Tax Tip 58: Two on title One on loan. Who claims Interest?

Usually all on title to a property must go on the loans - not a legal requirement but a lender requirement.

But there are instances where this won’t necessarily be the case. Such as the PPOR in the husband’s name, a line of credit (LOC) set up secured by the PPOR and only in the name of the husband. The LOC is used to pay cash for an investment property.


e.g. Husband and Wife buy a rental property 50/50 for $200,000. Husband provides the cash from his LOC. The LOC loan is in his name only. 50% of the interest on the LOC will be deductible to the husband and 50% to the wife.


There are exceptions for trust relationships and where partnerships are involved.


Authority:

Taxation Ruling TR 93/32 states in paragraph 6 that the income/loss from a rental property generally must be shared according to the legal interest of the owners


PBR Authorisation Number: 1011592189419
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/1011592189419.htm


PBRs cannot be relied upon.

 

However, the situation may be different where one party pays cash for their share.

Example

What would happen if A and B jointly buy a property for say $100,000 with A contributing $50,000 cash and B borrowing $50,000 from a LOC?

Usually the names on title will determine deductibility of expenses, including interest, but in this case A has not borrowed, so the expense on B’s loan is an expense incurred by B and deductible by B against B’s share of the rent.

I cannot find any authority for this situation, but I think it could be arguable that only B will claim the interest on the LOC.

 

Yes....But take care

Rental properties 2013-14 | Australian Taxation Office

Interest on money borrowed by only one of the co-owners which is exclusively used to acquire that person’s interest in the rental property does not need to be divided between all of the co-owners.

The word EXCLUSIVELY is critical. A LOC may not be a smart loan product for this situation.

 

Thanks Paul. I take 'exclusive' here to refer to that person's share and not the non borrower. It wouldn't make sense that they are referring to using a LOC only for one thing. The LOC could still be apportioned based on other ATO statements. And this is just an ATO comment, not to be taken as law.

 

The tax ruling (TR 93/32) at that link says same. That makes it law and binding on taxpayer as a law....

I believe exclusive needs an example - eg outgoings like council rates etc. eg Total $50K LOC used $48K LOC for acquisition of A's share and $2K used for say legal fees on settlement. The $2K is a problem as its a mutual cost of A + B rather than for A's express share of ownership interest....You follow ?? The exclusive refers to A's interest in the ownership and not outgoings or for B's share. Use the LOC for these purposes and it could taint it all. Still deductible but in shares eg 50/50 not all for A.

 

Tax Rulings are not law, but just an opinion of the Commissioner of Taxation. It is the commissioners interpretation of the law. They are binding on the commissioner even if he is wrong.

 

Yes but as good as law... Binding on taxpayers too. Failure to follow a ruling = penalties.

 

Not sure what you mean by binding on the taxpayer - it is not binding in the sense that these rulings can be challenged. A court may find them incorrect. The ATO needs to change its view regularly.

 

Taxpayers are bound to follow them OR follow the costly appeal process to appeal the adverse decision by the Commissioner. For the average investment punter they wont and cant afford to take on the might and budget of the Commonwealth and aren't armed with the technical skills to do so in any event. I would never recommend a client defy a Ruling. Taxpayers are bound therefore to follow the Ruling or be subject to penalties for recklessness. (Given the TR on Repairs and endless questions on PC I question if most taxpayers can truly understand some rulings without advice)

That's why Tax Rulings make such entertaining (?) reading. They are part of the tax law framework including common law. The ATO do from time issue decision impact statements on cases and on occasions these do require revised rulings - But usually just elements of the rulings are revised. One of the largest impacts in recent years gone was Anstey....Self Ed. Very much an exception in withdrawal of TR and later rewrite of the tax act.

 

About the only time I've seen this kind of scenario from a lending perspective is when one of the owners fronts up cash for the investment, the other owner needs to borrow money to buy into the investment. In standard residential circles the cash owner would need to give a security guarantee to the bank lending money to the second owner.

