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!