Tax Tip 22: Security for a loan does not determine Deductibility of Interest

Security for a loan does not determine Deductibility of Interest


Some people get confused about the deductibility of interest - which is understandable.


The security for a loan does not change the deductibility of interest for that loan.


If I use my main residence as security and set up a $500,000 line of credit and then use those funds to buy an investment property - which will not be mortgaged - the interest WILL be deductible.


If I use an investment property to secure a new LOC and use those funds to pay down the loan on my main residence then the interest those funds will NOT be deductible.


Its the use of the money that is important - that is, where and how the funds are applied.

 

Hi Terry,
Question on this! We have 2 properties in a trust which currently has a quarantined loss of 30k after purchase/borrowing costs due to a retention wall needing to be completely redone on one house (32k cost)
We have already loaned deposits for both houses to trust which is discretionary with corporate trustee. (No FTE)

We are thinking of doing a Reno on the other house of approx 30k by lending to the trust.
We are taking out a loan to build a PPOR (personal names) clearing this loan after sale of current PPOR when it is built.
If we borrow against the equity in the new PPOR to pay down the large debt accrued by the trust (personal loans from us to trust to fund the above) is this tax deductible?
Or if not, can we borrow against personal equity to fund the Reno ?

Is the tax deductible only relating to the purchase of investments and not any other scenario?
Or can a trust borrow money from the trustees to pay the trustees back and have that loan as tax deductible so we can release personal funds for another IP?

Apologies if this is a silly question!

 

Cara

Not sure that I follow so seek advice. You can lend money to the trustee. You cannot lend to yourselves though so no the extra borrowings will not be deductible if you use the funds for the PPOR.

Trust could borrow money to pay back the lender which appears to be you and the interest on this loan may be deductible. But if you lend the trust this money it would only be one loan replacing another so no change in deductions. Trust could borrow from a bank though.

 

Hi Terry,

Really appreciate the reply, apologies for the confusion though!
The trust is set up with a corporate trustee, currently 2 properties.
We loaned the corp. trustee 770k to purchase 3 houses (1 sale fell through) and there is a mortgage in trust name for 660k
I am hoping to increase the mortgage to 80% value of combined properties, this will allow an additional borrowing power of 420k and obviously increases the mortgage and the interest only repayments.
This would cover the 'trust borrowing from the bank' you mentioned.

The corporate trustee would then pay back this amount to us the lenders.

We would get some of our invested cash back to use for the build of our PPOR instead of paying non deductible on this amount.

The loan between us and the trustee is only currently documented as transfers between personal and business accounts and stated loan to trust on our statements and no interest is payable on this by trust but it is in the trust documents minutes.

Is it legitimate for us to claim the interest on the increased mortgage in this instance?

 

You had $770k cash and lent the trustee and took a mortgage? If the trustee now refinanced this loan with a bank and gave you back the $770k it is just a refinance and won't change the deductibility of interest.

If the trustee pays you back an additional $420k then this won't be deductible to the trust nor would the interest on the loan to do this. It could be taxable to you though depending on the circumstances.

If there is no commercial loan agreement in writing between yourselves and the trust for the $770k then the interest on any refinanced loan would probably not be deductible. Minutes and transfers are not enough.

No you cannot claim the interest.

 

Ahhh - There is an exception to the title deed rule. Its a issue more for those who have significant property interests. There comes a point when all the % TIC, Joint etc can just be ignored and the whole lot may well be 50/50.

The point is that of when they are considered to operate a property income business. Its a vague area and generally will require professional tax opinion and a ATO ruling to support / confirm / refute it.
- Substantial holdings....Not five, not ten...Loads. And perhaps whole unit blocks.
- Substantially rely on rents as predominant form of income/s rather than other jobs
- Generally don't sell / trade properties

 

Hi Terry,

Thank you for the post, very useful!

I just have a question which is a slight variation on the scenario you described.

I'm in the process of purchasing an IP using a LOC on the equity in my dads PPOR. So I am borrowing funds from him, however the property will be purchased under my name. Will this interest be deductible for him?

 

Nope.

