All Topics / Help Needed! / Is this interest really deductible?

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  • Profile photo of AilimeAilime
    Participant
    @ailime
    Join Date: 2008
    Post Count: 28

    Hi all

    My sister & BIL are thinking of upgrading their current PPOR (let's call this PPOR 1 and its corresponding home loan as Loan 1).

    They were suggested by friends (who have done and are doing it) and their accountant to do the following:

    – Turn PPOR 1 into IP by renting it out.

    – Redraw the equity from PPOR 1 and use the money to (partially) fund a new PPOR (let's call it PPOR 2). 

    They were told by their friends and accountant that by turning PPOR 1 into IP, the interest of the redrawn fund from Loan 1 becomes tax deductible (with the reasoning that Loan 1 has become a loan for an IP).

    Is this correct?

    Can turning PPOR 1 into an IP and use the equity of Loan 1 to fund PPOR 2 = making the interest of Loan 1 become tax deductible?

    My understanding from reading what TerryW, Richard, Jamie, and other experienced investors here said before is that the deductibility of interest depends on the purpose of the use of money.

    In their case, the money is used to fund PPOR 2 (ie. a personal use). Therefore, the interest from loan 1 is not deductible – despite the fact that loan 1 is now linked to an IP.

    Did I miss something?

    If my understanding above is correct, is there any publication or link to ATO website that I can use to point them to an accurate information?

    What will/can happen if they follow their friends' way?

    Please help!

    I wish to prevent them from getting into trouble.

    Thank you so much.  

    Profile photo of PLCPLC
    Participant
    @plc
    Join Date: 2012
    Post Count: 400

    Hi Ailime,

    Your friends and accountant are incorrect (I would be wary of using one who didn't know this).

    The interest on the existing PPOR loan minus the redraw would be the maximum they would be able to claim (assuming it didn't include any other personal borrowings). If they want to use equity to finance a new PPOR they should do it a a split to separate the existing loan from the new borrowings.

    This is something that I could find on the ATO website under unable to claim : http://www.ato.gov.au/content/00113233.htm

    Cheers

    Tom

    PLC | Phoenix Loan Consulting
    Email Me | Phone Me

    Melbourne based Mortgage Broker | Making Finance Simple

    Profile photo of AilimeAilime
    Participant
    @ailime
    Join Date: 2008
    Post Count: 28

    Thank you so much, Tom!

    Your response made me think…

    Does doing it in the following order make  a difference to their tax deductibility?

    1. Redraw from loan 1 the maximum redrawable amount, turning the loan balance into its original amount.

    2. Park the money in a separate saving account (to be used later as PPOR 2).

    3. Turn the PPOR1 into IP, change loan 1 into IO and dedicate loan 1 purely for the now IP purpose.

    Will this work for them?

    Profile photo of Jamie MooreJamie Moore
    Participant
    @jamie-m
    Join Date: 2010
    Post Count: 5,069

    Hi Ailime

    Looks like you know more than your friends accountant :-)

    1. No – they will still only be able to claim against today's loan balance – not the redrawn amount.

    2. They can do that – but those redrawn funds aren't going to be deductible.

    3. I would change the current loan to IO now so they can preserve the current principle balance.

    Cheers

    Jamie

    Jamie Moore | Pass Go Home Loans Pty Ltd
    http://www.passgo.com.au
    Email Me | Phone Me

    Mortgage Broker assisting clients Australia wide Email: [email protected]

    Profile photo of PLCPLC
    Participant
    @plc
    Join Date: 2012
    Post Count: 400

    Ailime, basically once the principal has been paid off whether through normal P&I repayments or extra repayments into a redraw, you have lost the ability to use it for deductibility purposes. You cannot "gain" it back (unless it is taken out for investment purposes). Hence why in my opinion an offset account should always be used instead of redraw.

    As Jamie mentioned, best option for them is to change the current loan to IO so that they maximise their deductibility going forward (i.e. not lose any more principal).

