Join Australia's most dynamic and respected property investment community

Tax Tip 93: Subdividing Property and Deductibility of Interest

Discussion in 'Accounting & Tax' started by Terry_w, 20th Dec, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    Subdividing Property and Deductibility of Interest

    I have mentioned this before, inside other threads, but worth starting a new thread on it.


    When splitting titles into 2 or more any loan on the original property will also need to be apportioned between the new properties. These portions should ideally be split.


    There seems to be a common perception out that there where you are subdividing a main residence that all the debt can be loaded up on the new property which will be rented out. That is the owner will try to load the debt on to the investment property thinking they can claim more interest.


    This doesn’t make sense from either a tax point of view or a common sense point of view.


    Any loan used to purchase a property will relate to the house and the land of that property. So if a part of the land is chopped off then part of the existing loan will relate to the house and its land and the other part will relate to the new land.


    Even where the land is split down the middle so that each part will be 50% of the whole the loan cannot simply be split into 2 because one block will have a house and the other won’t. A valuer will need to be engaged so that they can put a value on each part and then the loan can be split into these relevant portions.


    Where one property of the new split will be lived in, the loan on this will want to be minimised where possible and the investment loan maximised. This cannot be achieved until later until after the titles are split. Once the titles are split the offset account can be linked to the portion relating to the main residence and the costs borrowed for the investment property.


    And a simple way to maximise deductions is to keep the original loan high, using an offset account, and to borrow all expenses relating to the sub-division. Get the valuer out once the subdivision is complete and make sure the valuer knows all costs relating to the subdivision so that the relevant costs can be loaded to the relevant property.


    Once the subdivision is complete then the loan should be split into the 2 relevant portions and then and only then should you pay down the PPOR loan down. If you pay down the loan sooner you will end up paying down the investment portion as well.
     
  2. ppnuwan

    ppnuwan Active Member

    Joined:
    21st Jan, 2016
    Posts:
    40
    Location:
    Forrestfield
    Thanks heaps for this information Terry.. Any insight for a sub division by demolishing the old house? How does the existing loan get split then?
     
  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    It should worked out on the same basis. You just have apportiin the loan between the two parts of the property.

    It may pay to apportuon before the demolition or after it depending on the circimstances.
     
    ppnuwan likes this.
  4. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

    Joined:
    18th Jun, 2015
    Posts:
    2,374
    Location:
    Sydney
    I don't see a compelling reason to split the loan if the property is being retained on each side of the dev / build. However the loan MUST be calculated to be apportioned between Lot 1 and Lot 2 (likely based on a reasonable basis of apportioning akin to the costbase). This often will need a valuation where the site is not homogenous eg : One lot is larger, One lot has a house etc.

    But that said splitting the loan may have some benefits especially if one lot (rather than none or both) is to be sold. The loan could end up "crossed" so that if any one lot is sold the bank will retain all the funds and discharge the loan etc. They could end up holding the equity as a discharged loan. A better outcome may be two loans so that the bank only discharges the portion of the loan against the sold portion.

    These issues are often complicated by lender rules and refinancing where a new loan is also used to construct. The bank may cross the loans in any event unless care is taken. Working with a quality broker who knows your project would be a prudent strategy.
     
    ppnuwan likes this.
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    There are 2 reasons to split, broadly:
    1. Tax
    2. Security

    Tax: allows the 2 separate investments to be segregated so each loan can relate to each property.
    When selling it allows the relevant portion to be paid down. Before selling it allow property specific expenses to be borrowed and incorporated into the relevant loan.

    Security: No crossing of securities needed. One title secures one loan. Good for a a variety of reasons.
     
    Perthguy and ppnuwan like this.
  6. ppnuwan

    ppnuwan Active Member

    Joined:
    21st Jan, 2016
    Posts:
    40
    Location:
    Forrestfield
    Many things to consider here.. Thanks a lot for your valuable input guys..

    @ Terry: If we need to get a loan even to sub-divide then how does this splitting work? (especially when splitting is not half half). So the current loan will be topped up for sub-division works and then further topped up to build units.. Is this something banks will be keen on doing? Can any of these loans be approved based on interest payments only (so that I can save some money for further improvement works outside the loan)?

