Reimbursing yourself - Impossible It is impossible to reimburse yourself with borrowed money after an asset has been paid for. And interest will only be deductible if the borrowed funds are used to produce income. Where people get into trouble with this sort of thing is when they don’t plan ahead, but may pay a 10% deposit using cash before they have the loans sorted out. Once a deposit is paid in cash it is paid. If you later borrow an equivalent amount from a loan increase and ‘pay yourself back’ the interest on this loan cannot be deductible. So, before you pay any money for a property make sure you get the loans set up so that you can borrow to pay for that property. On a $500,000 purchase a 10% deposit is $50,000. A $50,000 cash payment, while you have non deductible debt on the main residence, will result in about $2,500 per year in lost deductions ($50k x 5%). That is per year for the life of the loan. That could cost the average person $1000 per year out of their pocket. Enough for an overseas airfare.
Hi Terry, Where people only get the loan after paying the deposit - what are the options? What's your opinion on capitalising interest? For example the $50,000 in your example. One could set all the repayments for that mortgage to come from the $50,000 loan instead of paying themselves back. That way over time they have the opportunity to save up again, even if not directly paying themselves back. Is this generally OK without the ATO considering it a scheme under Part IVA? Am I right in guessing it's a case by case basis depending on circumstances? It's something I know some people do, but it can be tricky if they are diverting the money to pay their PPOR or some non-deductible debt based on previous cases..
You cant contract with yourself (or the same entity). Or lend, borrow or even trade with associates in so many instances... Its only later when the ATO review that the problem is evident. Too late Good tip. 20% of problems I see are this issue. But sadly few see the issue and rely on their own opinions. Good example of when DIY fails
Get yourself a LOC before you go shopping - at least that way you have borrowed the funds before you have established your main loan.
Not many options as the deed has been done. Capitalising interest - will depend on the reasons. Generally not deductible. Borrowing to pay expenses may help -slowly, but get advice about Part IVA applying. But there are some ways to rectify if you get it quick enough. When you pay a deposit it is held on trust for you, the purchaser. It only becomes the vendor's money at settlement. So you could possibly take the money back and then repay the deposit. A bit tricky. If it was a spouse or a different entity then it may have been a loan.
Technically you won't have borrowed, but will have the loan facility in place so you can borrow to pay the 10%.
Terry - that is assuming the deposit funds are going to be borrowed and aren't sourced from cash. I have no non-deductible debt. My cash sits in an offset account against an IP. When purchasing again I will use cash as the security for the deposit and set up a loan against it. It costs a bit (about 1% difference between interest earned and interest paid) - then as LVR reduces I will top up the investment loan and repay the 'cash loan' (or do a security transfer) thus releasing the cash back to me. This ensures I pay everything with a loan, and not cash. The 1% cost is small change compared to life long non-deductible loans. You cant access the cash used until you re-finance, or switch securities. Wont work for everyone, but works especially well when flipping/adding value. Or when the cash is held in a different entity to the borrower/purchaser. Blacky
Most unusual. However this is not reimbursing yourself but refinancing one loan with another. I have never seen or heard of someone doing this before - but perfectly acceptable. Why not just set up a LOC which you can reuse and recycle over and over again. It would be much simpler and cheaper.
Im drawn to 80% already. I could push into LMI territory, but the cost doesn't really make sense to me when I have cash available. Using a loan account allows me to maximize my tax benefits for minimal cost. Also - as usually happens the cash is held in a different entity to the borrowing entity. There are a number of ways to move the cash, but it would usually result in some kind of profit being made (paying dividends) although I could do an inter company loan. However, there can be issues with that as well (as you well know). So instead you provide a cash deposit security from entity A and entity B borrows against it. Entity A needs to give a guarantee also - but in my case it would have to any way. Just one other possibility. Blacky
Part IVA could still apply if the arrangement provides a tax benefit. ie a deduction. ANYTHING can be a scheme. Then you may need a lawyer. My experience in audit cases include many loan arrangements the ATO seek to attack. Dont trip on the dance floor.
Ok so assume you have no non-deducible debt. (ie no PPOR loan). You are fully drawn to 80% on all properties. You have cash available and want to purchase. If you put the deposit down as cash, you cant then re-draw at a later stage to 'repay' yourself. Instead you use the new purchase as security and borrow to (say) 88%. Rather than putting in 12% cash - you top up the security with a cash deposit (12%+costs). Often the bank will even offer you one loan against the IP at (say) 105% of purchase price, using the IP and cash as security. At some point in the future when there has been capital gain - you re-value the property and release the cash deposit back to yourself - while leaving the loan in place (now at LVR 80% of the new valuation). Banks will take 100% LVR agains tax. The cost differential (deposit vs loan) is somewhere between 1-2% so yes - you do pay to use your own money. One of the major benifits is when the cash is held in a different entity to the IP. eg - you purchase the IP in a company/trust and the cash is in your personal name. You could create a 'directors loan' or 'loan from shareholder' and repay that loan at a later date. But the ATO likes to look at this as a way people avoid tax. The loans have to be commercial yada yada yada. So instead you provide cash (held in your own name) as top up security to the company (which borrows against it) and provide a personal guarantee (which you probably would have in any case). The interest earned is taxed to you personnally (cash in your name), and the loan interest is deductible to the company/trust. So there is some implications there. However, it does save you from having to move cash between entities. There is also risk to consider - as you would not be a secured creditor to the company/trust - so it may not be the best option for asset protection. So its an option
This is pretty much my scenario. This is exactly what I would like to do if possible. What is the actual mechanism for using the cash as security? Like a term deposit? Or is it another product completely?
hmm Its a term deposit but it is a different product. Usually called a "security deposit". I think its just a term deposit which you dont have access to. It pays interest but less than what you pay as a loan. Note that most brach lenders wont have seen it before. You need to get up the chain a bit higher into a private banker/business lender. Or a good broker. Blacky
