Tax Tip 93: Subdividing Property and Deductibility of Interest

Good day Terry,

I have a question on this matter and would really appreciate your take on this.

I have recently took $100K out of my redraw facility on home loan and used it as a deposit to by investment property. The day deposit was paid, i have split my original home loan into two parts, where the second part is a loan of $100K I/O used to pay the deposit for investment property. When I was splitting my home loan i have added my redraw facility available from original home loan to this second loan of $100K. So what I have now is a loan of $300K, where 200K appear as repaid and they available for me to use at any time and net debt is $100K.

If I dont do anything with this loan and only repay interest, the whole interest paid is tax deductible because $100K were used to pay investment property. However, if at some point in future, i will say take 100K available on this loan and spend it on something irrelevant to investment - holidays,car etc.- would it be fine with ATO, if I will keep deducting interest relevant to original $100K only? I am obviously not going to claim interest on 200K%. The purpose of this loan will become mixed, where 50% are for investment property and 50% not.

I hope I made this clear and appreciate you thoughts on this.

Thanks,

OMG

 

It would then be a mixed purpose loan.

Tax Tip 45: How to work out the Portions of a Mixed Loan https://propertychat.com.au/communi...o-work-out-the-portions-of-a-mixed-loan.4410/

 

I had a look at your link, thank you very much.

But to confirm, since I am going to have I/O and my proportions are easily identifiable as 50%/50% I should be good to claim the 50% of the interest even though it is going to be mixed purpose loan.

Thank you

 

Yes. Should be OK. The problem with bledned loans is that repayments dilute both elements. You cant apply a repayment for one use and not the other. eg You must equally reduce the $100K deductible and the $100K non-deductible. In otherwords its always 50%. If later redraws etc occur its a real mess. Thats why its best not to.

 

Yes whatever you do don't pay anything into the loan. Split first and then repay the non deductible portion.

The only exception is for a sale of the asset the loan was used for:
Tax Tip 55: An Exception to the rule about splitting before Repaying a Mixed Loan https://propertychat.com.au/communi...-splitting-before-repaying-a-mixed-loan.4729/

 

Hi Terry,

I wanted to get an opinion on this scenario.

I have an IP with 2 houses on 1 title
Value 1,200,000
Loan owing 1,000,000

After battle axe subdivision, say

Front lot with house valued 700,000
Back lot with house valued 700,000

My lender has advised that I could not split the variable rate loan for 2 reasons: (1) one would need to be variable rate and the other fixed rate (2) each new split will be securitised by both lots essentially cross collaterallising.

But, I could close the loan then reopen 2 loans, each securitised separately with each property.

Based on the valuations above, the max lending amount for
Front house 630,000 (@90% LVR)
Back house 630,000 (@90% LVR)

Since the current loan is 1,000,000, could I apportion:
630,000 to the back house (keep as IP)
370,000 to the front house (plan to have as PPOR) ?

OR

I must apportion them based on valuation %, so
500,000 to the back house (as IP)
500,000 to the front house (as PPOR) ?

 

Hello Peter


You can’t artificially increase the one that will be an investment property.


If the $1.2mil loan currently relates to the purchase of both properties (and/or improvements etc) then you will need to split this loan on a reasonable basis.


A reasonable basis could be based on the portions worked out by having a valuer value both houses. I think it would be rare for both houses to be valued at the same amount as they would have different designs and different aspects.


But lets say they were both valued the same then you would have to apportion the loans as 50% of the $1mil relates to property A and 50% relates to property B.


So the ideal loan set up would be 2 splits of $500,000 each.


You could structure the loan other ways but you could only claim the interest on one portion of $500,000 so the best way to do it would be to split the loans accordingly.


Tip – when getting the valuer in, tell him what the valuation will be used for and which house you will be living in.

 

But lets say your current loan was in 2 splits:

Split A $800,000 relating to this property and

Split B $200,000 which was an equity release and used to fund another property (property C)


In this situation you would only need to split the $800k loan into 2 portions and then keep the $200,000 as is.


