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another question on LOCS

Discussion in 'Accounting, Tax & Legal' started by voigtstr, 15th Mar, 2008.

  1. voigtstr

    voigtstr Well-Known Member

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    If a LOC was used for the deposit costs on a ppor the loc would not be deductable, correct?

    What if, the loc was used 100% to buy units in Navra, then 1 month down the track all units were redeemed with the cash going into a savings account, and then the ppor deposit was funded from the savings account. Would the interest on the LOC being deductable still once the units were sold out of Navra. Is deductability based only on the originial purpose of the loan?
     
  2. CJ. Wentworth

    CJ. Wentworth Well-Known Member

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    Correct me if I'm wrong.

    From what I've read, if the original purpose of the loan were to purchase Navra Units and they are sold, the proceeds are then deemed to have paid the loan off, as the original purpose of the loan has been fullfilled.

    Unless the LOC has been used to purchase another form of investment, then the loan will lose it's tax dedutibility.

    My assumption is that it works similarly if a percentage of the Units were sold, ie 20% sold = 20% of the loan "paid off".

    I may not be using the correct wording though when I say "paid off" as I don't necessarily mean that the money has to go back into the loan.


    I think I'll stop now and wait for someone with more of an idea to come along lol, clear things up a little :)
     
  3. voigtstr

    voigtstr Well-Known Member

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    Please note that I'm not intending using the loc like this. But I do want to understand how literally the deductability rules apply. Peoples circumstances do change over time.
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I'm inclined to agree with CJ.W here - I think you would be on extremely shaky ground if you tried to claim that the loan interest was still fully deductible after the asset had been sold. You generally need to "follow the money" in these cases - and in your example, the borrowed money is subsequently being used for non-investment purposes and is thus non-deductible.

    Just a suggestion - one thing you need to learn about tax law - there are almost no black and whites - only grey areas which are often open to interpretation and will often need lawyers to get a court to make a case-by-case decision (which may or may not be relevant to future decisions or situations!). Once you get over the expectation of getting a black-and-white answer, you'll sleep a lot better at night :D
     
  5. voigtstr

    voigtstr Well-Known Member

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    Thanks Sim.
    For our first LOC we've decided that for less than 1 thousand, the deductability on a 30k loc doesnt really matter, getting into the market sooner and enjoying the capitol gains is more important.

    All future borrowings after the next ppor will be deductable and I expect they will add up quite nicely.
     
  6. voigtstr

    voigtstr Well-Known Member

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    An update.
    We have organised to get a loc on the villa unit. The valuation will probably happen this week.

    The LOC will be to 90% rather than 95%LVR (the original loan on the unit was to 95%). We will live in the unit for a few more years. The loc will be used to fund the purchase costs of 3 bedroom unit in the range 250-280k at 95%LVR. We will rent out the 3 bedroom unit and continue to live in the 2 bedroom unit (paying a mortgage fixed for a few more years at 6.75%).
     
  7. Billv

    Billv Getting there

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    ok but where are you going to get the fixed rate of 6.75%?
    Cheers
     
  8. voigtstr

    voigtstr Well-Known Member

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    The 6.75% is our existing mortgage on the villa unit, its fixed for another 3 years (was a fixed interest for 5 years in 2006)

    The LOC and the new mortgage on the new property will be variable, (but both interest only).
     
  9. Rod_WA

    Rod_WA Well-Known Member

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    Nice rate. My 6.49% IP loan expires in October. At the time, the 3-yr rate looked the best option, but your 5-yr rate looks the goods now!

    Like Sim says, tax law is open to interpretation. But I reckon that there's enough established case law that makes a few things clear.

    1. The 'original purpose of the loan' concept is thrown out the window when you change the purpose of the loan.

    2. Obviously, you can't open a loan for investment, buy lots of shares, sell them after a bit, pay down your PPOR loan with the proceeds and then say, "I have a large loan that must be deductible since the original purposes was to buy shares."

    3. Deductibility must be apportioned across the loan usage. If half is for income-producing investment purposes, and half is for a holiday, then half the interest is deductible.

    4. You cannot choose to capitalise the deductible bit and selectively pay down the personal-use bit (the essence of Hart's case). Any pay down on a loan must be apportioned.

    It remains the best option to keep deductible and non-deductible loans completely separate (not even a 'split loan'), ie one LOC for investment, and another for personal use (if at all!).
     
  10. Rob G.

    Rob G. Well-Known Member

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    FCT v Brown .....

    If you have taken out an investment loan and have committed to a contract for a specified period, then even if you are forced out of the investment prematurely and cannot repay for some reason then you can still claim deductions after your income-producing activity has ceased.

    Difficulties occur at times of refinancing, where the Commissioner may regard this as a redraw and will look to the purpose of the new borrowing.

    This is the problem with a LOC, as it is regarded as monthly rolling refinancing. TR 2000/2

    Cheers,

    Rob
     
  11. voigtstr

    voigtstr Well-Known Member

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    With a loc though you haven't committed to a contract for a specified period. Its really like a big credit card with lower interest (secured by property)(in this case).

    So... I guess the loc (and also the new mortgage) is deductable up until the point the new house is no longer a rental and we move it into it. At that point the mortgage on the 2 bedroom villa unit will be deductable because we would start renting it out..

    I guess it will be a bit of a mess untill a ppor is paid off, and we only have a bunch of ips.
     
  12. voigtstr

    voigtstr Well-Known Member

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    What's the best thing to do with the LOC when we change the use of the property in a few years time from IP to ppor?

    The LOC will be set up in a few weeks time. We'll draw on it when we find a property that will be a good rental for the next 2-3 years. The loc will fund the deposit and legals and stamp duty etc.

    Is the thing to do, to just pay the interest (no principal payments) on the loc while the new place is a rental, and dont draw on it for any other purpose? Spare cash could be going into Navra (I figure we are closer to the bottom of the market now, than we were 4 months ago).

    When we finally move into the new property, then we could pay down the loc as soon as possible, then start debt recycling the mortgage on the new property (which would mean setting up a new loc secured by the new property).