Tax Tip 24: Capitalising Interest and Non working spouses

Capitalising Interest and Non working spouses


I am a big advocate of couples not jointly buying property together as there are a heap of strategies that can be used.


One strategy may be to borrow to pay the interest of an investment property while the owner is not working. This may be when the children are born/young for example.


Where a couple jointly own an investment property the opportunity will be lost as the other spouse will be left to foot all the interest. But where one person is owner and they have no other income then in may (and I say MAY) be ok to borrow to pay the interest.


This will mean that funds that would have been diverted from paying down the PPOR loan can be used to pay off the non deductible debt faster. It will also mean that the owner of the IP will have higher deductions - which won’t help when they are not working but any losses can be carried forward and be offset by future income when it is incurred.


Also when the non working spouse does return to work they will have a higher loan balance which will mean further ongoing deductions.


You will probably need to see your lawyer or tax agent to get a private ruling to do something like this.

 

@Terry_w, this sounds like a grey area which I understand you put MAY in capital letter.

I don't fully understand this bit though:

Could you please give another Borat example?

In regards to paying IP interest by borrowing, would there be any income test from ATO for how much you can borrow to pay interest? The reason I'm asking is because If her maternity pay is enough to cover half of the interest, I would imagine then she can borrow half. But of course rather than getting confuse down the track, probably it's better to just borrow the full interest amount.

 

Yes it s a grey area. But not for the ATO to tell someone how to spend their money. So he the wage is not enough to pay for living expenses it may be justifiable in borrowing to pay interest.

This may free up the cashflow of the other spouse who won't have to divert funds from the PPOR loan to the IP.

 

Example

A owns the main residence with Spouse B. A also owns an investment property.

A ceases work to have children. The property is $5,000 per year negative cash flow. The only choice, it seems, is for B to pay A’s loan or to sell the property. A cannot pay as they have no income.


Instead, B lends A money to pay the loan. This money from B comes from a loan secured by an investment property owned solely by B. B is the sole borrower for this loan and enters into a contract with A to lend $5,000 per year at the same interest rate that the bank charges.


Result. Cash is not diverted from B paying off the non-deductible home loan. They would have $5,000 more coming off this loan per year. At the same time A is gaining extra tax deductions by being able to claim the interest on the $5,000 per year borrowed from B. This could be claimed against the income – creating a larger loss, or perhaps it not be claimed and will come into play reducing CGT when the property is sold.

 

I would be concerned Part IVA could apply. And promoter penalties could be applied to a marketing of such an arrangement. Also highlights the issue when planning ownership if A has a neg geared property then the tax loss may accumulate if income isnt earned for a prolonged period.

The best arrangements for capitalised expenses are those which arise from pure necessity rather than those which are planned extensively especially where there is a deliberate choice to pay all the cash shortfall on the IP using a new loan and yet increasing principal repayments for a corresponding sum on their own home. Many people who engineer benefits like this will actually be that blatant in their attempts to plan a tax benefit.

 

I would have to disagree just because I like saying the opposite to Paul.

It is true that Part IVA could apply, but the question is would it. That would depend on the circumstances and where spouses own properties separately and enter into contracts to borrow money I think there is a good chance that it will be acceptable.

Best to seek specific tax advice on this, and ask whether a PBR would be recommended to confirm - private binding ruling

 

I'm also with Terry on this despite appearing to disagree. I believe the issue is not something a taxpayer should self assess as it could create a serious tax concerns capable of amendment for years ahead to disallow some of the taxpayers deduction/s.

A few different ways to address the uncertainty.
1. Personal tax advice based on full and honest disclosure with an adviser
2. Advice should cover whether a BPR is wise. In some cases it may be recommended. In other cases there may be no need.

My warning is also that taxpayers should be cautious about mortgage brokers who discuss tax issues. Terry is a rare guy - He is a qualified solicitor, broker and tax adviser which can be a invaluable trinity of skills. Otherwise if a broker starts to recommend tax strategies its time to be concerned.

 

@Terry_w how does this work? I know you can carry forward Capital losses but don’t understand how this works for non capital gain income. Does a tax payer have the choice not to claim a deduction in one year and “carry it forward” to a future year? Could you possibly elaborate?

 

Income losses.

Capital losses can only offset capital gains

 

Understand this.

So you can carry forward income losses for individual tax payers into the next tax year? How?

 

Yep

 

Ah, I see now.

How to claim a tax loss
Individuals can generally carry forward a tax loss indefinitely, but must claim a taxloss at the first opportunity. You cannot choose to hold onto losses to offset them against future income if they can be offset against the current year's income.