Ask Ban Tacs Question
My husband and I have lived in our own home for 4 years, taking out the original loan with no thought of renting it out at any time in the future. However, we have now decided to rent our home as we are leaving the area, with the possibility of returning in a few years to once again live in our home. We will be renting a home to live in during this time away.
The original loan was for $177,000. This was refinanced with an advance of $66,000 two years later, total $239,000. Half the advance went to pay out a personal loan, the other half went back into the mortgage and was redrawn over time to make impovements on our home which we mostly did ourselves. For a while we also deposited all our income into the loan, making monthly redraws for living expenses.
What are the implications of this fluctuating balance and redraws from our mortgage on claiming tax deductions for loan interest once our home is rented out? Are we likely to have lost all deductability?
We have also considered buying another investment property in the near future. Could we use this to help reduce our tax liability for our original home while it is being rented?
We are now aware than an offset account would have been the best option rather than redraw, and intend to now do this. However, we will have to again refinance as our lender does not offer this option.
Answer
You have good reason to be concerned. It is quiet possible that none of this loan is any longer deductible. On average churning a loan by banking your pay into it then drawing out to pay living expenses or your monthly credit card balance, will turn a deductible loan into a non deductible loan within 5 years. The process to work out what is left that is deductible is very simple but very time consuming.
The basic rule is all deposits to the account have to be divided on a pro rata basis between the portion of the loan that is deductible and that which is not deductible. All draw downs take on the character of the use the money is put to. So your wages must also pay off the deductible loan. The draw down for your personal loan, living expenses and credit card payments for personal expenses will be 100% borrowing for non deductible purposes. The draw down for the improvements can increase the deductible balance. Every transaction needs to be analysed and a running balance for non deductible and deductible kept Reference TR 2000/2 For example:
A $100,000 loan used solely to purchase a rental property is financed as a line of credit. To pay the loan off sooner the borrower deposits his or her monthly pay of $2,000 into the loan account and lives off his or her credit card which has up to 55 days interest-free on purchases. The Commissioner now considers there to be $98,000 owing on the rental property. In say 45 days when the borrower withdraws $1,000 to pay off his or her credit card the loan will be for $99,000. However, as the extra $1,000 was borrowed to pay a private expense, viz the credit card, now 1/99 or 1% of the interest is not tax deductible.
The next time the borrower puts his or her 2,000 pay packet into the account the Commissioner deems it to be paying only 1/99 off the non-deductible portion i.e. at this point there is $96,020 owing on the house and $980 owing for non-deductible purposes. When, 45 days later, the borrower takes another $1,000 out to pay the credit card, there will $96,000 owing on the house and $1,980 owing for non-deductible purposes so now only 98% of the loan is deductible, etc, etc.
For the short period of time you will be away from the property it is probably not worth spending much money on fixing this problem. For example one spouse buying half the house off the other. But if you are going to refinance anyway to buy another property and after doing the above calculations there is still a deductible portion of the loan it would be worth splitting the loan into two separate loans the deductible portion being interest only and the non deductible P&I with as short a term as you can manage. Also borrow interest only all the costs involved in the second property. Then set up a line of credit to pay any extra expenses for the rental properties. You are not required to use your wages income to prop up investment properties. You can borrow to pay these expenses including the interest on the loans when you are short and the interest on this line of credit would be deductible also.
If you want to know more about claimable loans there is a free booklet by that name under the free publications section on this site.
