Tax Tip 502: Borrow to Buy Div Paying Shares, Reinvesting Dividends & Selling Some of those Shares

Discussion in 'Accounting & Tax' started by Terry_w, 20th Jun, 2023.

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  1. Terry_w

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

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    Tax Tip 502: Borrowing to Buy Dividend Paying Shares, Reinvesting Dividends and Selling Some of those Shares



    Things can get messy where a taxpayer has borrowed to buy shares, has participated in a Dividend Reinvestment Plan and then sells part their parcel of shares but not all.



    Example

    Homer borrows $100,000 to buy 10,000 x AAA shares which pay a dividend. Interest is deductible.



    Later Homer sells 5,000 x AA shares for $80,000

    How much interest is deductible on the loan?


    Since Homer sells half of his parcel of shares only half of the loan relates to the shares he still owns so only 50% of the loan would relate to the production of income going forward from the date he sells some of the shares.


    Practically speaking Homer should pay $50,000 into the loan so that only $50,000 is outstanding. There is no need for the loan to be split, see my Tax Tip 55: An Exception to the rule about splitting before Repaying a Mixed Loan Tax Tip 55: An Exception to the rule about splitting before Repaying a Mixed Loan


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    What if Homer had held these 10,000 AAA shares for a few years and they paid dividends and Homer had these reinvested. He might end up having 10,800 shares at the point he sells 5,000 shares. This is where it can get complicated. Homer has to decide which of the shares he is selling. For the shares that were acquired using the dividend reinvestment scheme it is the same as if he bought these with cash. So, it might be worth considering whether to sell all the shares bought with cash and less of the shares bought with borrowed money – so this will allow for more of the interest be claimed going forward. So, in this case Homer might sell 4200 shares that he borrowed to buy and 800 shares that he acquired with the dividend reinvestment scheme. This way he could continue to claim the interest on $58,000 of the loan.


    However, keep in mind that the DRP shares will be acquired at different periods and have different cost bases some may have been acquired less than 12 months ago and may not qualify for the 50% CGT discount.
     
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  2. Paul@PAS

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

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    And ETFs may be even more complicated with costbase adjustmnets due to AMIT tax reports. Reinvestment dates and income dates may be different too.

    Example : June 2022 distribution for VAS is paid on 19 July. It is taxable as income at 30 June and included in the annual tax statemnet however for CGT purposes the reinvestmnet is dated 19 July. Also the amount for income ands costbase are not the same. Most if not all dividend and distribution reinvestmnets credit a cash account with the income and then reduce it for the rounded number of shares / units closest to that amount. A cash residual commonly rolls along. The higher the share or ETF cost the more effect this can have. eg a $3.60 ETF would be minimal but a $80 one would be larger. This can be higher or lower than the income. These are issues which we look for to avoid minor mistakes. The ATO doesnt accept such trivial amounts are correct and will amend. And it consumes time. Diligent preparation is wise.

    I read a recent ATO audit concern that in their new chase for loan interest on property they are going to look at share sales where there is borrowed money where a loan is not repaid and new replacement invstments are acquired using cash in the broker account. The ATO indicated in a clear manner (and you think I can find it ?) that this arrangement may be incorrect and borrowed funds were not used so no interest is deductible. The info didnt indicate if a offset is any different. I suspect it may as it would reduce or end the intrest being incurred.

    So why would they say this ? Borrowed funds may have indirectly been used originally but on sale that deductibility ends. The only way for it to restart is to use new borrowed funds to invest. I encountered the issue with a property owner recently. Its not unlike it. The investor had a fixed rate loan for the investment property of 1.98%. They sold the property and then thought...hey what if we dont discharge the loan but we use the proceeds to invest in a 4% term deposit. They discussed with bank who agreed providing the loan be resecured against the home not the IP security. The term depsoit was never acquired using borrowed money. The loan remains settled for the original purpose eg buy the IP and wasnt refinanced on sale so deductibility ends. But cant restart. . If the sale settlement had refinanced the term deposit by the bank receiving the proceeds to discharger and redraw for the Term deposit it would have likley been OK. But it never was. Instead the sale proceeds were received in cash banked to a savings account then used to invest. No borrowed funds were used. Changing loan security doesnt help either.

    So in the taxpayers mind they used borrowed funds to buy the TD but in reality this never occurred and no interest is deductible. Its equally arguable they used their own equity
     
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