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Margin Loans Margin loan: to prepay or capitalise?

Discussion in 'Finance & Banking' started by Glebe, 21st Apr, 2006.

  1. Glebe

    Glebe Well-Known Member

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    Hi there,

    I'm trying to work out whether it's in my interests to pre-pay my margin loan in June or to capitalise it. I am not really sure what to choose so I was hoping the Invested members could help me out.

    Let me throw in some numbers:

    Portfolio value - 915 000.
    Loan - 500 000.

    Loan cost at 7.5% prepaid: 37500
    Loan cost at 8% capitalised: 40000 (plus future interest on interest).

    Now, people say it's best to pre-pay when you have a large taxable income to offset it against. I don't have any negatively geared property, all I have is a taxable PAYE income of $115 000 and distributions from the portfolio crudely estimated to be about $40 000. I do like the idea of dropping that $155k in taxable income down to about $120k.

    I do have the $37 500 in a bank account so I can pre-pay without selling down, but all things being even I really really like the idea of capitalising forever and not ever really paying back the interest :)

    Anyone have recommendations otherwise I'll just be flipping a coin!

    And also, my accountant is Nick M. Nick if you're reading this, are you comfortable with capitalised interest on interest being tax deductible?
     
  2. MrDarcy

    MrDarcy Well-Known Member

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    When you pre-pay and capitalise, you get the tax deduction now, and the cash flow. That's what I'm doing, this year anyhow.

    If was on anything near $155k a year :eek: , I would be looking very hard for all deductions given that next year's tax brackets make deductions worth more this year.
     
  3. Here_To_Learn

    Here_To_Learn Well-Known Member

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    Looking forward to some more input from others as I am in a similar position to Glebe.

    Let's keep things simple and see if I understand ...

    If you can borrow funds at 7.5% and receive a 10% income this makes sense. You are however risking your capital as it can down.

    If the capital however moves up it's your to keep FOR FREE !

    Did I miss something ?
     
  4. Nigel Ward

    Nigel Ward Team InvestEd

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    Hi Glebe

    It's well past Beer O'Clock so I'll make this brief.

    I think the question boils down to:

    a) what return will you get on the $37500 over the next 12 months after tax
    b) does that exceed the discount plus the tax refund plus earnings on the tax refund over 12 months?
    c) flexibility - once you pay the $37500 it's gone and the most you'll get back from the tax man is just under half that.

    d) seeing as you've got the $37500 is there another option? Namely just pay the interest month by month out of those savings?

    Just some exhausted ramblings. Somebody pls spreadsheet it...Michael? :D
    N.
     
  5. Here_To_Learn

    Here_To_Learn Well-Known Member

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    Dear Guru's, please help me understand ... if you proceeded to pre-pay capital as you mentioned above -

    Year 1 - For 05/06 tax you would claim your interest payments for the year + the pre-paid interest

    Year 2 - For 06/07 tax you pre-pay Interest for 07/08 and deduct.

    Year 3 - For 07/08 tax you pre-pay Interest for 08/09 and deduct.

    Year 4 - For 08/09 tax you pre-pay Interest for 09/10 and deduct.

    Did I miss something ? I am trying to find the benefits of pre-paying interest other than receive a discount and reducing your income in Year 1 by claiming a years worth of interest + the pre-paid interest ?
     
  6. Here_To_Learn

    Here_To_Learn Well-Known Member

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    Anyone willing to post their thoughts ? :confused:
     
  7. Leandro

    Leandro Well-Known Member

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    I am also interested in an answer to this question.

    Also, what happens if you want to sell your units half way through the following year, can you get part of that prepaid interest back?
     
  8. Here_To_Learn

    Here_To_Learn Well-Known Member

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    Good question ! :eek:
     
  9. MrDarcy

    MrDarcy Well-Known Member

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    For me it's about deferring tax.

    For example I have a CG event this year, by prepaying interest I can offset this. Next year there are higher tax brackets and I'll be well below (ie much less than $125k pa) them so deductions are worth more now than next year. Put another way, this year $20k prepaid interest will be deductable on the 48% bracket. If I don't prepay, next year the $20k will only be refunded at 30%.

