Tax Tip 77: Redrawing Extra Repayments to Increase Deductions?

This sort of question is pretty common:

Q: I am about to move out of my home and rent it out. To increase tax deductions can I just borrow up to 80% of the property? If not, can I just take out all the extra repayments I had made over the years? If not, then ‘that is stupid!’

The increasing of a loan means you are borrowing more money. Taking money out of redraw means you are borrowing more money. The interest on borrowed money is only deductible if the borrowed money is used for an investment or business purpose.

So if you increase the loan the use of the extra money will determine it is deductible. Most people want to do this so they have transfer money to their new main residence and thereby pay less non-deductible interest. But the interest on this extra money borrowed will not be deductible and it will also create a mixed purpose loan.

This is very logical.

Plan ahead. If you could move out then ideally an IO with an offset account may be the way to go from the beginning - not easy these days on a main residence though.

 

Hi Terry,

I've been reading your tax tips for a while now and it takes time for my brain to digest. Hence I might as well ask for your wise opinion on my current scenario ;

I have PPOR unit say current value $420000 to be conservative. It's a P&I loan with loan balance $285000. I am planning to make it an IP and then buy another IP2 with that equity.
What's the best way of doing this? In terms of loan structure( should I refinance/split loan or just redraw from existing loan to pay for next IP)
If the equity in my existing property is only $51k based on LVR 80%, what would you do with it if you were in this position?
p/s i would like to lower down my tax bracket by maximising tax deduction (makes a lot of difference in this instance )
Thanks in advance for your advice

 

Quickly change it to IO.
Don't redraw
Set up a new split against it and use this as deposit
avoid borrowing and parking in an offset

 

What options are there to make it tax deductible?

Example - PPOR1 (now IP1) has 100k line of credit to go toward purchase of PPOR2.

 

To make what deductible?

If you are borrowing to pay for private expenses the interest cannot be deductible.

 

Sorry i was not clear enough, I understand that it is non deductible.

Is there any debt recycling methods used to eventually make the 100k line of credit tax deductible again at some point down the track?

Or your only options are to rent out PPOR2 or pay off the 100k LOC against IP1 and redraw for investment purposes?

 

You could start a debt recycling strategy

 

Much harder these days. I have done this (optimised minimal deposit on new PPOR, cash in offset) but absolutely kills serviceability. To the extent that I will probably have to unwind it a little.

Also note the perhaps small risk of having more than 250k in one account:

More than $250k in the offset?

 

Yes, I agree it can kill serviceability. Sometimes it is just better to pay down loans.

 

Thanks Terry. Just to clarify, so now i will need to refinance 90% LVR and split the loan into 2;
1. $285000
2. $93000

If i use this $93k for IP2 downpayment it is tax deductible, correct?
How about tax deductibility on IP1 now? I can only claim for $285k?or i can claim for the whole $420k as I've borrowed the equity in IP1(used to be PPOR)?
Do i need any offset account for these?
Thanks

 

Basic on my interpretation of what you have writtenl
1. relates to the purchase of the main residence
2. relates to the purchase of the IP

So the interest on 1 will be deductible (providing no redrawn amounts) when the main residence becomes an investment.

The interest on 2 becomes deductible once drawn to pay for an IP.

Each is deductible against the property it relates to.

note that you cannot claim the $93,000 but just the interest on this loan.

You should have an offset on the loan attached to your new main residence. If there won't be one then it would be a good idea to set up one on one of the investment loans - better with the higher interest rate loan so you save more tax.

 

Hi terry,

May i ask why on higher interest rate ? Dosen't the highest interest charged means more tax deduction??? Im confused

 

"better with the higher interest rate loan so you save more tax"
by this I meant you might be better off using an offset account attached to the loan with the highest interest rate as this would save you more tax.

Think of a $100,000 loan split with 4% interest on its linked loan, compared to another loan with 5% interest. Say you had $100,000, and use of both loans was by the same person. Which would you want to link the offset to?

On the 5% loan you would save $5,000 but on the 4% loan you would only save $4,000

Which would you prefer? If you factor in the tax on the $1,000 difference at 33% the higher interest rate loan offset would save you $667 more each year.

 

It wont save any tax. Its will save non-deductible interest expenses which is then not taxed like interest may if it was earned

eg Use aoffset and 3.25% loan interet on the home is not charged. Where if the offset savings earned interest that interest may be taxed....and also earn a appalling rate.

The best choice for the loan to offset is
1`. Firstly. Non-deducible loan; then
2. The higher rate loan if both were non-deductible and lastly
3. IF a borrower ONLY has deductible interest consider the highest rate loan.

eg Fred has a LOC secured over his home used for a improvemnet at a 5% rate and two owner occupied loans used to buy his home. One is variable at 2.25% and the other 3 years fixed at 1.98%. Fred also has a investmnet property loan which is 2.30% variable. Fred cant offset the fixed rate loan and very few lenders allow a offset on a fixed rate loan. The LOC would be best as it is a higher rate. However the lender wont offste it. The variable loan is his best alternative. Fred should NOT offset the IP loan as he should first consider the non-deductible loans. If he offset the IP loan it will reduce interest but he will lessen his tax deductions so he may lose 30-47% of the benefit.

 

Keep in mind that not all investments will be done in the same tax entity. There could be advantages to offsetting a lower rate loan in some situations.

 

Yes - One such reason can be debt recycling issues. The rate may be inconsequential to the ability to recycle for a new purpose later etc.