    Cheers

    Tom

    PLC | Phoenix Loan Consulting
    Email Me | Phone Me

    Melbourne based Mortgage Broker | Making Finance Simple

    Profile photo of crjcrj
    Participant
    @crj
    Join Date: 2004
    Post Count: 618

    Penalties from the ATO.    If they have redrawn previously for a non income producing purpose, then the total interest on their current total borrowing will not be tax deductible if the property becomes an IP

    Profile photo of PLCPLC
    Participant
    @plc
    Join Date: 2012
    Post Count: 400

    With the way the Australian tax system works on self-assessment, there is nothing really stopping them from claiming even if fraudulent. However if they are audited by the ATO and found to be falsely claiming interest, there would be at the very least extra tax to pay for all corresponding years that they were claiming, interest charges for shortfalls accrued, and penalties for the false tax returns. There might even be civil or criminal legal matters.

    Are they willing to take that risk?

    Cheers

    Tom

    PLC | Phoenix Loan Consulting
    Email Me | Phone Me

    Melbourne based Mortgage Broker | Making Finance Simple

    Profile photo of AilimeAilime
    Participant
    @ailime
    Join Date: 2008
    Post Count: 28

    Thank you so much, Jamie and Tom!

    I am glad to know that I gave my sister and BIL the correct information.

    What sort of risk (especially from law &/ tax point of view) may my sister and BIL face, if they follow their accountant and friends' advice and claim the interest of the redrawn amount as tax deduction?

    Profile photo of TerrywTerryw
    Participant
    @terryw
    Join Date: 2001
    Post Count: 16,213
    Ailime wrote:
    Hi all

    My sister & BIL are thinking of upgrading their current PPOR (let's call this PPOR 1 and its corresponding home loan as Loan 1).

    They were suggested by friends (who have done and are doing it) and their accountant to do the following:

    – Turn PPOR 1 into IP by renting it out.

    – Redraw the equity from PPOR 1 and use the money to (partially) fund a new PPOR (let's call it PPOR 2). 

    They were told by their friends and accountant that by turning PPOR 1 into IP, the interest of the redrawn fund from Loan 1 becomes tax deductible (with the reasoning that Loan 1 has become a loan for an IP).

    Is this correct?

    Can turning PPOR 1 into an IP and use the equity of Loan 1 to fund PPOR 2 = making the interest of Loan 1 become tax deductible?

    My understanding from reading what TerryW, Richard, Jamie, and other experienced investors here said before is that the deductibility of interest depends on the purpose of the use of money.

    In their case, the money is used to fund PPOR 2 (ie. a personal use). Therefore, the interest from loan 1 is not deductible – despite the fact that loan 1 is now linked to an IP.

    Did I miss something?

    If my understanding above is correct, is there any publication or link to ATO website that I can use to point them to an accurate information?

    What will/can happen if they follow their friends' way?

    Please help!

    I wish to prevent them from getting into trouble.

    Thank you so much.  

    This is basic tax law, s 8-1 ITAA 1997. Interest would be deductible to the extend that it relates to money borrowed to purchase income producing assets.

    Your accountant is wrong.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://structuring.com.au/
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of DerekDerek
    Member
    @derek
    Join Date: 2004
    Post Count: 3,544

    It seems as if not all professionals are created equally.

    This example is a case in point to show that while we should defer to professionals for advice it also pays to 'know a bit' yourself. 

    Profile photo of gmh454gmh454
    Member
    @gmh454
    Join Date: 2003
    Post Count: 537

    it could be done many years ago, but think they change may be around 15 years ago ..

    so he is either dumb and dangerous or been living under a rock (or just got out)

    Profile photo of AilimeAilime
    Participant
    @ailime
    Join Date: 2008
    Post Count: 28

    Thank you so, so much, everybody!

    Really appreciate your responses.

    I am going to send this to my sister and BIL :)

    Profile photo of AilimeAilime
    Participant
    @ailime
    Join Date: 2008
    Post Count: 28

    Totally agree with you, Derek!

    Profile photo of AilimeAilime
    Participant
    @ailime
    Join Date: 2008
    Post Count: 28

    Thank you so much for the reference from tax law, Terry!

Viewing 14 posts - 1 through 14 (of 14 total)

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