Tax Tip 60: Never use cash to invest

Discussion in 'Accounting & Tax' started by Terry_w, 18th Oct, 2015.

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  1. Terry_w

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

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    I don't follow. How is this the case?
     
  2. Phase2

    Phase2 Well-Known Member

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    If you don't borrow the deposit/stamp duty amount for your future PPOR, I presume you have cash available to cover this cost?

    If you have equity in the current PPOR and can use a LOC to borrow for the new PPOR, you're worried about this LOC not being deductible? Am I correct?

    If so, the idea is to still borrow the full amount, and keep your cash in an offset against your PPOR. When you move house, you move the cash into a new offset against the new PPOR.

    True the LOC won't be deductible, but you're offsetting against the main loan, and you have the flexibility to do whatever you want with your cash.

    You could pay out the LOC (so there's nothing owing) with the cash in the offset, and use it for the next investment. I think. @Terry_w could probably confirm whether repaying a LOC in full, resets it's "purpose".
     
  3. Terry_w

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

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    Thanks right Phase 2.

    He would be better off too as claiming more deductions before the move.
     
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  4. LaoBan

    LaoBan Well-Known Member

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    But if I pay down my PPOR loan now and moving forward with borrowing further against that, then when my PPOR turns to IP, my tax deductibility (against the interest) is reduced, no?

    I also can't redraw the amount that I would have paid to the PPOR loan and then claim the full balance as tax deduction as I read in one of your Tax Tips..
     
    Last edited: 2nd Nov, 2016
  5. Terry_w

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

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    That is right.

    But can u do it without paying down the loan? or is your LVR too high?
     
  6. LaoBan

    LaoBan Well-Known Member

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    The bank did a valuation on the PPOR earlier this year and I unlocked some equity which most of it has been used for deposit for an IP.
    I don't expect it to rise in value much for at least few years (if I am to believe that Syd market is cooling down..).

    So I am pretty much cannot gain and access any equity for that period because I am not paying down the loan. However, I got some money in the offset and by this time next year if all goes to plan, I would have around 150k-200k there but not sure how to best use it to invest in most beneficial way..

    Might also add, when the current PPOR switched to iP say in 7-10 years time, the plan is to buy a 3 bed townhouse/villa (or house if I can afford! ) in Hills district. Looking at the price now is already 1+ Mil, so not sure if better to keep the cash in the offset rather to invest it, but may lose out on growth opportunities in that time..

    What would you guys do if you are in this situation?
     
  7. Terry_w

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

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    If you cant borrow now for the deposit it might be better off using the cash
     
  8. nothingman

    nothingman Active Member

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    further to this question:

    what if the scenario above plays out, except you
    a) don't have any non deductible debt, ie you have 1 other IP but no PPOR
    b) plan on knocking down the new IP and building a PPOR on it once the 2-3 year period is up

    would you
    a) pay deposit on the new IP with cash, because its going to be a PPOR at some stage anyway
    b) try borrow 105% for the new IP purchase, keep the cash in offset against IP with highest interest rate, and then use it for deposit for the building/construction loan
    c) other?
     
  9. Terry_w

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

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    It all depends on many things.

    If you can borrow against the existing IP without incurring any LMI and then borrow 105% that would be the most flexible.
     
  10. Anthony Brew

    Anthony Brew Well-Known Member

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    What if you have

    IP1 200k equity 300k loan
    IP2 200k equity 300k loan

    300k in offset for one or both of these


    A banks serviceability calculation ignores money in offset (as far as I understand).

    Say your income is not enough to meet the serviceability needs calculated for IP3, but your living expenses are much lower than what a bank will use for calculations (eg if someone lives in a different country where cost of living is massively lower leaving a lot more cash available), so you can actually service it very comfortably despite the bank's calculations saying you can not.

    Is there any way around using a lot of the money in your offset to make up for the very small loan that they will give you?
     
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  11. Terry_w

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

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    Borrow from a related entity is one way. Spousal loans, parents etc.

    I should never say 'never' because the final option is to use the cash rather than paying down the loan and redrawing.
     
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  12. Anthony Brew

    Anthony Brew Well-Known Member

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    Yeah, without an option to borrow from a related entity, seems paying with cash is the only option left, which is pretty gross but sometimes you have no alternative.
     
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  13. Annaelsa

    Annaelsa Active Member

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    I'm newbie here and also new investment.

    I have no choice but have to use cash + $15k redraw to buy 2nd IP outright because Banks won't lend me money even though my 1st IP worth $560k, mortgage balance is $0, redraw avail $80k. I wish I could have borrowing power.
    I can't work as I need to care for family member.

    Now after purchasing 2nd IP, my annual Rental income is still only 30k. Hard to get loan. I can only buy in cheap area
     
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  14. Terry_w

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

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    What you could have done is purchase in a company and loaned the company the money. Later on the company could refinance this loan with a bank. The company could have been a trustee or in its own right.

    But using a different entity will have other things to consider besides deductibility of interest - just one strategy.
     
  15. Paul@PAS

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

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    I strongly suspect that in the forseeable future (either budget night or election) the concept of negative gearing will shift from the view that you should or could max out borrowings for a deductible purpose and become one of taxpayers losing such benefits. Instead, property investment will rely on broader tax assumptions that restrict or limit losses so that the investment is inefficient.