Doesn't relate to the production of income. You will not be able to claim it either unless you have a written loan agreement with dad, the lender. If you do your interest paid to dad would be deductible to you and income to him. He could then claim the interest he pays the bank as a deduction.

Get legal advice though as many other issues.

 

Just found this relevant TD:
TD 93/13 Income tax: is interest paid on a loan used to acquire income producing property an allowable deduction where non income producing property (e.g. the family home) is used as security for the loan?

TD 93/13 - Income tax: is interest paid on a loan used to acquire income producing property an allowable deduction where non income producing property (e.g. the family home) is used as security for the loan? (As at 28 January 1993)

 

#1 : It is the USE through payment of the borrowed money that determines whether the interest is deductible or not. Not security, nor source. eg You pay borrowed money to a law firm and they settle the property. If you pay the law firm with savings and then recover those lost funds through a bank loan then its non-deductible.
#2. If one or all owner/s of the property do not borrow the funds then the borrower must correctly onlend those funds to the owner. If not done correctly a tax problem may occur.
#3 : Borrowed money must be directly used to acquire the property etc.
#4 : Loans must be documented and established and continually maintained on arms length terms
#5 : Loans may require security to be considered arms length

 

Interesting topic, glad I found this thanks @Terry_w .

What if I were to draw equity out of my IP and then use that money to purchase a business/franchise? From the research that I have done, I would have to show the business performance to the bank so they can assess security. Would the interest still be deductible as its being spent on an investment?

 

if you borrow to invest or use for business the interest should generally be deductible under s8-1 ITAAA97.

Doesn't matter that you are using your home for security.

Of course if your business is being operated through a company or a trust then it would be different. In that case you would need to onlend the money on commercial terms evidenced in writing.

 

There are instances when the borrowing won't be deductible. Prior to investing in a business / franchise its important to get personal legal advice and tax advice that confirms the structure and deduction.

 

Hello @Terry_w and @Paul@PFI , most grateful if you can kindly clarify the following scenario for me:
PPOR: title under my name with joint P&I loan under my and partner's name, there are several loan splits.
We want to purchase an IP under partner's name only, we will repay one of the loan splits and redraw (Loan A) to pay 20% of the deposit & 6%upfront cost etc.
Borrow the other 80% (Loan B) under partner's name.
In terms of the destructibility, we know Loan B is entirely deductible for partner, how about loan A? Can he claim interest on all 26% or can he only claim half of it which is 13% since the PPOR loan is a joint loan?
Thanks heaps!

 

Her name on title to the property the borrowed funds are used for - she will claim the interest on the loan.

I think I have a tip on this somewhere.

 

Tax Tip 58: Two on title One on loan. Who claims Interest? https://propertychat.com.au/communi...n-title-one-on-loan-who-claims-interest.4822/

not that one, but this:
Tax Tip 79: Interest Deductibility for 1 on title 2 on loans https://propertychat.com.au/communi...deductibility-for-1-on-title-2-on-loans.5838/

 

Provided the loan proceeds are used to acquire a investment property the female owner on title will claim all income and deductions on each property. The new loan (B)would be deductible against property B, not property A as IPA is just loan security. Each split must be considered for the purpose of that split. eg if one was for a car then that loan is likely non-deductible. A co-borrower is ignored for income tax.

The other thing to take care with is the Loan A and B arent crossed. Terry is also a broker and can explain that issue. It has no tax impacts but does affect loan payouts and sale/s and refinance at times.

 

Thanks heaps @Terry_w and @Paul@PFI !

 

@Terry_w sorry for asking this as I should know and I Think I do but wanted to ask again anyways.

If you set-up a new loan split and the bank puts the funds into your personal savings. Am I correct in saying it's only an issue if you then use them funds for investment purposes direct from that account?

You could however leave them in their and they get mixed up for say 3 months. As long as you pay the money back into the loan and redraw prior to purchasing (ideally paying direct from the loan if you can) then you don't have an issue?

 

Redraw from a loan is considered new borrowings.

So if the borrowed money has been placed in the wrong account you can pay back into the loan, down to 0 and then redraw and directly use to invest and then legitmately claim the interest.