Question referred from Noel

Question

I recently read an article about issues involved in transferring property to one’s wife. THe article said that it may not be advantageous to do so for ‘natural love and affection,’ as this would have negative CGT consequences upon future sale.
In light of this, I have a question that I would like to ask you regarding an alternative transfer to my wife for market value that I am contemplating instead. Namely, I own an apartment in Melbourne which I bought for $320K, but is now worth about $580K. I have an accumulated prior capital loss of $250K and would like to ‘sell’ this apartment to my wife for $580K, principally to take advantage of the loss, but also to remove this property from my ATO records. There would be no actual money exchanging hands. My wife would possibly benefit from an updated depreciation schedule on the apartment that is more expensive.

The relevant question is this: We currently have a series of loans in joint names, secured over this apartment and another one, including a $400K loan split and a $180K loan split, but each of us receives bank statements individually, while I claim the interest on loans as a deduction with ATO in each case, as the properties are in my name. Am I able to ‘sell’ my wife the apartment by a mutual agreement between us whereby she takes responsibility specifically for these two loans (as between us), despite the fact that we will both continue to have a joint loan with the bank. The consideration will be $580K, in the form of her taking first/sole responsibility for those two loans. My reasoning is that this should be allowed, as it is a separate contract detailing responsibilities as between the two of us. The bank advises it is happy to change the title into my wife’s name for market price under this proposal, as nothing changes as between us and the bank. My main concern is: would ATO accept this ‘sale’ so that my wife can claim interest deductions on the two loans from time of purchase?

Answer

Sorry for the delay in answering. I ran away from TC Debbie in Mackay and she followed me!
You are spot on, transferring for natural love and affection can really stuff up your tax deductions. When you transfer for natural love and affection you are making a gift, the new owner has not borrowed any money to acquire the asset because they have not paid any money for the asset.
The rule with interest tax deductibility is that what the borrowed money was used to buy determines whether the interest on the loan is tax deductible. If the borrowed money was used to buy something that is producing taxable income for you then the interest on that loan is tax deductible. It does not matter where the loan is secured.
So if you have a loan that was used to buy that property and you gift the property to your wife then the borrowed money was used to buy a gift. This means that the interest on the loan is not a cost of earning income so is not tax deductible.
Selling the property to your wife is a much better idea but money needs to change hands. There needs to be fresh borrowing by you wife to pay you for the property. This money is then used to pay down your loan for the property. Taking over the loan won’t cut it.
She is deemed to have paid you market value so she may as well borrow that much and you can use the excess to pay down any non deductible debt.
The ATO generally accept that the banks will require both husband and wife to be on any loan documents even if the money is used to buy an asset is just one spouse’s name. But I have known them to fuss about this so it would be prudent to persuade the bank to just lend the money to your wife with you as guarantor but not on the loan bank statement. If this is not possible you could draw up a document where you loan your share of the borrowed money to your spouse for the same interest rate that you are paying the bank. So no tax consequences and no need to argue with an ATO auditor.
Be warned that the ATO could use Part IVA to treat the property as still owned by you and possibly with no interest tax deduction if you pay out your old loan. Part IVA voids any arrangement where the dominant purpose is a tax benefit so you need to have another valid reason for the transfer.
CGT – the transfer to your wife will be treated as a sale at market value for CGT purposes so will trigger a large amount of capital gain but fortunately for you your loss should cover it. Losses must be offset against gains before applying the 50% CGT discount. Are you likely to be able to utilise these capital losses in another way in the future? You see if you never sell this property you never pay CGT and you maybe able to use these capital losses elsewhere.
Your wife is deemed to have purchased it from you at market value which will be the first element of her cost base.
Building depreciation is based on the original building cost, the amount does not change now that the building is worth more.
To specifically answer your question, if you sold the house to your wife would the ATO accept that she could claim a tax deduction for the interest on the loan that was used by you to buy the property? I think you would have a difficult time through an audit. The ATO have no moral objection to catching you out on a technicality if they can. The borrowed money was used by you to buy the property not by your wife. TR 2000/2 allows you to trace the use of the funds if you buy and sell assets but this does not address the situation where the actual owner of the asset changes. I recommend you do not take the risk because there is far too much at stake it is worth going through the refinance process.

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