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Tax Tip 71: Deduction of interest after assets sold

Discussion in 'Accounting & Tax' started by Terry_w, 29th Oct, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Some people imagine they can borrow to buy shares (or property), claim the interest, and then sell the shares but use the proceeds to pay off the non deductible debt such as the main residence loan, and yet still continue to claim the interest on the loan that was used to buy the shares.

    They argue that the ‘purpose’ of the loan was to buy shares. This may be true, but if there are no shares there is no income or possibility of income so the interest could never be deductible under s8-1 ITAA97 or any provision.

    Another example is borrowed deposits on investment properties. You borrow the 20% from a LOC and can claim the interest. Once the property is sold you can no longer claim this interest.

    Tip: Once an asset is sold any loan used to acquire that asset is no longer deductible

    Note- there are limited exceptions for where the asset is sold at a loss and I will cover this in a future tip.
     
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  2. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Yes....s8-1 contains a simple and important nexus between the outgoing (interest) and the production of income. This nexus is also reason why borrowing to buy shares that dont pay dividends may not be deductible. When the expectation of income ceases on sale of the asset so does the deduction. When a asset is sold its logical to consider repaying the loan.

    There can be some infrequent exceptions to this eg : a CGT loss or destruction of the property etc. All such exceptions need advice.

    This is also reason why a person cant borrow money and invest the money in a discretionary trust. The discretionary trust doesn't have a fixed obligation to give the person income. So the interest is non-deductible. This is important to consider when a related party onlends funds to a disc trust etc. Essential that a loan agreement be entered into AND that the loan is maintained correctly to avoid problems.
     
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  3. S0805

    S0805 Well-Known Member

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    So legally, you suppose to pay off all the loans attached to property if its sold (given enough sale proceedings). Trying to understand if related party loans are involved how will this work. I assume person selling will have to pay off that related party split of the loan cause secured property is sold. So person selling has two options either
    • to pay off this split by ending related party loan and get the principal back or pay off this split OR
    • use access sell proceedings $$$ (if there) to pay off the split and continue related party loan. Can person selling use personal savings to pay off this split and continue related party loan?
    In the end if related party loan still exists between two parties then person who sold will claim the related party loan as interest, now as income.
     
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    No. You don't have to pay off a loan - you just cannot claim the interest.

    if you are selling a property that secures a loan for another property you can keep the loan open by substituting security.
     
  5. S0805

    S0805 Well-Known Member

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    lost here...If you have 50K, 40K & 30K split secured against one property. you sell the property and say you've 120K left after all taxes.....bank won't ask you to pay off the loan?? I mean the security against that loan is gone.....

    Is this refinance or minor paper work?
     
  6. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    So - That's the problem with Xcoll. That a different problem. When multiple assets are used as loan security and you sell one of the assets then the total security may no longer support the loan even if it partly paid down. So the bank will pay it down using as much of the proceeds as it wants - Not your choice ?

    How much ??? Hmmm that's the problem. They could ask for all the proceeds if the other assets are not sufficient security for the remaining loan.
     
  7. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Minor yes.

    I think I have written a tax tip on this before.
     
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  8. S0805

    S0805 Well-Known Member

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    Terry can u pls elaborate ...If you have 50K, 40K & 30K split secured against one property. you sell the property and say you've 120K left after all taxes.....bank won't ask you to pay off the loan?? I mean the security against that loan is gone isn't it ??..
     
  9. chylld

    chylld Well-Known Member

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    Is there a tax tip on substituting security on a borrowing used for investments? I just realised I might have trapped myself as I have a big LOC for managed funds secured against an IP, and that LOC is too big to be secured against any of my other properties without pushing that property's LVR over 80...

    Can it be split and then substituted? Or will selling that IP force me to lose the deductions on that LOC?
     
  10. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I thought I had written about this, but cannot find it so I have written another and will post it soon.
     
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  11. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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  12. Kirsti327

    Kirsti327 Active Member

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    Hi Terry. What about the case where an asset (eg dividend shares) purchased from borrowed money was sold, then the proceeds used to immediately acquire a different income producing asset (eg different shares or deposit on IP)? Would the loan need to be paid off and redrawn or can you substitute the purpose asset like that?
     
  13. Greyghost

    Greyghost Well-Known Member

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    Good thread @Terry_w .

    Another tip worth mentioning is deductibility of interest in discretionary trusts when the beneficiary's account(s) are overdrawn (in debit).
    I won't elaborate so to not hijack your thread.
    Cheers
     
  14. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    When the shares were sold you would have received the proceeds. If you paid down the loan and reborrowed the interest would be deductible.

    If you somehow just substituted the security for the loan the purpose of the loan changes and I would think the interest would be deductible as long as the normal requirements are met.
     
  15. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Hi GG

    Do you mean the trustee borrowing to pay out unpaid present entitlements? I don't think the interest would be deductible for discretionary trusts.
     
  16. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Roberts and Smith (Roberts v FCT 1992 ATC 4787) is precedent law dealing with the refinance principle. Where a trust has a unpaid present entitlement, the trustee may be required to borrow to make payment of a returnable amount where the returnable amount had been blended within the trust earning further assessable income. IMO this may pose a concern if the trust borrows to pay the present year income but not a prior year returnable sum. Other non-allowed amounts include borrowing to payout revaluation reserves etc A trustee cannot borrow merely to pay a distribution to a beneficiary. A area of extreme care for DTs.

    The interest would be deductible. However care must be taken that the loan is not blended with money for a non-deductible purpose (ie advancing further money to a beneficiary). Unit trusts may additionally borrow to allow redemption of a unitholder entitlement. Care should be taken regarding the manner and revaluation of units and older deeds can trigger other tax concerns. eg redemption at something other than market value.
     
  17. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I believe the refinancing principal can only apply to fixed trusts and partnerships, not to discretionary trusts.
     
  18. Greyghost

    Greyghost Well-Known Member

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    That yes, but moreso referring to beneficiaries drawings in excess of their entitlements.
    Cases where business owners are not on wages, business makes $100k profit, distribution $100k, drawings $100k, all fine.

    Profit $60k, distribution $60k, drawings $100k still. Debit loan by the beneficiary.
    Creates interest deductibility issues as trust has "funded" the loan to the beneficiary.
     
  19. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Read TR 2005/12 Example 3.

    It can be very difficult to establish that a returnable amount is reinvested into the trust to produce income. Example 3 (para 39+) is a basic but good example of the basic principle that may give deductibility
     
  20. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Not quite that simple I'm afraid but the non-deduct example given I agree with. The tax ruling explains that the entitlement or funds loaned need to be reinvested into trust income producing activities. That involves more than a returnable amount but also a reinvestment that is used to produce income. That takes time also.