account (this being one of the justifications behind the loan contamination principle of TR 2000/2), and I don't have other cash on hand to cover this expense, isn't it reasonable for me to redraw for this purpose and deduct interest accordingly?

I know, I know, seek professional tax advice, etc. But I would be interested to hear people's thoughts on this issue. TIA

 

Part IVA could potentially apply to anything...

Whether the interest would be deductible or not is discussed over the previous 9 pages.

 

Thanks Terry, did read through the whole thread but couldn't find anything particularly relevant to my situation of having all available funds tied up in redraw. Was hoping you or others might have further insights.
My interpretation so far is that the legitimacy of deductability of interest for expenses is fairly uncertain, unless the taxpayer is in a position where they have no choice but to borrow for the expense, in which case the ATO has said yes, that is deductible.

 

Interest on Borrowings to pay investment is deductible under s8-1. No doubt about that.

But could Ato use antiavoidance legislation to deny the deduction. Yes.
Would they? I have seen no evidence to say they have, but they could potentially

 

You are considering just one element of a scheme. ie the spending part. The element of how liquidity came to be parked in that facility is a issue. The more you plan a outcome the more Part IVA could apply.

A person who is compelled for financial reasons to borrow money may have valid reasons and claim deductible interest. (eg Unemployed two months) However if you construct a scheme that leaves you with a choice of how to engineer and produce that choice while you use your cashflow from working etc to make preferred payments to pay down your own home loan and leave no cash to pay your other financial commitments that seems more a scheme than a compelling purpose.

 

Apologies if this is covered somewhere. I have a PPOR that I'm intending to later turn into an investment property, am I able to borrow to pay things that would be investment expenses if it were an investment property (i.e. rates, insurance, water, repairs, gardening etc.) and then when the property becomes an investment property would those loans become deductible? Or is the interest on the loans only deductible if they pay expenses at the time it is an investment property? Also, assuming the interest is deductible, would it be possible for the loans to be 0% from a family trust while a PPOR and then refinance them with the IP IO loan when it becomes an investment property?

 

Part IVA needs to be considered.

I don't see how interest on borrowings now to pay rates could be deductible if later rented. But improvements or repairs may be ok.

 

That makes perfect sense. Council rates really only refer to a specific period whereas repairs and improvements (like the purchase price and stamp duty) are more general. Thanks Terry

 

If property is currently PPOR and I borrow to pay for house (building) insurance premiums and then subsequently rent out, does the interest on the loan then become deductible as it relates to insurance intended to preserve the value of an income generating asset?

 

You would need to ask the commissioner that to get a firm answer. You might have an arguable case tho

 

The interest for the period from when the premises are used to produce assessable income would be deductible once the property is available for rent. This is under general principles of deductibility. (Based on the policy dates not when paid)

It is a outgoing necessarily incurred as a property ownership cost. Excepting a third element CGT cost the Commissioner does not accept insurance as a costbase addition as a fourth or fifth costbase element. It doesnt preserve the asset. It assists to replace the asset if a defined policy event occurs that causes the asset or an element of it to be destroyed. There have been people raise this in cases which the AAT have denied.

 

Thanks Paul. Sorry for being a bit slow, but I'm not clear whether you're saying the interest on a loan used to pay insurance premiums for a policy that covers a period solely when the property is not available for rent could then become deductible when the property is then available for rent?

I'm also not clear what the significance is of the insurance premium being a third element CGT cost as opposed to a fourth or fifth. Is it right that any house insurance premium adds to the cost base (as a third element CGT cost)?

 

Lets say you pay by the month. So 12 payments of $102. The policy period is 1 January to 31 December. You cease to occupy the property on 13th March. You clean up and repaint and make it available to rent with the PM on 31 March.

9/12th x ($102 x 12) would be deductible. However, as the payment for the pay by month spans two tax periods the deductible portion to 30 June is 3 months and 6 months runs to the next tax year. (July to December)

A third element CGT cost is a ownership cost for which a taxpayer has not claimed a tax deduction. If the property is treated as 100% CGT exempt it wont be a issue. If s118-192 is used any ownership cost incurred prior to that same date cannot add to the costbase anyway. Only if a pro-rata CGT calc occurs will the 3rd element cost become a issue.

 

Thanks Paul. I follow that with regards to the destructibility of the insurance premiums themselves. But I'm trying to understand whether interest on loans used to pay those insurance premiums are deductible.

So say I've paid insurance premiums for an entire year and do not rent out that year and I've borrowed to pay those premiums. It's clear that I can't claim the interest on that loan during that period. But if I were to then rent out (and assume I stop paying insurance), can I claim the interest on the loan used to pay those earlier insurance premiums?

 

@Terry_w and/or @Paul@PFI, can you comment or provide any insight on using equity from a margin loan to pay IP expenses.
E.g. IP land tax $2000, draw $2000 from margin loan to pay the land tax bill. Is this allowed and is the interested accrued on the margin loan for the $2000 deductible?

Does the ATO see the margin loan's purpose as 'for investment purposes' or see its purpose as 'for share investment purposes'? and if the latter, then therefore interest not deductible when used for other investment vehicles?

 

No. The private cost of insurance isnt a element of the costbase. Hence its not a deductible acquisition or use. You also cant backtrack borrowings.

 

Typically speaking a margin lending facility is restricted to shares that are on an approved list.
If it was allowed I wouldnt. It will result in a blended loan issue ie property v shares. Dont use the arguement its all still deductible. Its blended. It will be a problem. You cant just calculate interest on $2k and deduct that and the balance is shares. You will taint both purposes.

 

You can't 'use equity' only borrow money. if you borrow to produce income the interest on that loan would generally be deductible. It doesn't matter what the security for the loan is. 'purpose' of the loan doesn't matter, it is the use of the borrowed funds that count.

 

@Paul@PFI, Hi, I might be completely off subject & confused but is insurance a deductible cost? e.g. buildings & landlords Insurance? cheers

 

Yes if it relates to a property that is producing income it usually would be.