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Tax Tip 74: Selling a property that secures other loans

Discussion in 'Accounting & Tax' started by Terry_w, 30th Oct, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Selling a property that secures other loans

    When selling a property that has been used as security for other loans you must make sure you do not pay off these other loans as you could lose tax deductions.

    Example 1
    Burt owns a $500,000 property, PPOR, with a $100,000 which was used to purchase it ages ago.

    Burt then sets up a $300,000 LOC which was used to fund the deposits on 2 investment properties

    IP 1 $500,000 purchase price with a $400,000 loan from ANZ and $130,000 loan from Burt’s LOC which is with CBA

    IP2 $500,000 purchase price with a $400,000 loan from ANZ and $130,000 loan from Burt’s LOC which is with CBA

    Burt decides to sell the PPOR for $700,000 and then buy a replacement one for $600,000.

    Burt doesn’t plan ahead. Come settlement time Burt’s conveyancer says sign this discharge of mortgage form. Burt’s sale proceeds of $680,000, after the agent’s commission, is used to pay off $100,000 loan, the $260,000 LOC balance.

    Burt is left with just $320,000 cash and must borrow another $280,000 @ 5% pa to get into his new house. This means he pays $14,000 per year in interest and this interest is not deductible.


    Example 2 of a better way
    Burt’s neighbour Fred is in the same predicament.

    Fred seeks advice early on. He plans ahead. Fred realises he must keep the $130,000 x 2 loans intact so that he can still keep claiming the interest.

    The first thing he does is ascertain the values of the 2 IPs. Luckily they have grown in value.

    IP1 is now worth $700,000 and so is IP 2.

    Fred applies to ANZ to increase the existing loan secured against IP 1 from $400,000 to $530,000. The extra $130,000 will be used to pay off the LOC used for this property. There is no need to keep the $130,000 as a separate split because both the $400,000 loan and the $130,000 loan relate to the same property.

    Fred does the same with IP2 and makes sure ANZ do not cross collateralise the loans by using both properties as security for the one loan - which they may do with both applications going in at the same time.

    Fred decides to sell the PPOR for $700,000. This refinancing is done prior to settlement of the sale of PPOR so that there is only the $100,000 secured by the main residence now. On sale Fred will then get $580,000 cash from the sale after agent’s fees and paying out the ANZ loan ($700,000 - $100,000 loan - $20,000 agent fees). He still needs to come up with another $20,000 to settle, but he will have much more tax deductions and less non deductible debt.

    Fred talks to Burt over a BBQ and explains he is now getting $260,000 x 5% pa = $13,000 per year more in tax deductions than Burt is. At the top tax rate that is about $6,110 per year cash in this pocket.

    Example 3 another good method
    At the same BBQ is another neighbour. Gordon. Gordon is also selling his PPOR and also has used $130,000 for each of 2 properties. He did the valuations but there has been no growth so he cannot refinance the LOC into the investment loans. In a panic he drops his sausage.

    Bert picks up the sausage and wipes it on his t-shirt before sticking it in Gordon’s mouth saying “there is another way”.

    Gordon can keep the LOC open by substitution of security. There are 3 ways this can happen.

    • New property Simultaneous settlement
    • New Property Settle on purchase first
    • Cash
    The easiest way for this to happen is Gordon makes his new purchase settle on the same day as his sale. He then substitutes the security for the LOC from the old PPOR to the new PPOR. Simple - except it is very hard to get the timing right.

    An easier way would be to settle on the new property before settling on the sale of the old one. This will allow him to move his stuff from the old to the new place too. A bridging loan could assist.

    But this may not be possible due to servicing. So instead Gordon speaks to his broker and they arrange for the sale to happen and the $100,000 loan to be paid out the mortgage discharged and the $260,000 LOC to be kept open by Gordon keeping $260,000 of the proceeds from the sale in a term deposit at CBA. The cash itself will secure the LOC. The LOC doesn’t change and interest will still be deductible against the investment properties it was used for.

    When Gordon finds a new property the bank can then release his cash, at settlement, and the new property can then be used as security for the LOC.

    Gordon achieves optimal deductibility too.

    Example 4
    Bob another neighbour in the same predicament says bugger this it is all too complex I am just going to sell up and rent!
     
    Last edited: 31st Oct, 2015
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  2. Nemo

    Nemo Well-Known Member

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    Nice neighbourhood.
     
  3. S0805

    S0805 Well-Known Member

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    Terry, can you please explain how you get to the below numbers in example 2.

    My undertanding: Existing PPOR is worth 500K with 100K mortgage and 300K LoC hence total owing is 400K on PPOR. PPOR gets sold for 700K. so how does he end up receiving 580K cash what 20k still needs to be paid...
     
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Sorry S I buggered up the numbers a bit. I have fixed the original post now.

    Fred sells for $700k, pays $20k in agents fees and $100,000 to pay off the non deductible ANZ loan = $580k cash left. He then buys a $600k property so needs another $20k (plus stamp duty etc.)
     
