IP Loan Structure and Cash Flow Cycle

I have a PPOR in the  Western Suburbs of Melbourne. I got the property valued and got a good valuation.

As a result of an increase in Equity on my current PPOR, I have got a new loan set up for 90% of the Valuation.

I want to use the funds in the new Loan (Equity Loan) to put a deposit towards the purchase my/out First IP. 

The questions that I have are:

- Is interest on the funds used to put a deposit for the purchase of the IP are tax-deductible?
- Can I have my mortgage repayments of the IP come out of the Equity Loan?
- Can I have my Rent deposited into the Equity Loan?

- Most importantly, how do set up the IP Cash flow cycle for effective Tax calculation?
- How do I ensure the right IP Cash Flow has been set up to leverage funds for future IP purchases?

- My ultimate aim is to borrow from the Equities gained in the IPs and leave the PPOR as is..

I would be very interested in getting referral on Tax and Property Accountants and Weatlh Advisors who can provide expertise on basic fundamentals of developing wealth via creative investing in Property.

Any help on this matter would be highly appreciated.

cheers

Do you have a separate loan for the equity release? If not you should

If you borrow to invest the interest is generally deductible.
You could set yourself up so that you borrow from the LOC to pay the interest, but this must be done properly or you may find the ATO will disallow it.
You could have your rent paid into your LOC, but why pay down investment debt. Look at putting the rent into an offset attached to your home = saves non deductible itnerest

Terryw

Thanks Terry.

 I do have a seperate Loan for the Equity Release.

Agree with depositing the Rent into the Offset Account.

But where should the IP Mortgage Repayment come out from ??

If youre saying not to reduce the Investment Debt, then how can I leverage extra cash for borrowing for future IP purchases ??

cheers

You would want to pay down the non-deductible debt first. This will save you tax,

You would generally have all monies going into the offset and all repayments coming out of this. A variation is to borrow the repayments for the IP loan from the LOC so that your cash stays in your offset saving you interest. This needs careful planning however.

You will build up substanital cash in the offset and then can decide whether to pay this into the PPOR loan and set up a new split and repeat the process.

Terryw

Thanks Terry once again.

Hi Terry,
Would this method save you much money? If the money goes in from rent, and out again for mortgage repayment, when does it actually offset your mortgage?
thanks.

Every day the money is in there it is saving you interest. not much maybe, but it still helps.

Terryw

Terry Just another question on this one.....
I recently requested equity increase of $45200 from my PPOR lender. I have setted up separate loan of $32,000 to be used as 10% deposit for my IP purchase and mixed the remaining $13,200 into my existing PPOR loan amount. Have I done something wrong. Should I have settled up another loan account of $13200 to be used for my 2nd IP purchase.
OR i have to request alteration to the loan structure again and separate this $13,200 as deposit for 2nd IP purchase.

To give me tax-deductibilty on this amount how does ATO distinguishes whether its the same equity increased amount ($13,200) or I have just used my offset to put money back into my loan account and re-created new account with same amount for tax-deduction (to fund IP purchase)?

Is there any rule to follow or I can just restructure PPOR loan and create new loan account to pay off for 10% deposit on IP purchase and claim deduction on that separate loan account?

Please advise. Thanks

hi Amsaini

Its not wrong to do that, but it is less than ideal.

The problem will arise when you take that money out of the loan. You will have one big loan with part investment and part personal. If the loan were interest only then it would be easy to calculate the interest. But if it is PI then each repayment you make will need to be aportioned between the investment portion and the personal portion. You can't just chose to repay the personal portion first because it is one big loan. Its like mixing coke and water in the same glass and then saying you will just drink the water portion first. every sip would be taking a bit of each. If you pay down the investment portion you are losing tax deductions = paying more tax.

If you had an offset account then the same thing would happen. You would be saving interest on an investment loan at the expense of the personal.

So I would suggest you not redraw that money, but to increase the investment portion when you need  to, or set up a separate account. I would personally use a LOC as it is easy to withdraw money when you need it and they come with a cheque book.

Terryw

Thanks for detailed explanation Terry. In probably a year time, I will move away from my existing lender for PPOR to have both loans with my new IP lender and setup LOC there.
Luckily I have changed my PPOR to IO now so If redraw on that 13,200 later for 2nd IP purchase, Tax-deduction calcuation should be still manageable.
Now when I redraw on that $13200 for 2nd IP and start claiming tax-deductibility, Can I still withdraw my money sitting in offset when required later on? Would ATO allow this as the Interest on Investment portion (And PPOR portion as well) is increasing by withdrawing offset funds.