    This paradigm change occurred in the last UK budget as they had the exact issues our markets face at present. Media had speculated all the things we have read in the past year or two. Many of the changes made in Australia to date have been prudential and relate to lender risks. The UK also made prudential changes in its first phase. Phase 2 of the UK policy shift was to them implement tight curbs on tax policies that were reflected in their budget including :
    - Tax is based on the turnover of the property (ie rental income) and not on whether it produces a profit or not.
    - All deductions are basically disallowed but...
    - A statutory deduction is allowed of not more than 20% of the notional interest property deduction that is no longer deductible.

    Hence landlords with negative gearing in most instances now face radically changed outcomes. Not only have they lost negative gearing they now face actual tax payments. All property is now basically positive geared. And even positively geared property faces higher taxes as all deductions are effectively "lost". eg repairs, rates etc are all not deductible in the UK.

    Lets use a basic Australian comparison to measure what this means. Judy owns 2 x IPs. Lets assume they each produce rent of $24,000pa and have tax deductions available of $32,000 so that Judy offsets a $16K tax loss on property rents against her $150K a year salary.

    At present (Using Australian tax rates as a example) Judy's tax situation is :
    Taxable Income $134,000
    Tax Payable $39,892
    Tax Refund due to rents $6,240

    Under the UK rules this would become
    $48,000 rents would be taxed at 40% with a tax credit given for the basic notional deductible (20% x mortgage interest ONLY). Lets assume the properties have a $960K loan). So .
    ie $48,000 less $9600. Judy now pays tax of $15,360

    Hence Judy would face an additional tax outcome of $21,600 based on this tax change. And not one cent of extra income occurs.

    And for the many who say "it will never happen". Thats what they said in the UK...Nobody saw the UK changes coming either. The UK changes has removed tax breaks as a element of any decision to buy property or produce income from property.

    Now I dont believe for a moment that Australia would impose such harsh changes as we also have a CGT regime to consider. But in its simplest form if negative gearing was to end it could radically affect some people's capacity to service. I did a quick calc of all our rental clients and calculated a extra $1.4m in income tax per annum. We are talking billions of extra tax dollars a year folks. The smallest change was a few dollars but the largest impact ona client was fifty thousand dollars. And I imagine nobody has capacity to service a extra $50K a year of tax assuming that borrowing wont be permitted to increase.

    Also these UK style changes would harm long term owners with positive tax income. That element doesnt seem fair as many self funded retirees use property as their super. But the bigger issue is such a policy change would radically affect servicing capacity that Banks have relied upon. There is a fundamental lending policy that (up to now) assumes lenders wont review and reappraise their ongoing commitment to lend. So I ask the question ...,.

    If the changes made in the UK were even partly mirrored here to end negative gearing and to dramatically affect servicing would lenders be told by APRA to reappraise borrowing capacity AND even ask some owners to divest property ?

    I reckon that risk is very real. What do others think ?
     
  16. Terry_w

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

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    I have just finished writing a book on deductibility of interest. I hope it doesn't change that dramatically otherwise I will have to rewrite the bloody thing!

    But change is surely coming.
     
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  17. AlexV_Sydney

    AlexV_Sydney Well-Known Member

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    PPOR loan, 600K
    two attached offset accounts:
    acc #1: 100K
    acc #2: 200K

    If I use that 200K to invest and NEVER deposit any cent to Acc #2 after that, why the interest (for 200K) is not tax deductible?
     
  18. Terry_w

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

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    Because you haven't borrowed.
     
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  19. Paul@PAS

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

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    OR

    If you drew down equity on the PPOR and parked it in the offset one of two problems is evident
    1. The PPOR borrowing is now a blended loan
    2. The offset may taint the deductible purpose for the borrowing against the home eg the offset contains borrowed money and savings banked to the offset.
     
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  20. AlexV_Sydney

    AlexV_Sydney Well-Known Member

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    1. but ATO allows blending loans: "Banks and other lending institutions offer a range of financial products which can be used to acquire a rental property. Many of these products permit flexible repayment and redraw facilities. As a consequence, a loan might be obtained to purchase both a rental property and, for example, a private car. In cases of this type, the interest on the loan must be apportioned into deductible and non-deductible parts according to the amounts borrowed for the rental property and for private purposes."

    So if I borrowed the money for PPOR and then changed my mind and used a part of that loan to invest, why that interest (for investment part) is not tax deductible?

    2. Acc # 2 is a separate offset account used to invest. There is no any savings banked to the offset - I mentioned that (NEVER deposit any cent to Acc #2 after that)

    What if I have this scenario:

    Before refinancing:

    PPOR loan: 400K (P&I)
    Offset Acc # 1: 100K (used for salary and private expenses)

    After refinancing:

    Step1:
    PPOR loan: 600K (IO) (increased due to re-valuation)
    Offset Acc #2: 300K (they put 200K to it)

    Step2:
    PPOR loan: 600K (IO)
    Offset Acc #1: 100K (used for salary and private expenses)
    Offset Acc #2: 200K (used for investment - no other credits/debits)

    Also it seems mixing deposit/credit is also allowed:

    If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and it is used for both private purposes and rental property purposes, you must keep accurate records to enable you to calculate the interest that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds.
     

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