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  5. S0805

    S0805 Well-Known Member

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    Terry, trying to understand above from example 3 in numbers. PPOR worth 500K has 400K owing (100K + 300K LOC). On the proceeds of PPOR sale Gordon receives 680K (after agent's fees). Gordon only pays off only 100K owing to release the title. But bank leaves the 260K LOC open in a arrangement where Gordon invests 260K in TD with bank.

    Does Gordon receives interest on this TD?
    How easy it is to arrange this with bank (i.e. leave the loan and secure it by cash)? Is it common?
    Does it have paperwork involved (i.e. security for 260K is changed to cash in papers)?
    IF above is done, can ATO challenge that as it appears you've left the arrangement on just to maintain the deductibility?

    Can't understand this process on settlement day. I thought Gordon has to tell in advance how much he requires from bank about new property purchase. E.g if he required 500K for new property you suggesting bank will only lend him 240K (500K-260K) and continue the 260K as separate split?
     
  6. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    PPOR sold for $700,000

    -$100,000 loan

    =$600,000 proceeds

    =$20,000 agents fees

    = $580,000 in hand


    But he wants to keep $260,000 loan outstanding so

    $320,000 cash received

    $260,000 cash kept in term deposit


    Your questions

    Does Gordon receives interest on this TD? Yes
    How easy it is to arrange this with bank (i.e. leave the loan and secure it by cash)? Its not hard
    Is it common? Not very common
    Does it have paperwork involved (i.e. security for 260K is changed to cash in papers)? Yes
    IF above is done, can ATO challenge that as it appears you've left the arrangement on just to maintain the deductibility? No. Because there is no extra tax deductions generated. It is just a change of security


    On settlement of the new purchase the bank will release the term deposit and replace this as security with the new property. The $260,000 cash can then be used to pay the vendors. Bank will have to be notified in advance and bank cheques drawn up to be handed over at settlement.
     
  7. S0805

    S0805 Well-Known Member

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    Thanks Terry. It is good to know such arrangement can be done. I mean bank giving you a loan on the cash as security, never thought of it. As Gordon is receiving the interest on TD and paying the interest on the loan money to bank as well...end effect could be nil (subject to TD rates & loan interest rates).
    I guess it still provides a good option to have this split active until new property is purchased....where security can be easily substitute..
     
  8. chylld

    chylld Well-Known Member

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    This is genius! Didn't know a term deposit could be used as security. I thought only tangible assets could be used...
     
  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Money is tangible. I made a bed out of $50 notes - wasn't very comfortable though.
     
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  10. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    BTW, There have been a few threads about using cash as security lately.
     
  11. Nemo

    Nemo Well-Known Member

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    What about..

    Ppor and ip both valued at $500k each. 20% of IP is secured against ppor. Both properties are owned jointly by husband and wife.

    Husband and wife split up, want to sell ppor, wife keep ip.

    Could you sell ppor prior to getting consent orders, but put the proceeds into a term deposit to secure the ip until such time as you can finalise everything else?
     
  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes, should be possible.

    But think of the tax consequences. Wife will need to pay out the husband's share of the loan and the interest on this will not be deductible.

    see
    Tax Tip 17: Divorce and Deductibility of interest https://propertychat.com.au/community/threads/tax-tip-17-divorce-and-deductibility-of-interest.2848/
    Tax Tip 18: Strategy to Increase deductions on Divorce https://propertychat.com.au/community/threads/tax-tip-18-strategy-to-increase-deductions-on-divorce.2874/
     
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  13. sandyfeet

    sandyfeet Well-Known Member

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    Hi @Terry_w

    could the substitution of security also be used in a situation where IP2 is secured by IP1?

    just thinking in a situation where IP1 has had some great growth and you sell down to pay off PPOR debt,

    Thanks,
     
  14. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes.

    But if IP1 is sold its loan is no longer deductible. So it is best to pay it off and the proceeds left over used to pay off the PPOR debt.
     
  15. Clayton Sharp

    Clayton Sharp Member

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    Hi Terry, how would you do it if the new PPOR loan is with another vendor?
     
  16. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Vendor finance?
     
  17. Clayton Sharp

    Clayton Sharp Member

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    Sorry, to clarify:
    Current PPOR1 with lender A (includes a LOC with deductible debt separate from the non-deductible debt).

    Buy a new PPOR2 and get a loan through lender B.

    Sell PPOR1. How to get the deductable debt transferred from Lender A to Lender B?
     
  18. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    2 methods if getting the new PPOR before selling the old:

    1. Buy new PPOR first, set up a loan split which is the same amount as the LOC and pay out the LOC.

    or

    2. Settle at the same time and refinance LOC over to the new property

    or

    If not buying new PPOR until after setltement then

    3. Sell current PPOR and let bank keep cash as security for the LOC until you can find the new PPOR.


    Of course if the property that the LOC was used for has grown then the LOC can be refinanced over to this property.
     
  19. Clayton Sharp

    Clayton Sharp Member

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    Great, thanks.
     
  20. MichaelT

    MichaelT New Member

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    Hi Terry,

    If I brought my new PPOR first, setup a loan split which is the same as the LOC and pay out the LOC. Is that mean I'm borrowing 80%LVR + LOC against the PPOR?