Without going into the legal nitty-gritty, it seems fairly obvious that the person who had to borrow money for the investment would also get the deductibility that comes along with borrowing those funds. The cash investor didn't borrow money to invest so they don't have any interest to deduct. The loan documentation should represent adequate evidence of who borrowed how much and to what purpose.

I imagine any other deductions arising from things like holding costs such as management, maintenance and rates, as well as depreciation would be split between the two parties based on ownership.

 

Note that all the examples in the TR93/32 involve a Mr and Mrs X. i.e. spouses. Spouses tend to be a bit different as they do things together as a family unit. There is a presumption at law that any property in one name is owned by both of them where they both enjoy the benefits. This is a rebuttable presumption.

The situation is different with say siblings.

not that this should change anything in this situation.

I am not sure Paul's example of borrowing from a LOC is correct. It would be a mixed purpose LOC with part of the purpose relating to the husband's borrowings and part relating to the wife's borrowings. The interest could therefore be apportioned between husband and wife.

but such a set up should still be avoided where the 2 parties won't be claiming based on ownership percentages they should source their own funds separately.

 

Peter - Not always that obvious. They must have a clear use of their personal borrowing tied to the acquisition. Then their loan is their deduction and balance of rental income and joint interest etc joint.

To identify when you can use this strategy :
- Identify a co-owner who has other equity available
- Identify where one owner may have a higher income than other
- Possibly a third party (parent?) with cash also. - Loan agreement needed.
May even be a working v non-working spouse situation where the working spouse borrows against their IP/s.

This can happen for a variety of reasons - Parent to adult child, spouse to spouse !! and even two friends - One with equity elsewhere and other without equity. These "preferred deduction" loans tend to be where one party uses other equity. It could be a equity release on their other IP etc....

One variation on this is two mates etc who want to do a dev. One has cash and other none. This may not work where the nature of the borrowing is to acquire a property intended to be developed for profit. That makes it a partnership business. Fails. The partnership rules then prevail and its 50/50 unless there is some other written agreement.

 

I don't have a answer on the LOC. Like all blended loans its messy. Best avoided and may taint. Like all posts about not blending this is no different.

 

This "preferred loan" issue is not greatly different to a unit trust. Like a ungeared UT strategy it does generally require other equity for each borrower however.

 

New link
PBR Authorisation Number: 1011592189419
Legal Database

 

Some people ask for BPRs for the most inane things. Reading TR 93/32 would have been prudent.

The information concerning this can also be found in the Rental Property publication issued each year.

There can be exceptions where each party acquires their interest and each borrows using individual loans.

eg Sue & Peter contract to buy an IP. Sue doesnt work but has received an inheritance of $250,000. Peter borrows $250,000 from the bank. They purchase a new IP for a total cost of $500,000 and each contribute their respective money to their solicitors trust account. Peter and Sue would each receive 50% of the gross rental income and claim 50% of all expenses excepting interest. Peter would claim his loan interest and Sue would claim nothing for interest.

However Peter and Sue could also apply for the loan together not realising the consequences. In that case the exact same net rent arises but is uniformly equally shared 50/50.

Sue would be wise to ensure her $250K is never co-mingled with Peter's borrowed money if she wanted to ensure her net rent was positive geared v's Peters neg geared.​

 

related thread:
Tax Tip 79: Interest Deductibility for 1 on title 2 on loans

 

Can I ask a bit more detailed question on Two on title, One on loan:

• X and Y buy a property together for $1000k and both on title 50/50. The intention is to go 50/50 with everything.
• X obtains the one loan for $700k with only his name on it (Y will be guarantor). The intention is for both X and Y to service the loan and pay interest.
• X and Y will also split the remaining $300k by paying cash of $150k each.

Since the loan is only under X's name, can Y deduct 50% of the loan interest expense? Additionally, if not, if they have a separate agreement to split the loan, will that help? Thank you.

 

The question is ‘did Y borrow to buy the property?’ If not how can they incur interest?

 

Thank you for the quick response and that is a very interesting question. Would the interest be deductible by Y if there was a documented agreement between Y and X stating that Y is liable for 50% of X’s loan, and demonstrated with monthly payments to prove this?