Tax Tip 84: Don’t Pay your Rent into a LOC

Discussion in 'Accounting & Tax' started by Terry_w, 19th Nov, 2015.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    Some people have their rents paid directly into their LOC. I must say that I am not in favour of this strategy and outline my reasons below.


    There are 3 possible scenarios with this method:

    1. Rent is less than interest

    In such situations the LOC interest will be capitalising unless there are further deposits made. It is relatively easy to make a deposit, but difficult to get the exact figure right.


    Capitalising interest raises further deductibility problems.


    2. Rent is equal to interest

    This would be rare as the interest varies each month. But if achievable then there are no immediate issues


    3. Rent is more than the interest

    Here you are paying off debt. This should generally be avoided where there is non-deductible debt as each payment decreases your tax deductions while increasing the incursion of deductible debt.


    Paying down debt is a good thing in general. But where there is no non-deductible debt I still don’t like this as you are tying up money. Say you wanted to buy a new car but all your money is tied up, you would have to borrow to buy the car and the interest would not be deductible. If instead you had an offset account and deposited the money in there instead of paying down the loan then the interest on your care loan would be indirectly deductible. See Tax Tip 82: Taking money from an offset account on an IP and Claiming Interest


    Another reason is for ‘retirement’. Say you had been paying extra into the investment loan and you wanted to retire early – you may have to take some money out for living expenses and it you did this the interest on the loan would not be deductible – similar to the above paragraph.


    Where you are not claiming the interest on the LOC then the above is irrelevant. But why would you not set up your loan in such a way that you could maximise the claiming of interest while at the same time building up cash reserves for personal expenses such as ‘retirement’.

    Please feel free to pick my theories apart.
     
    pommy likes this.
  2. Riot

    Riot Member

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    Hi Terry,
    I haven't left the computer...

    So the offset account that is attached to the LOC (which one can take out to secure a loan e.g Mortgage) is the structure that allows you to:

    1. Increase cash reserves by depositing into the offset account.
    2. Gives you "deductible debt" to play with in the form of interest on the LOC

    If I understand correctly, these 2 are directly correlated as one can be used to reduce/increase the other. And so in the example of wanting to purchase a car, if you followed this strategy you would not be going to the bank to obtain finance, but rather use your cash reserves from the offset to fund the vehicle? and then at the same increasing your "Deductible debt" obligation back on the LOC?

    Best
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker Business Member

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    You can't get an offset with a LOC product usually.

    If you are using a master facility you could reduce a term loan with cash and increase a LOC, but the offset account would be on the term loan.