The 2 broad methods of Debt Recycling

Discussion in 'Investment Strategy' started by Terry_w, 14th Jan, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    The 2 broad methods of Debt Recycling

    Debt recycling is the conversion of ‘bad debt’ into ‘good debt’. See What is ‘Debt Recycling’? – The Structuring Blog


    Broadly speaking there 2 ways to ‘debt recycle’.

    1. Use the income from investments to pay down non-deductible debt, then borrow to invest further

    Or

    2. Selling investment assets and using the funds released to pay down the non-deductible debt and reborrowing


    The first approach is pretty common, but the second one is often missed. It can work well where the person owns shares because the transaction costs can be very low, compared with property - but it can still work with property.

    The best approach might be a combination of 1 and 2.


    Example

    Bart has owned a few investment properties for a few years. They are positive geared by $100 per week so that is about $5,200 per year in extra funds he can use to pay off his non-deductible home loan.

    But the properties have about $500,000 in equity in them.

    Bart only owes $400,000 on the main residence so what he could do is to sell the properties, pay the tax and used what is left to pay off the main residence debt, and to reborrow to buy more properties.

    This way he uses a combination of the 2 debt recycling methods.

    Of course, there is a lot else for Bart to consider such as, most importantly, his ability to qualify for finance to buy more properties.
     
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  2. codebeard

    codebeard Member

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    Are there any tax rulings showing how the ATO views this in terms of Part IVA? There isn't any interest capitalised so I don't know if 2012/1 applies.

    However, if you were always planning to sell X and buy Y, couldn't the ATO argue a counterfactual that the most direct way to do that would be to sell X and immediately (ot as soon as possible) use the proceeds to buy Y? Adding the additional steps of having split loans of a convenient size, moving sale proceeds to a loan, and then redrawing from the loan and moving it somewhere you can access for purchasing Y, is several extra steps whose end result is materially the same except you gain a tax benefit.

    Thoughts on this? Have you had any success getting private binding rulings for this?
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Yes there is one entitled 'wash sale' and part IVA should be considered and advice sought on whether a pbr might be wise or not.
     
  4. codebeard

    codebeard Member

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    If selling X to buy Y incurs capital gains, or if X is substantially different from Y, then it's probably not a wash sale. Still, a tax benefit results from putting the money into and out of the PPOR loan between the disposal of X and the purchase of Y.
     
  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    The same could apply to selling one property to buy another.
     
  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    The wash sale is of a particular concern to the ATO where someone has a capital gain and sells other assets with a loss so as to offset the gain and then repurchases the same assets again.

    This top deserves its own tip;
     
  7. codebeard

    codebeard Member

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    Interesting, looking forward to it :)
     
  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    That should have been 'tip' and not 'top'!
     
  9. ShireBoy

    ShireBoy Well-Known Member

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    I hold some VAS/VGS retail shares, directly through Vanguard's portal.
    If I were to sell those, and buy the ETF through a standard broker, would that be a wash?
    Can't argue that I simply want to pay less management fees? :p
     
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    The ATO would be happy for you to trigger CGT without any corresponding Capital loss. You would be paying tax you otherwise may not have to.

    If you sell ones at a loss and buy them back again that might be a wash sale.
     
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  11. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  12. househuntn

    househuntn Well-Known Member

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    Just to clarify, you're saying pay off $400,000 ppor debt using profit/equity (I'm ignoring tax here for simplicity) and then immediately borrowing that amount (or part of)
     
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    You can't pay a loan off with equity. Pay off using cash and then reborrow to invest in income producing assets. If done right the interest will be deductible
     
    househuntn likes this.

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