    Finally will banks be strict on finance terms especially given me and my wife both are not high income earners.. I would have thought if the bank gets enough security (I'm sure there will be 80% LVR for both lots after building), then they may not be that strict lending..?
     
  7. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    You will have to work out the portions relating to each 'lot' and split the loan accordingly.

    Banks will lend for this sort of thing and they will lend on interest only basis. But a lender will not be able to lend where you cannot demonstrate the ability to repay. The amount of security is irrelevant if you don't have enough income.
     
    ppnuwan likes this.
  8. ppnuwan

    ppnuwan Active Member

    Joined:
    21st Jan, 2016
    Posts:
    40
    Location:
    Forrestfield
    Thanks Terry,
    Is there any tool to determine the required combined income for a given development value?
    For example, aforesaid development will need a loan of about 800K (existing loan and sub division costs and building costs all inclusive). Do you know how much should we have as combined income to convince the bank? (we have two children to make the situation rather complicated.)
    I know I'm going bit far away from original topic.. But a rough figure or a way to calculate this would be highly appreciated..
     
  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    Yes, brokers have access to lender calculators to work this out. It will depend on your overall financial situation.
     
    ppnuwan likes this.
  10. GreatPig

    GreatPig Well-Known Member

    Joined:
    1st Jul, 2015
    Posts:
    153
    Location:
    Sydney
    If you're subdividing a PPOR property for a dual-occupancy, with one remaining as the PPOR, and there's no existing loan, is it possible to get a loan for constructing just the rental building - ie. pay cash for construction of the PPOR but borrow for construction of the rental building, so that the interest would be fully deductible? And if so, would this take significant effort with documentation to ensure that the loan funds were only used of the rental building, requiring the builder to separate all those costs?

    On a somewhat related issue, when subdividing as above (strata in this case), I gather subsequent rent is apportioned based on percentage ownership of the title(s). Does who pays for the cost of construction have any affect on apportioning of the rent? For example, if my wife and I own the property 50/50, but I pay 100% of the construction costs, do we still get 50% of the rent each, especially given that construction costs will be significantly more than we originally paid for the whole property?

    The reason I'm asking the latter question is in relation to tax tip 47 on spousal loans. If rent is apportioned on ownership percentage, with who pays for construction being irrelevant, then could my wife lend me the funds to pay for construction of just the rental building, I pay the full cost of construction, then subsequently we receive 50% of the rent each and I pay her loan interest from my half of the rent with that interest being deductible - the reason of course being that I have significantly higher income than her. In this case there is no existing loan and she has sufficient funds in her name already (so I wouldn't have to give her the money to do this). Or would this likely be caught under Part IVA?
     
  11. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    Mr Pig

    Can you remind me to answer this tomorrow as i am just on my mobile now and its too hard to concentrate on this topic.

    But one loan strategy i have used with a client building 3 properties subdivising and living in one is to get him to borrow 100% for tje lot and use and offset account while construction happens. Once complete split the loan into appropriate portions and then pay down the ppor portion or ise an offset account.
     
  12. GreatPig

    GreatPig Well-Known Member

    Joined:
    1st Jul, 2015
    Posts:
    153
    Location:
    Sydney
    Thanks, Terry. One aspect of my question was in relation to trying to effectively transfer more of the rent to my wife than the ownership percentages would dictate, but being able to get a bank loan against just the rental property is also a consideration.

    I don't know that we'd have the serviceability to borrow 100% of the construction costs, but if it was possible to do that by immediately offsetting the loan (or most of it) with cash, so little-to-no interest would be payable, then that strategy seems like it would work. Ultimately the aim would be to have no loan against the PPOR (or perhaps some loan fully offset), and a loan against the rental property, also fully offset until we wanted the money for something else.
     
  13. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

    Joined:
    18th Jun, 2015
    Posts:
    8,979
    Location:
    Sydney
    If dual occ that means one title so make sure you get some tax advice.

    Rent would be apportioned based on legal ownership of the property, as would expenses.

    If your wife is a part owner I can’t see ow she could lend you money for the property as she would be lending to herself – which isn’t possible.
     
  14. GreatPig

    GreatPig Well-Known Member

    Joined:
    1st Jul, 2015
    Posts:
    153
    Location:
    Sydney
    Thanks, Terry.

    The dual occ will be detached with a strata subdivision (at least that's the plan), so will ultimately be two strata titles.