PPOR to IP Interest Tax Deduction Question

I am currently having loan on my PPOR, which is the one with REDRAW facility (NOT offset). I plan to build a new house next month (April 2013), and then rent my current home out. Because I have already transferred a lot of money into my loan account and some one told me once I transfer money to the home loan account, I can not claim tax deduction for interest occured on this part. My situation is detailed as follows. Can you please give me some advices on how to legally minimise my tax. Any of your advice would be much appreciated.

May 2012 – I settled my current home at value $430,000. $315,000 is loan amount; $115,000 is deposit. My Loan is with Commonwealth with REDRAW facility (NOT offset)


May2012 – I transfer all my remaining savings $200,000 into home loan account to avoid interest. At this stage my loan balance is $115,000 ($315,000 – $200,000) with $200,000 available to REDRAW.

From May 2012 to March 2013 – I transferred all my and my wife’s salary into home loan account once we got it (About $80,000 in total) and use redraw facility to pay our daily expenses (Buy Cars, travel, food. Etc…)

March 2013 – I requested bank to refinance and transfer my REDREAW home loan to an Offset home loan. The property value is still 430,000. So, my current loan balance is that $344,000 is loan amount, 86,000 is deposit and $220,000 is sitting in Offset account.

In future, I want to transfer this PPOR to an Investment Property and rent it out at $460/Week and use $220,000 in offset account to build a new home.
Let assume interest Rate is 5%

So the taxable income = $460 *52 = $23,920. But what about deduction? If I can not claim interest on the money I have already transferred to home loan. the deduction can only be $1,750 (315,000 – 200,000- 80,000)*5%, even if the interest I paid is 17200 (344,000*5%).

Is it the way to calculate the deduction of interest? If this is the case, Should I set up a family trust and transfer this home to the trust, can this way clear the ‘repayment history’?

 

You have created a mess, albeit unintentionally. But at least you know you have a problem, unlike most.





From an ATO ruling: "The deductibility of interest is typically determined by reference to the use of the borrowed funds. In Ure v FC of T (1981) 11 ATR 484 (Ure's Case) it was established that the purpose of a borrowing will be determined objectively having regard to such matters as how the taxpayer arranged the use of the funds and his subsequent actual use of the funds. "


Your loan had a balance of $115,000 which can be associated with the purchase of the house. But you have place about $80k worth of further deposits from wages. So this means the amount associated with the purchase of the house would be only approx. $35,000

If in future you rent this property out you will only be able to claim interest on the $35,000. It may even be a lower figure than this because you put money in and out several times.

If you set up a discretionary trust you will need to sell this house to the trustee of the trust who could then borrow to buy it. The interest on the loan may be deductible, but if the trust has no other income and there is a loss then the loss cannot be used to offset your personal income. There will also be land tax payable. Stamp duty is payable on the transfer in NSW. A fixed unit trust may be a better option.

Now, if you had structured your loan differently at the start, then it could have been much different.
Eg. $430,000 x 6% interest = $25,800 per year
$35,000 x 6% interest = $2,100 per year.
So structuring differently could have enabled you to claim an extra $23,700 per year. This could have saved you around $10k in tax per year. All this could have been done without you paying anymore interest on the loans too. Imagine how much interest this could have saved you over say 30 years on your new home loan.

 

Hi Terry

Thank you very much for your replies. I know I have made a mess. Even if I already converted the redraw home loan to offset home loan. Wouldn't it clear the history? Is the claimable interest still 35000?

Thanks

 

Its not possible to clear history. The deductibility depends on what borrowed funds are used for.

Initially you borrowed $315,000 to buy a house. If this was interest only then after ex years you would still have $315,000 associated with the purchase of this house. Once the house was available for rent this interest on this loan would be deductible.

But if you place a $1000 wage into this loan the balance reduces to $314,000. If you take money out of a loan then it is new borrowings. So if you took out $1000 for living expenses you would have a loan of $315,000 but only $314,000 relates to the house and $1000 is a private expense.

In your situation you did this many times. So the part of the loan associated with the house is very small even though you have a large loan.

 

Thank you Terry,
If ATO looks at the purpose of the fund. What if I did this?
If I repay other 100,000 to the loan, so, at this moment My deductable interest should be 0. then redraw all 315,000 to buy shares, at this stage my deductable interest should be 315,000 (for investemnt purpose) and then I sell the shares immediate and deposit the 315,000 'proceeds' to the offset account? Would it fix the Issue?

thanks,

 

No, it wouldn't fix the problem because once the shares are sold you would be unable to claim the interest - generally.