On another note, I had to redraw on my existing offset on PPOR loan to pay for 5% deposit on IP during the early days of the settlement as my Loan structuring(  to increase loan amount and create separate account) was still in process. I have replaced back that 5% amount back into my PPOR account from my newly created IP account. Is that allright? Wouldn't ATO say that 5% deposit did not came from the separate account straightaway. Can I explain them I had to borrow funds from offset in my PPOR which were replaced once structuring was done. In other words, does it matter - when was restructuring was done, from where was 0.25 deposit paid to secure property, from where was 5% drawn, etc. Do I have to explain them that stamp duty is being paid from my PPOR offset and I am keeping these 13200 for next ip purchase in 6 months time. Or I should say how is the tax -deductibilty on the PPOR loan account to be used to pay deposit on IP decided? What are the rules regarding this? Please advise. These questions have been bothering me for days now

Sounds confusing

If you have funds in an offset account - ie a separate account, then there are no real consequences when taking money out as it was never paid into a loan. The interest will increase, but should be still deductible.

For the other matter, the ATO don't care about  the explanation. They will look at the funds and where they went. If you took money from a loan then these are borrowed funds. If you borrowed some more funds and paid back into the loan you borrowed from then you are really just refinancing that loan so the interest should be deductible.

Where you will have a problem is that you had one big loan, not split, so when you repay that deposit borrowed temporarily you cannot just plonk the funds on the deposit portion, but the deposit must go to the loan in proportion to the borrowings. hard to explain, let me do an example.

Your loan is $90,000 and you take $10,000 for a deposit temporarily. your total loan is $100,000 and it is just one account and one loan number.
90% is personal and 10% investment. So you should be able to claim 10% of the interest.

You then set up your LOC and decide to repay the 10% borrowed temporarily from the home loan with money from the LOC. Because the loan is one account that $10,000 must be attributed in the portions above. ie only 10$ of the loan can go to the investment portion because the investment portion is only 10% of total loan. Same with each subsequent deposit.

So what you are creating is a nightmare! sorry to say!!! It will be very hard to manage the workings out at tax time. The $10,000 borrowed from the LOC will only be 10% deductible etc. After a few months this will be very hard to work out.

Not sure what you can do to rectify it as it has already been done.

Terryw

Hi Terry
  I know I have messed up in my explanation. You have explained well and I understand that but still I am not sure if this apply in my case. I will explain again my dilemma with actual facts. Please help me understand. I really appreciate your time and effort in this.

Current Loan Situation:
Type                                               Redraw Amount                                 Current Balance
Loan Account A - IO                        27000.00                                                  92000.00
Loan Account B - PI                                 0.00                                                  75000.00
Loan Account C - IO                                 0.00                                                  32000.00

Before Loan Structuring, Account A and B were both PI and Loan Account C did not exist. Increased Valuation amount came at $45200. I requested a new Account C to be created for $32000 and remaining increase $13200 to be mixed with LA - A. (That was a mistake, I should have created another account D for that amount). Now amount in A is mix of my personal amount and investment portion. As I understand If I redraw on $13200 for 2nd IP purchase in 6 months time, It will be complex calculation separating Interest component on $13200 and personal loan but its still possible.

As you explained before
"You can't just chose to repay the personal portion first because it is one big loan.... If you pay down the investment portion you are losing tax deductions = paying more tax."

I am thinking of not to pay any extra on this loan (and transfer all personal redraw amount into B) as I dont want to reduce tax deduction on the investment portion by having more amount in offset. Instead, I will try to pay down Loan Account B which is fully personal amount. What do you say? Will this be easier

OR

I should just refinance my loan with another provider and ask them to setup LOC for 13200 in 6 months time, So that calculation will be easier. Is this possible to separate investment portion and personal loan amount in 6 months time by setting up Loan. Can ATO figue out this nexus?

 

Loan Account A was $106000 before and has increased to $119000 with $13200 in redraw. Is this considered ($13200) to be paid into the loan or just kept in redraw. I think this is very basic but I still cannot understand that asking my lender to put $13200 into Loan A means paid into the loan or as the amount is sitting in offset means its just a separate account where deductible interest can be proportionated once redrawn.

 

I understand this now. :) I borrowed from offset in A to pay for 5% deposit and replaced it back from the loan account C. As the amount has been used for Investment property it is still tax deductible no matter from where it came from.

 

Instead of proportionating extra deposit between personal amt and investment amt, as written above, I would put all my deposit into my Loan  Account - B.

Being a first time I am still getting my head around this which is causing more confusion When I am trying to explain something. I hope you understand as you seems to helped so many like me before.
Thanks

hi Amsaini

Its still confusing to me.

I think you are saying that you used part of loan A to pay for an investment and that loan B is personal. If this is the case I would pay off loan B first.

You could refinance with another lender and split loan A but we are only talking about small amounts of interest so it may not be worth the hassle. Your chances of getting audited are slim and it is an honest mistake that probably 90% of people make.

In future I would suggest you try to set up new splits for any investment portions - before you invest and maybe try to use 100% offset accounts to avoid paying down loans. Eventually you will have a large sum in the offset and then you can pay off the loan and redraw for investing via a new split, but it gives you flexibility in the mean time.

Terryw

Thanks Terry..
            I think I have got answers to my questions now    Yes, Part of Loan A ($13200) will be invested later and that will leave Loan A s Mix loan. I will be better off paying down Loan B first.

I will be careful in future to setup my Increased amount as a new split. Thanks once again. Your are a legend !!

Aman