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Using debt recycling to restore deductibility of interest

Discussion in 'Accounting & Tax' started by hotmail, 13th Sep, 2015.

  1. hotmail

    hotmail Well-Known Member

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    Hi all,

    I have been doing some reading of posts on both Propertychat and on Somersoft and also trying to decipher some information from ATO rulings regarding the use of debt recycling in order to accelerate the repayment of non deductible debt. Most of the examples I have read however pertain to using this strategy to pay off the PPOR a little sooner. I was wondering if it would be possible to use debt recycling in order to 'decontaminate' (or at least partially 'decontaminate') mixed purpose loans and regain deductibility of interest that has been lost from previous structuring, funds transfer/mixing and purpose mixing errors.

    Let's say that you succeed in obtaining a loan increase on an interest only variable rate for an investment property. The bank provides you a loan split separate from the initial loan against the property and parks the funds in an offset account offsetting the new loan split. You then go and contaminate the loan purpose by firstly depositing non borrowed funds into the offset account and then also use the funds parked into the offset to purchase something for private use and something for investment use. You then refinance this entire property to another lender who instead of preserving the two loan splits, combines them into one loan with owings equivalent to the sum of the two previous loans with the previous lender.

    1) Does re-splitting the loan with the new lender from such a mixed purpose loan whose interest is only partially deductible and then paying off ONLY ONE portion of that loan split mean that the fully paid off split has it's deductibility 'refreshed' back to 100% and thus if funds are redrawn from that loan split account again and used solely for investment purposes in future?

    2) If instead of retaining the new re-split loan as an interest only basic loan, you convert the new split into a LOC, pay that off and start re-spending the funds, does that have the same implication as using an interest only split?

    3) If the answer to question 1) is "yes", would the re-split process would have to involve achieving the same loan values as were present when the loans were with the original lender for deductibility refreshing scheme to work?

    4) If the answer to question 1) is "yes", in the event that I only have sufficient cash to pay off 95% of the loan split before needing to redraw again for investment purposes, is it simply apportioning the claim of deductible interest to be 95% and the rest of that loan split to be not deductible?

    5) If the answer to question 1) is "no" then does that mean that the whole loan has to be discharged, that is, to pay off both splits altogether and reborrow the entire loans again in order to 'refresh' the tax deductibility?

    6) Separate to the situation mentioned in the last 3 questions, let's say you redraw funds from a "clean" (fully tax deductible loan) and directly transfer this money into a solicitor's trust account to purchase a property and such redrawing of funds does fully use up all the available funds from that loan. What do you guys usually do with the undrawn funds with consideration to the fact that you do not want to create a mixed purpose loan, increase the ease of calculating and apportioning interest deductibility and also would like to sell the properties against which the new and old loans are securitised?

    Thank you
     
  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    i can't follow. can you give some numbers as an example
     
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  3. hotmail

    hotmail Well-Known Member

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    Ok, yes sorry I should have put some numbers in.

    1. So let's say you have an investment property (IP1) against which there is a $100k loan.

    2. You go to the bank and ask for a $50k increase to the loan which is funded as a new loan split of $50k and the $50k cash is deposited in the an offset account offsetting the $50k loan.

    3. You deposit some salary and rent worth $50k into the offset account containing the existing $50k worth of top up loan money. This brings the balance of the offset account to a $100k representing a mixture of borrowed and non borrowed funds.

    4. You take that $100k and use $50k as the deposit (including purchase costs) to purchase IP2 at 80% LVR. You also take another $10k out of the offset account to purchase a motor vehicle, the remaining credits in the offset account against the $50k loan of IP1 is now $40k.

    5. You refinance then proceed to refinance the 2 loan splits of $100k and $50k securitised against IP1 to a difference bank which then combines those two splits into one big loan of $150k.

    6. You wake up one day and realise that you done goofed :( and hastily ask the new bank funding IP1 to split the $150k loan back into the original $100k and $50k splits.

    7. You take $50k worth of cash and pay off the $50k loan split against IP1 without closing the account and then redraw the $50k and with a direct EFT to the solicitor's trust account, use the funds for IP3.

