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Tax Tip 54: Why Not to Mix Loan Purposes

Discussion in 'Accounting & Tax' started by Terry_w, 13th Oct, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    This is a bit of a rehash of Tax Tip 3 Mixing loans - Don't do it. https://propertychat.com.au/community/threads/tax-tip-3-mixing-loans-dont-do-it.1517/

    Where there is a mixed loan any repayment into that loan must come off all parts of the mixed loan in proportion to those parts.

    e.g.

    You have a $500,000 loan out of which you bought 5 properties for $100,000 each. It is one big loan.

    If you happen to be living in one of those properties the interest on this portion is not deductible. So in this case 1/5 of the loan is private use and 4/5 is investment use. So 80% of the loan is deductible and 20% isn't.

    If you win $100,000 from lotto you would want to pay this off the portion of the loan that relates to the property you are living in. This interest is not deductible whereas the interest on the investment loans is.

    But because there is one big loan you cannot choose to pay it off part of the loan. If you deposited the $100,000 into the loan 20% of the $100,000 will come off each of the 5 portions. The result will be the main residence portion reduces by 20% and each of the investment portions will reduce by 20%.

    This is not ideal as you are not maximising tax deductions.

    So what you would need to do is to split the loan before paying it off. The ATO accept that a mixed loan can be unmixed. TR 2000/2 paragraph 18

    In this case you could split it into 2 portions. $400,000 investment portion and $100,000. Once it is split you would then pay off the $100,000 portion

    But since you are splitting things anyway you might as well take the opportunity to split all 5 loans into their relevant portions. Do it all at once and get it over and done with as problems will arise in the future and you will be in a bad position legally if there is a default on the loan. All properties will be exposed.

    There is one exception where part of a mixed portion can be paid off a loan without splitting it. I will cover that next.
     
  2. Ravi

    Ravi Active Member

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    Hi @Terry_w

    Please tell me if my understanding of above concept is correct.

    I have a ppor
    bank value = 620k
    ppor loan = 378k.
    Equity available = 118 (80% LVR)

    I used above equity and create a separate loan and attached offset account for future investments purpose.
    Loan #1 = 118k
    offset bal = 118k

    Then I used money in offset account to buy two properties say, prop#1 = 50k and prop#2 = 40k:
    After this:
    Loan #1 = 118k
    offset bal = 28k (118 minus 50 minus 40)

    As you can see, I have a mixed loan situation.

    Questions:
    1. Can I leave loan#1 (118k) as it is and continue to claim deductions (based on apportioning 50:40).? Assuming no plan to sell properties in near future.

    2. Say after 2 year, values of my investment properties go up. Can I use equity from prop#1(50k) and prop#2(40k) and offset bal = 28k to pay off loan#1(118k) fully?

    3. There was a registration fee $350 and settlement fee of $200 each which was paid from offset bal. So actually I have 28k-$750 = $27,250 instead of 28k. After 2 years when I pay back my loan fully, do I have to apportion this $750 between prop#1 and prop#2? So, basically I have to pay $50,416.625 from prop#1 equity and $40,333.30 from prop#2 equity. Is that correct?

    Thanks for helping.
    Ravi
     
  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Hi Ravi

    Assuming you have not mixed other money in the offset by making any other deposits into the offset and therefore you can trace the loans:

    1. Yes I think the ATO would accept this as you can trace the money, but you would need to adjust the portions being claimed if you take out further money from the offset.

    2. If you want to access further equity by borrowing and placing more borrowed money into the offset then this would be similar to increasing the limit of a LOC. You should then have to readjust the portions claiming for each property.

    3. Sounds like you are wanting to split the loan and refinance in 2 years? If so you would need to refinance on the same day. If for example you paid $50,416 into the loan today, this amount would need to be apportioned between the 2 parts of the loans. The balance of the loan is $90k and $50k has been used for IP1 so 55% of that $50,416 would be coming off the portion of the loan used for IP1 and 45% coming of the portion used for IP2. Your repayment would be reducing deductible debt. Not all the interest on the refinance loan would be deductible because of this.

    If the next day you 'refinanced' the 2nd portion of the loan then the portion associated with the use for the second property has already been reduced so you would not be able to claim all of the interest on this new loan either.

    Both new refinanced loans would also be mixed purpose loans too.

    Technically you need to split the loan before refinancing it. But I think the ATO would probably accept that each portion is paid off in full and refinanced by repaying both portions at the exact same day.

    How you could do this is to set up a new loan secured by the IPs themselves. 1 LOC on IP1 and 1 LOC on IP2.

    Then on the same day repay the exact portions used for each property into the offset.
    For IP 1 this would be:
    $50,416.625

    For IP 2:
    $40,333.30

    You would then have $18k (or so) left over in the offset account so on the same day transfer this $18k back into the loan account.

    Once the loan balance is $0 you can either close it, or keep it open and keep using it for other properties. The loan will then be clean so there should be no issues if you use it for 1 property. But if you use it for 2 or more you will have mixed it again and have to apportion.


    As you can see it gets very messy when using the parking method. You also have borrowed can extra $18k which you haven't used which adds to the complexity here.

    This is why I prefer to recommend use of a LOC type product to access equity. Once you have used the equity the LOC can be converted to a standard IO loan.
     
    Ravi likes this.
  4. Ravi

    Ravi Active Member

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    Thanks Terry. I got it now.
     
  5. Elives

    Elives Well-Known Member

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    Hi Terry,

    i have a question which i'm a bit confused about (scenario) i have a loan for ip1 (200k) i've split that loan so it's now 155k and 45k split the 45k i'm going to be using for deposit and closing costs for ip2. i have about 100k equity in offset account offsetting loan for ip1. now the question is how do i do this correctly? do i put the 100k equity back into the 155k split and then transfer 44,990 from the 155k split into the 45k split and then from the 45k split use a bank cheque to pay the deposit and closing costs?

    Cheers, Elives
     
  6. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    This sounds confusing to me. You cannot have equity in an offset account, but you can borrow funds and deposit into an offset account. You need to seek specific advice as it sounds messy.
     
  7. Elives

    Elives Well-Known Member

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    oh the 100k equity was originally taken out of the 200k loan and transferred to the offset account