Tax Tip 446: When Onlending Borrowed Money Does the Money have to pass to the borrower first?

Discussion in 'Accounting & Tax' started by Terry_w, 3rd Aug, 2022.

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  1. Terry_w

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

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    People often borrow money to acquire property or shares. When borrowing to buy property they may borrow the deposit from a related entity and the rest from a bank or non-bank lender. When this happens should the related party loan be actually paid to the entity that is acquiring the property or can it be paid directly to the real estate agent’s trust account?


    Example

    Homer and Marge want to debt recycle their non-deductible home loan. They will be investing in property Marge’s name – more correctly Marge will be investing. But the house and loan are solely in Homer’s name.

    Homer has a written loan agreement prepared by a lawyer and will redraw, which is borrowing, and then onlend to Marge who will be using that money to pay a deposit on an investment property.

    Does the money have to go into an account in Marge’s account first or could Homer directly pay the real estate agent on Marge’s behalf?


    I don’t think it matters too much from either a legal or tax point of view. When a person borrows money from a bank to buy a house, for example, the bank will pay the vendor directly and won’t pay the money into the account of the borrower. The same principal can apply here. Homer can pay directly to the real estate agent’s trust account as directed my Marge. This would also avoid any potential loan contamination happening by having the borrowed funds inadvertently mixing with cash.

    There could be a legal argument that a resulting trust happens where Homer pays for a property in Marge’s name, but the written loan agreement is evidence that this was not the intention.


    Seek legal advice before trying this at home.
     
    craigc and Paul@PAS like this.
  2. Paul@PAS

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

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    Agree. However the one thing to watch is when the advanced funds dont actually pass through to the soliictrs trust. I will use a example

    Dad lends to his son Peter. Dad transfers the $250,000 to Peter. Peters leaves thisin a bank account that includes $100K of savings and $250K borrowed from a equity loan. Peter then transfers $500K to his soliictor. Peter may have reduced the deductible interest on BOTH loans by 16.66% since he blended the two borrowings with savings.
     
  3. Terry_w

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

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    It is not the solicitor trust account that is the problem in this example but the parking of borrowing money in a savings account with cash.
     
  4. Paul@PAS

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

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    Yes...But how many people overlook that factor and suggest because $$$$ went to settle that its a clean borrowing and fully deductible.
     
  5. Terry_w

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

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    Of the people that mix loans I would say 99% overlook it - or more.