Tax Tip 60: Never use cash to invest

See tax tip 1.

 

you can put it in the history section of the library

 

True. Problem is many taxpayers dont retain accurate and diligent records or dont apportion correctly. I have seen way too many who think that the $80K borrowed for the new IP means its always a $80K portion of the PPOR loan. Then I ask them for their records from 5 years ago and they seem surprised. There is a formula to determine the % apportioned. BUT for some loans like a LOC its aweful to keep recalculating over and over. The deductible % can erode month by month. The ATO then gives up and its too hard and disallows 100% and its an objection case then.

Then the loan gets refinanced or more redraws - especially lots of small ones and tracing becomes harder etc etc...

Split loans done correctly mean this issue doesnt occur. See my example attached for complexity. The Redraw calc is a simple basis and the Full Year Calc shows how redraws can complicate it further

 

I found this thread very useful and insightful. The strategy of never using cash for deposits works for all taxpayers, but is more beneficial particullary for taxpayers who 1) Have current non deductible debt (very beneficial); and 2) don’t have non deductible debt now but will do so in the future (taxpayer has no PPOR debt now but plans to upgrade the house (PPOR) and must borrow heavily to do so).

If you have no non deductible debt, and will never do so in future (house fully paid off, no plans to upgrade, and no other reason to borrow money on a non deductible basis in the future), I was thinking it is of less benefit. Or is it? For taxpayers in this situation (assume also taxpayer has $200k in bank, and is on high marginal tax rate), rather than using some of the $200k for a IP deposit, potentially better to buy $200k in shares (as an example) and still borrow 105% of the cost of the IP. Provided the investment of the $200k produces less in taxable income v % interest rate on the borrowed funds, taxpayer is ahead from a tax point of view. If the taxpayer does not want to invest in shares, many other things could be considered like gifting funds to spouse or putting money into trust, etc, etc (admittedly, other considerations will apply if you do some of this which I have not considered) and still borrowing 105% for the IP. The main point is, strategy of not using cash for IP deposits holds in almost all cases as far as I can see.

 

I can think of several reasons why these types of people would ideally not use cash as deposit:

1. retire faster by using the cash to live on
2. retire more tax effectively by increased deductions as cash is drawn from offset to live on
3. bigger buffer
4. You can always pay off a loan whenever you want, but you cannot covert a deposit into a loan without tax consequences.
5. Different structure - cash holder may be different to owner
6. later serviceability reduction possibly - get it while you can.
etc

 

Thanks Terry. Really appreciate you being so generous with your time and advice. Enjoy the rest of your Easter break.

 

Hi Terry,

Thank you for your wisdom and effort to provide this information to everyone.
This kind of strategy is definitely interesting when you have been focused on a more traditional deposit %LVR strategy... in trying to come up with scenarios where this may not be beneficial.... Would you still consider your strategy feasible if you are expecting to enter a much lower tax bracket in the near future?

Theoretically you kinda need to have enough income to reap the benefits of extra deductions?

 

Am I right in saying, Increased interest to claim from the increased debt repayments is only beneficial if you have the income to claim against as well as well as your ability to service the increased repayments?

 

they say you should never say never!

I guess there are cases where it would be better to use the cash to invest rather than paying down a loan. One example is where there are different ownership structures.

each scenario should be considered on its merits at the appropriate time

 

Thank you Terry I now have a better perspective on the potential benefits of the balance between Savings/Equity and what you should use to borrow in order to grow your wealth.

Cheers

 

Hi

Just in the process of buying my first IP and once settled the LVR will be around 85 % but I will have nil or very little equity. I was planning on perhaps using cash as a deposit to buy my 3rd property later this year with a 10 % deposit, but after reading this I can see its not ideal to use cash. Would I be better to wait till I have equity to use as a deposit and potentially not be able to borrow as much (because of having kids) or use cash sooner?

 

maybe I shouldn't have used the word 'never'!

If you don't have a main residence you may have little option, but either waiting or using cash. But using cash will mean you will have less money when you do buy the eventual main residence which will mean you will have more non-deductible interest

 

I should have mentioned I do have my PPOR and one investment, I would happily lend 105 % but I doubt I would be able to with nil equity?

 

That is an important thing to know.
You should get tax advice in case there are more things.

You would want to use your cash to pay down the main residence debt and then redraw to invest. This would make the interest deductible.
But there are many tax issues to consider as well as loan issues - such as splitting.

 

Ah I see, would you not lose 20 % of what you pay into the PPOR though? I guess it would be a horses for courses arguement with the deductions

 

Think of it this way

You have a $90,000 loan on the main residence worth $100,000 and $10,000 cash

If you used the cash to invest, that is $10k less in your offset account saving you interest. the interest on your main residence increases as a result. This extra interest is not deductible.

Instead, you split hte $90k loan into 2
$80,000, and
$10,000

You pay down the $10k loan to $1 and redraw to invest.
Same debt as before but now you can claim the interest on the $10k loan. this is the main difference really - total debt is still the same.

 

This post is a very useful reminder because I have this situation of needing to use my cash buffer for a 20% deposit after getting preapproval for an IP loan with 80% LVR. Too late in my case but out of interest. is it still possible to borrow 105% nowadays? I’m now thinking of refinancing an existing IP loan to get the 20% deposit.

 

Yes it is certainly possible to borrow 105% by borrorwing against 2 properties, separately.

 

Thanks Terry, so does that mean cross collateralising and using future IP as well as an existing property as security?

 

definitely not