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Refinancing & tax deductibility

Discussion in 'Accounting, Tax & Legal' started by Maverick, 3rd Feb, 2006.

  1. Maverick

    Maverick Well-Known Member

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    Hello,

    I will appreciate your opinion about deductibility of the interest on loan in the following refinance situation.

    Original investent property value was $200,000, bank loan is $160,000 (80% LVR). Current investement property value (as per bank valuation) is $250,000.
    If I refinance at 80% LVR the new loan of $200,000 can be used to re-pay the original loan ($160,000) and $40,000 will be left over.

    My questions:
    a) Will the interest on the new loan be deductible if the $40,000 are used for lifestyle (hypothetically)?
    b) Will $40,000 be considered as the income and be subject to tax or is it a capitan and therefore is tax free?

    Thank you.
     
  2. Simon

    Simon Well-Known Member

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    You will need to apportion the interest claimed to the amount used for income producing investments. ie 20% of the interest will always be non deductible. Even if you pay it back into the loan due to a windfall it equally comes off both the deductible and non deductible debt. ie if the $40K is repaid in 12 months then $8K will come off the lifestyle debt and $32K off the IP debt.

    I would try to avoid contaminating the loan because you normally need to pay off both loans at an equal rate making this a long term situation.

    The easiest way around this is to arrange the loan to be split so that the two different amounts are clearly seperated on the loan statement. You can then go IO on the IP loan and pay the non deductible loan down first.

    even easier might be to not use the $40K for anything but income producing investments. Maybe use it to buy $80K worth of Navra units via a margin lender, and then use that income to enhance your lifestyle? Will be more tax effective and should preserve the capital.

    I hope this all makes sense.
     
  3. Nigel Ward

    Nigel Ward Team InvestEd

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    a) for the $40k No.
    b) Not income. Not taxable.
     
    Last edited: 3rd Feb, 2006
  4. Simon

    Simon Well-Known Member

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    Not quite right Nigel.

    $160K will be deductible and $40K nondeductible.

    in addition the $40K is received tax free, you just need to repay it with interest.
     
    Last edited by a moderator: 3rd Feb, 2006
  5. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    You're quite right there Simon.

    Might just take it a little further and say if you want the $40,000 for personal expenditure, it would definitely be a good idea to split the LOC so you can easily show which part was for investment purposes and which part was for personal use.

    Mark
     
  6. Nigel Ward

    Nigel Ward Team InvestEd

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    Sorry I was referring to the 40k only. in answering both. post now edited. Thanks for the pickup Simon
     
  7. NickM

    NickM Co-founder Staff Member

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    I agree
    Nick
     
  8. MichaelWhyte

    MichaelWhyte Well-Known Member

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    I agree too.

    Goes to the "purpose" of the loan or what the funds are used for. In reality, I don't think the lender would give a new loan of $200K. They're more likely to just give an LOC of $40K to take the LVR back to 80% and leave the existing $160K loan in place, unless of course its a refinance with a different lender. So, the $40K LOC's deductibility becomes an issue of how its used. If Maverick uses it for lifestyle then the interest is non-deductible. 8% pa is pretty cheap "tax" on that income don't you reckon! ;) Gotta love LOE.

    Cheers,
    Michael.
     
  9. Simon

    Simon Well-Known Member

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    To put in perspective that is 8% pa tax that you keep on paying each year long after the $40K car is worth $7K (an example of a Jeep I was considering last week that was 8 years old and initially bought for $42K) or the holiday is just a pic on a screensaver.
     
  10. MichaelWhyte

    MichaelWhyte Well-Known Member

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    Good point...

    Tying to come up with something smart like: "Yes, but next years growth should repay that debt and alleviate the ongoing interest bill", but that's all too complicated to think about right now. :D True LOE requires a pretty big asset base to pull off successfully.

    Cheers,
    Michael.