Tax Tip 71: Deduction of interest after assets sold

I believe a example of a common PC type discretionary trust "refinance" that may be deductible could assist discussion.

2010. Dave and Mary establish a Disc Trust to buy a IP. Cost $100,000. The bank agrees to lend $80K. Dave and Mary inject $120K to the trust which is recorded as funds loaned to the trust. Interest is not charged. The trust uses the $120K from the various sources to buy the IP. No interest is charged as the bank has concerns for the trustee gearing etc . Dave and Mary have the funds from an inheritance.

2016. The property is revalued at $300K. The lender agrees to refinance at 80% LVR. The trustee applies to refinance and a facility of up to $240K is approved. The trustee proposes to :
1. Refinance the existing loan of $80K ; and
2. Draw a new sum of $120K to repay Dave and Mary's loan.
3. Draw a new sum of $40K for use to buy a further IP... To be held on a offset pending purchase. The trustee also proposes a new 80% loan on the new IP, subject to valuation.

I consider the new $120K increased loan is permitted under the refinance principles. Mary and Dave could use the proceeds to pay off their PPOR for example. Or buy a boat. etc. All of the interest deductible to the trust.

The key concern with this example would be the problem of neg gearing losses caught in the trust but lets ignore that. The issue is that the DT can borrow in some cases to discharge a trust obligation and the refinance principles may apply. DT's have a tougher test for the refinancing principles but its not prohibited.

The deferral of the refinance principle is a common aspect of advice often overlooked by many advisers in tax and also finance professionals.

A example of a non-deductible amount would be if Mary and Dave sought a refinance that paid them $160K in place of $120K. 40/160k (25%) would be non-deductible.

 

That is just the refinancing of a loan made by the beneficiary.

 

Common example of a likely failure can occur with property rich trusts. Unless a further IP or other financial investment is made that uses UPE's its very hard to argue that there has been a reinvestment of a UPE into the income production of the trust.

ie UPEs after say 10 years could not be refinanced if the trust assets remain as the single IP.

 

Again this is just the trustee refinancing the $120k loan from lender A to lender B.

 

You may be surprised how often I hear "my accountant said it wouldnt be deductible" just because its is a beneficiary or related party. The key issue is about how amounts owing by the trust have been used by the trust. Some UPE loans might not be deductible as my previous example explains. Review of the trust use is key

 

Ok, I see where you are coming from now.

 

I have always wondered what happens if the trust takes say $40K of UPEs from cash and buys some shares. Sells them after a dividend. Is that enough for a legit interest bearing refinance ??

 

Incidentally a UPE is not exactly a loan - I think a UPE is an entitlement in equity and not subject to the limitations act or contract law as a loan would be.

 

I don't think it would be

 

I worked a for a tax specialist who taught me to think "why" about some principles. After breaking it down you often see a strategy.

 

Dont worry ATO and Legal fraternity cant agree either. Tax law refers to a different meaning anyway That TR explains what the tax law term is for a UPE etc.....Its like Depreciation has ten different tax law descriptions.

IMO UPEs got way too much focus after Bamford. And nobody can still define agree what it is as tax law doesnt mention it.

 

Hi Terry

Wondering if this further tip has been written yet? I have always worked on the principle that once the asset is sold, interest payable can't be claimed, regardless of whether the asset is sold at a profit (loan paid off) or loss (loan not paid off).

 

I am sure that I did Mac, but I can't find it. Perhaps I wrote a draft and haven't posted. Will have a look.

Basically it can be possible to keep claiming interest, in limited circumstances, if an asset is sold and the proceeds are not enough to pay the loan out in full and it is kept open.

 

Would be great to understand. While we all invest for profit, there are unfortunately times when you don't come out ahead.

 

Here it is
Tax Tip 211: Claiming Interest after Sale of Asset at a Loss Tax Tip 211: Claiming Interest after Sale of Asset at a Loss

 

Don’t forget where someone borrows to buy an income producing asset and they sell that asset, if they use the proceeds of the sale to buy another asset the interest won’t be deductible. The loan must first be repaid and reborrowed for this to work.