But this may not work without cross collateralising the loans so you could split the loan as follows

Split A $400,000 secured by property A, not deductible as living in property A

Split B $100,000 Secured by property B, Deductible against property C

Split C $400,000 Secured by property B, Deductible against property B

Split D $100,000 Secured by property B, Deductible against property C

 

Hi Terry, this thread has been compelling to read and much of what you have advised makes sense to me.
What are your thoughts on the following please:
- IP purchased 2017 with single home and approved plans for 2 town houses. A loan of $1,250K was drawn for this purchase, property has been rented out. It was demolished and construction began in 2019.
- Loan interest deductions have been claimed in full to date as the 2 new town houses were intended to be Investment properties.
- My family and financial situation has changed recently due to COVID19 and we have decided to move into one of the townhouses and rent out the other.
- As soon as we made this decision, we thought about how to split the loan so that we could separate the investment portion & claim interest deduction; and another portion which is now our PPOR where we can't claim interest deductions.
- We did not borrow additional money subsequent to the original loan for building or other costs.
- Subdivision is currently in progress but not complete.

Is it as simple as apportioning the original $1,250k loan by the ratio of land per proposed subdivision? Given that the original loan paid for the land and demolished house only? This makes sense to me but it seems too easy and I fear I am missing something.....

 

You can no longer claim interest on vacant land but you should still split the loan. It might be split based on size, but the blocks could have different values if outlook different.e.g. battleaxe block.
Might be worth getting a valuer to value each block based on the proposed subdivision.

 

Thanks for your quick reply Terry!
The two new town houses have been under construction for the last 16 months and recently completed, so no vacant land period. It is a corner block so was just split down the middle.

Is the purpose of the valuation now simply to work out the ratio to split the loan based on the estimated value of the land based on proposed subdivision?
Is a loan split = refinance in terms of assigning cost to a specific parcel of land?

 

You would have to apportion on a reasonable basis. Using a valuer might be reasonable, as would land size and cost.

Interest is no longer deductible during construction either. I can't remember when the law changed so you should check on that before claiming

 

Unlikely you need a valuer. A reasonable basis is the requirement. Consider the land and the build as distinct elements. And finish and size. eg Two townhouses are indentical in size and finish and have approx 50% each for land then 50% is a reasonable basis. But a duplex with one side 3 bed and the other 4 bed and marble kitchen and better finishing may need a different basis.

Dont forget to add in to actual cost the non-deductible interest and other holding costs after 1 July 2019 as a costbase element.

 

Actually if you didn't borrow to construct you apportion the loan based on the land only, but different aspects of identically sized land can result in different values.

 

Hi Terry, I've read conflicting advice in regards to claiming interest deduction during construction on the ATOcommunity website, please see specifically the reply from KylieATO (community Manager) on 29/11/2019.
Answered: Re: construction cost interest for house and land ... - ATO Community

 

That post is factually flawed (for a post 30 June 2019 situation) . And it is not a public or private ruling and is non-binding and wouldnt even assist to be a basis for avoiding penalties for being reckless. The ATO post is not tax advice.

From 1 July 2019 laws apply which deny all deductions for newly constructed rental premises unless owned by a exempt entity, which are intended to produce rental income until the completion of both the following events:

1. A occupany certificate has been issued; and
2. The premises are available for rent

For a existing dwelling which is being renovated or repairs aftre ownership D15 may continue to be used for holding costs prior to it actually being available under the general principles of the decision in Steele's case. A property which is being developed for resale likely needs personal tax advice and many issues can alter the tax outcomes. Subdivision of land with retention of a old dwellinga d construction of new dwelling may require two approaches and apportionment.

I have posted to that thread to ask the ATO to correct their guidance

Further information and a flowchart for eligibility etc : Deductions for vacant land

 

Note the first line of the question:
Hi All, i have a case for 2017/2018 financial year

 

All good then.....
Late question. I always am amazed by the people who seek tax advice for a developement and subdivision well after its commenced.

All explained in the developer toolkit sufficient to then seek tax planning advice from any property savvy tax adviser - before commencing is best.

 

Terry & Paul - thank you for your valuable time and expert advice. It is highly commendable and appreciated (by the greater community I'm sure) for you to offer/share your knowledge and steer us noobs in the right direction, free of charge might I add.
We obviously run final decisions through our accountant but just to be able to bounce ideas initially from respected and knowledgable people in the industry is a god-send.

A massive thumbs up to you both )

 

thanks Mr Miyagi