    Hey, maybe next year I won't have any other income at all becase I have retired :D and what use is a big tax deduction then ?

    Do I prepay everything ? No, but enough to get my marginal tax bracket down.

    Defer paying tax as long as you can, you may not have to pay at all one day !
     
  10. MrDarcy

    MrDarcy Well-Known Member

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    The margin lenders I use state they do not refund the interest in any situation. Not sure how well enforced this is. Anyhow, I believe if pre-paid interest is refunded, you may need to do tax return amendment. Best avoided all round.
     
  11. Rickson

    Rickson Well-Known Member

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    If you prepay interest - and then you wish to sell units. One solution is to then buy units in a cash management trust, which the margin lender will lend 100% on. The distribution is approx 5.2% with BT. Does not cover the cost of the prepaid interest. But is better than nothing during times when you are not fully utilising the prepaid funds.
     
  12. Glebe

    Glebe Well-Known Member

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    I love the idea of pre-paying and capitalising it. I thought I would have to cough up the cash. Thanks alot Mr Darcy.
     
  13. Here_To_Learn

    Here_To_Learn Well-Known Member

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    Again ... the benefit only exists the first time you do this ... Am I missing something ?

    Either people are not interested in capitalising interest or this is a boring topic.
     
  14. MrDarcy

    MrDarcy Well-Known Member

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    Capitalise AND pre-pay interest. Sorry I can't explain any better, that's probably while I'm NOT a qualified financial planner, perhaps they should be your next step. Only sharing thoughts as requested.
     
  15. Glebe

    Glebe Well-Known Member

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    Here_To_Learn,

    What Mr Darcy is saying is this:

    Year 1 - For 05/06 tax you would pre-pay Interest for 06/07 and deduct- but have the interest capitalised so nothing coming out of your wallet

    Year 2 - For 06/07 tax you pre-pay Interest for 07/08 and deduct- but have the interest capitalised so nothing coming out of your wallet


    Year 3 - For 07/08 tax you pre-pay Interest for 08/09 and deduct- but have the interest capitalised so nothing coming out of your wallet


    Year 4 - For 08/09 tax you pre-pay Interest for 09/10 and deduct- but have the interest capitalised so nothing coming out of your wallet
     
  16. NickM

    NickM Co-founder Staff Member

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    Guys
    We all know prepaying interest is one of the few avenues available to reduce your taxable incomes.

    Capitalisation of interest is one of those grey areas.

    I am of the view that if you are an investor with several properties / and or shares/ and or managed funds and as part of your business you pay some expenses whether they be rates, repairs or interest from a LOC or a loan then the ATO would be hard pressed to disallow your deduction.

    If you had just 1 margin loan and prepaid and capitalised then you "might" be ok. Your position would not be as strong as the guy with several properties with a couple of loans.

    Tax is clear as mud.

    Nick M

    looking forward to shredding 2000 pages off my Tax Act
     
  17. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    Ah, not really 100% on this one fella's but to me that sounds like double dipping. Or do you mean pre-pay the interest for the coming financial year and deduct the interest from the current FY? Then deduct the pre-paid interest next FY?

    Thoroughly confused.

    Mark
     
  18. Alan

    Alan Well-Known Member

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    Hi Nick.

    Surely there are some Tax Rulings around on Capitalising interest on Margin Loans. Aren't there. :confused: :eek:

    I would have thought it was a reasonably common option?
     
  19. Glebe

    Glebe Well-Known Member

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    Lets say it's June 25, 2006.

    I've earned $70 000 from my job and $30 000 from my investments. So I have a $100 000 taxable income. I know that for the next financial year I'll be borrowing $500 000 so I pre-pay the interest on my $500 000 margin loan ($37 500 interest), so my taxable income is now $63 500.

    However by capitalising, I'm not shelling out that $37 500 in cash, I'm having it added onto my loan, so I'm really borrowing $537 500. It places me a little closer to a margin call so I'd be hoping the markets rise pretty quickly.

    Keep repeating every June...
     
  20. Alan

    Alan Well-Known Member

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    .....and if you get a bit of Growth from your shares, a large part of the Capitalised Interest may be offset anyway which will keep your Margin Loan Ratio to a similar figure that it was 12 months before. :)