Tax Tip 557: Debt Recycling into Assets that pay no Income

Discussion in 'Accounting & Tax' started by Terry_w, 25th Oct, 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 557: Debt Recycling into Assets that pay no Income


    Debt Recycling is converting a loan on which the interest isn’t deductible into a loan on which the interest is deductible.

    When borrowing to buy shares (or ETFs etc) that do not pay income the interest would not be deductible.

    This would include shares that just pay bonus shares instead of dividends. Note that bonus shares are different to dividend reinvestment schemes as the dividends are taxed as income, even if reinvested without being received, while bonus shares are not considered income they would be taxed as capital gains when sold.


    So, should you borrow to buy shares that pay no dividends?

    I am not interested in whether these are a good investment or not, we are just considering the tax aspect here.


    If you have non-deductible debt why wouldn’t you borrow to buy the shares! You will be removing money from your offset account if you bought them with cash anyway, so you might as well structure the use of the funds so the extra interest incurred becomes a cost base expense as it would reduce CGT when the shares are sold.


    Example

    Homer has a $500,000 home loan, non-deductible interest, and has $100,000 spare cash in an offset account. He is therefore only paying interest on $400,000 of the loan.

    He wants to buy some shares that will not pay any dividends.

    His mate barney, who is not qualified or licenced, tells him, at the pub, to just use cash as the interest can’t be claimed anyway.

    $100,000 is removed from Homer’s offset account and he buys the shares. After 5 years he has incurred around $30,000 in interest.

    He sells the shares and there is a $50,000 capital gain. Homer gets the 50% CGT discount as he has held them for 12months or more so he pays tax on $25,000 which works out to be $11,750 in his case.

    None of the $30,000 extra interest is taken into account.

    Ned overheard the conversation and did the same thing, but he split this loan and did some ‘debt recycling’ which isn’t technically debt recycling, but it doesn’t matter what you call it really. Ned split this loan and paid down the $100,000 split and reborrowed to invest in the same shares.

    He also got a $50,000 capital gain when he sold on the same date as Homer. But Ned had $30,000 in cost base expenses so his taxable capital gain was $20,000. After the 50% discount it become just $10,000.

    Being on the top tax bracket Ned paid $4,700 in tax.

    He saved $7,050 in tax just by taking 3 extra steps – splitting the loan, paying it down and redrawing. All up this took 7minutes and it saved him $7k, that is $1,000 per minute!


    Note that I am certainly not suggesting you invest in anything with this post. I am just pointing out that if you are going to invest and invest in an asset that doesn’t pay income, you can still structure the purchase of the asset so that it will save you tax in the long run.


    Who can advise? See a financial advisor on what to invest in, and whether you should invest.

    See a solicitor or tax agent on the tax aspects of structuring the funding of that investment.

    See a solicitor about the ownership structuring of that investment.
     
    craigc and Piston_Broke like this.