I/O + Offset, used with non-deductable asset

Evening guys and gals,

Just a quick question here in regards to the use of an Interest only loan with 100% offset, and non-deductible asset, ie, a block of land.

Let's assume you have a 100k IO loan with 100% offset and 20k sitting in the offset account, the loan having been used to buy a block of land (hence interest is non-deductible). If you were to take that 20k out to purchase shares, or some other income producing asset, does a portion of the interest then become deductible?

If so, let's go ahead and assume that you choose to do so. Over time you save a further 20k and deposit it into the offset account, however at an even later date proceed to take that 20k out to purchase shares... what happens now?



I've heard of "debt recycling" but haven't found any conclusive information on to what it is exactly (and whether or not it's entirely legal). Is that what this is ? or am I just deeply confused.


Thanks heaps

-CJ

 

Welcome CJ,

The money in the offset account is just that: YOUR MONEY. It is exactly the same as if you had taken it out of your back pocket. When you use it to buy shares, you are just spending your hard earned dollars. There is no tax deductibility associated with this action.

While the money is in the offset account it is `earning' money by reducing the amount of interest you have to pay on the IO loan each month.

The deductibility is associated with the interest payments on the actual IO loan. This is then dependent on what the original $100k purchase was for. In this case the purchase of the land.

(Correct me if I am wrong, but I thought the interest (on the $100k) was deductible IF the intent was that the land was to be used to build an IP on in the near future? If you intend to build your PPOR on it then it is not deductible.)

Assuming that the interest on the IO loan is NOT deductible then the correct approach is to transfer the $20K from the offset account INTO the IO account reducing the actual balance to $80k. You then get the bank to reduce the 'limit' on this account down to $80k. (BTW keep the offset account open, see below.) You then get the bank to open up a third account (with a limit of $20k), so that you can access the $20k of equity you have just created. You then use this new account to purchase the shares. The interest on this new account is then tax deductible, because the intent of the borrowing is for investment purposes.

Later, when you have `saved' the next $20k in the offset account, you can do the same thing. Take the money out of the offset account, put it in the IO account, reduce the limit of the IO account down to $60k. This releases the $20k as equity in the land. Then ask the bank to increase the limit on the third account by $20k (to become a $40K account). You now have another $20k available for investment purposes.

Hope this helps.


Tailcat

P.S. If you want to buy a new car or a holiday then pay for it out of the offset account!!!!!!!!

 

Wow thanks for the awesome reply Tailcat. Pretty much cleared everything up for me with it .

In regards to the intent to build an IP on the land, I've heard the same, however I have probably left it too long between purchasing and taking the first step towards building (2 years, I haven't done anything yet). I wonder what the time limit where one can argue that the intention to build has always been there.

Just a quick question in regards to having the bank open up a third account to purchase shares with, what kind of account would this be?

 

Generally a line of credit (LOC) - this has many types of names, eg Westpac call it an Equity Access Loan. But any bank will know exactly what you mean with an 'Interest Only (IO) LOC'.

But in fact, any loan that is set up purely for investment purposes (or the ATO would say "to purchase an income-deriving asset") can have its interest deductible. SO if you were desperate or just plain barmy, you could set up a credit card and buy shares with that, provided you did not use it for any personal-use purpose.

Although it's not absolutely necessary, you should maintain the LOC as 100% investment. If you use some of it for personal needs (eg a new car) then you would compromise the loan's deductibility, and you'd need to apportion every transaction from it - and any time that you pay money into it, eg interest payments, you would need to apportion those across deductible and non-deductible debt. A very messy situation indeed, and the main reason that Tailcat suggested you get an entirely separate loan to start with!

 

Thanks for another very informative reply Rod.

Other than being lazy I wonder if there's any side-effect towards your overall "desirability" with lenders if you based your shares investing in using Credit Cards lol. Probably one of the easiest "loans" to get your hands onto (and ignoring the monthly minimum repayment, potentially cheaper than some current Margin rates).

That being said I do realise that you're not suggesting that one do that; more as an example of the power of intent.

 

Debt recycling involves moving borrowings from a non-income producing activity to a deductible. In the above case you are talking about paying down the loan for the land and drawing on an investment loan.

If you are intending to build an IP on the land, then the loan itself becomes deductible purpose as the asset is used for producing income - provided all borrowings had been used to acquire the land.

Presently, every cent spent on interest, maintenance, rates, journeys to inspect & mow the grass, etc... is added to the cost base.

At the moment you COMMIT yourself to an income producing activity these recurrent types of expenses are deductible - including the interest. See Steele's Case.

This commitment is on an objective basis, look at the evidence as a whole such as applications for permits, negotiations of contracts with builders etc...

Then this interest, plus further borrowings for building and improvements, becomes deductible.

Cheers,

Rob

 

Thank you so much for clearing that up. In hindsight it makes perfect sense, but that's hindsight for you!

I suppose like many others, I forget that intentions can change, and it seems that the ATO takes that into consideration.

 

Your intentions can change today.

If you wish to earn income from rents, then conduct yourself in that manner.

Keep diaries & meeting minutes. Seek advice on income projections & expenses. Go to the council for permits etc...

Just make sure you don't go over the top getting personally involved development & subdivision such that the ATO might regard you as carrying on a business of development !!!

Doesn't cost much for some initial advice from a Tax Accountant.

Cheers,

Rob