    Question: In the case the deductilibility of the 20% of borrowings against IP2 is dead, but are the steps 6. and 7. sufficient to decontaminate the $50k loan securitised against IP1 to make it 100% tax deductible against IP3? If not, then does that mean I need to pay off both the $50k and $100k loan splits securitised against IP1 and then redraw those funds for the interest of both those loans to become 100% deductible again?

    If this strategy works, would it still work if I only paid off $40k of the $50k loan split in step 7 and redrew $40k to fund IP3 accepting that the interest from the $50k loan split would only be 80% (40/50) tax deductible?

    Much appreciated
     
    Last edited: 13th Sep, 2015
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    If you pay a loan down and then redraw it this is considered new borrowings. So as long as the funds are used directly for investing the interest should be deductible.
     
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  5. chylld

    chylld Well-Known Member

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    You dun goofed! haven't heard that in a while :)

    Paying down a loan to $0 owing resets its whole purpose; deductability should be fine as long as the new $50k split funds are used only for IP3 / other investment purposes.

    Interesting what happens to the $100k split though. I would guess that it is as contaminated as the $150k refi, i.e. very. You can gradually reset it (as was done with the new $50k split) to 'clean it up' although in the meantime I guess it's up to your accountant as to aportioning it / backtracing the stuffups with bank 1 to deduct as much as possible (wrt IP1)
     
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  6. hotmail

    hotmail Well-Known Member

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    Thanks Terry.

    Just to double check as well, if with the new loan split, there was only enough cash to pay down the $50k split to a remaining balance of $1k or the bank would automatically close the account below $1k balance, would it be a case of 49/50 (98%) of the loan interest being deductible? Would the deductibility of that 2% be lost forever?

    When the ATO audit you, how do they usually go about it?
    Do they ask to see your statements from 10 years back in the first instance, because I'm imagining that if you structure things correctly moving forward, most of the problems should be carpeted over, it's just in those initial years that the problems are glaringly obvious right?

    Hmm so that $100k split is contaminated too? That means the point of contamination must have been when they mixed the $50k split together with the $100k split during the refinance as the mixture of the non borrowed funds with the borrowed funds should not have done permanent damage as that offset (from the first bank) was only an offset for the $50k and not for the $100k. Do you think that apportionment and do we do it from the date of the refinance?
     
  7. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Yes you would have to apportion the interest. the 2% would be lost forever.
     
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  8. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    It is rare to get audited and they may not look too deep. If they a targetting interest in particular they may dig further. possibly won't go back too far. I am not sure how far they could go back - with fraud it could be indefinite but without it would be limited to about 6 years or so.
     
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  9. hotmail

    hotmail Well-Known Member

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    I am planning to structure future purchases like this then:

    1) start with a $50k loan fully paid off, securitised against IP1

    2) redraw $20k for IP2 purchase and then split off $20k loan split.

    3) redraw another $20k for IP3 and split this off as another $20k loan split.

    4)Then redraw another $9k for total purchase costs of IP4 and split this off as $9k loan split

    5) $1k loan split remaining automatically, not spent and no interest to be claimed

    That way come tax time we can easily calculate the interest for each loan split against each appropriate property right?

    Actually, would this work, or do we have to split the loan BEFORE redrawing the funds across as technically it would be a mixed purpose loan if we transfer the monies out first right? But then logistically the loan takes a few days to split anyway so how would that work?

    This is very reassuring to hear! I wonder if the ATO will investigate balances of non loan accounts such as offset and saving accounts with their automatic data matching, or if the initial shallow audit they simply match the interest incurred on each bank loan with the deduction number on your tax return declaration without investigating the 'nexus' between funds drawn down and funds specifically spent on investment purposes
     
  10. chylld

    chylld Well-Known Member

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    You would need a good accountant to confirm, but when your $100k + $50k splits were pooled together into one $150k loan, and then you split that $150k back into $100k + $50k splits, then it's impossible to say that all of the original contaminated $50k loan funds went to the new $50k split.

    I'd imagine it's a similar case to Terry's tax tip about not being able to reimburse yourself out of an offset account. Or to use a cooking analogy, you can't stir 50mL of jam into 100mL of cream, and then take 50mL of the mixture away and claim that there's no jam in the remaining 100mL