Refinance PPOR to an investment property

Question

I have spoken to a chartered accountant, however, I am not feeling comfortable on her advice as the information I read on the internet contradicts her advice.

Essentially, I have Full time job @ $99,000 p.a. My wife has no income beside Bank Interest which is not significant.

We are living in our home (PPoR) worth approx $1.2M with a mortgage of $150k paying off P + I.

We have an acreage of 5 acres which we bought for $450k and have just built a new house on it for $250k. So estimated market value of $700k and a mortgage of $480k.

Both titles and loans are under both our names.

My wife and I would like to move from the PPoR and live in the other Property. We would like to rent out our PPoR so essentially our current PPoR will become an investment property and the acreage will become our PPoR.

We have been advised that we can refinance the $1.2M property to say $150k + $480k = $630K and payout the $480k mortgage essentially leaving 1 mortgage of $630k on the $1,2M property. We have been advised that the interest on the $630k can be deducted fully against the rental received once we rent out the $1,2M property.

Furthermore, I can get a market valuation on the $1.2M property prior to renting it out as the cost base for CGT calculations when we dispose of the $1,2M property in the future.


From what I can gather, the above advice contradicts to what I read on the internet and on the BANTACS website.

If the above advice is indeed incorrect, I think my best option is to refinance both properties at the current loan amounts with the $1,2M property changed to interest only and then will be able to deduct the interest charged on the $150k loan. The other $480k will be changed to a Interest only with offset.

Is there a better alternative?

Could you provide me a quote on the cost involved to answer my situation please.

We have no plans to sell either property in the near future.

Answer


I don’t like to contradict another Accountant without giving references to support my argument as I realise that this puts you in a position of having to decide who is right without any training in the subject. There are many fields in which a chartered accountant can practice, the accountant you spoke to, area of expertise may not be tax law.

Here is an extract from TR 2000/2 in particular chapters 39, 40 and 43
Further borrowings
39. Where a loan facility allows for redraws of extra repayments, we consider those redraws constitute new borrowings of funds that cannot be traced to the extra repayments. In this regard the term ‘redraw’ is a misnomer. It is in effect a new borrowing of funds. Similarly, a draw down on a line of credit that has not been fully drawn is a new borrowing of funds.
40. In our view, it is not correct to characterise the reduced loan balance as comprising the previous loan balance with a notional offset credit available in respect of extra repayments as if those extra repayments were standing to the credit of the borrower in a separate account in the books of the lender. The extra repayments do not create a debt due by the lender to the borrower. Those funds used to make extra repayments simply cease to exist as an asset of the borrower after being used to discharge part of the loan debt. In our view, the redraw facility does not involve separate loan and deposit accounts of the type discussed in paragraphs 6 to 8 of TR 93/6.
41. In the case of a repayment of principal on a line of credit, the borrower acquires a contractual right to borrow a further amount equal to the difference between the reduced drawn-down amount and the available credit limit. That right to borrow further funds is a contractual right under the loan agreement permitting the borrower to draw down funds up to the agreed credit limit. The available credit is not an asset of the borrower and the available credit limit can be varied by the lender upon review.
42. Similarly, under a redraw facility, the loan agreement gives the borrower the right, subject to restrictions in some cases, to borrow a further amount up to the balance of the loan debt that would have been outstanding if the minimum loan repayments required under the loan agreement had been made. The extra repayments do not create a debt payable by the lender to the borrower and are not an asset of the borrower after they have been used to discharge part of the loan debt.
43. We consider a draw-down from a line of credit account or sub-account, or a redraw from a loan account, is a separate borrowing. Therefore, the deductibility of the interest on that separate borrowing depends on whether the interest is incurred in gaining or producing assessable income or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. Conversely, that part of the accrued interest attributable to borrowings used for non-income producing purposes is not deductible.
44. The balance outstanding on a mixed purpose line of credit sub-account or a mixed purpose loan account is an undivided single debt owed by the borrower to the lender. When repayments of principal are made, it is not considered possible to direct those payments to only that part of the borrowed funds used for a particular purpose as if it were a separate debt. While it may be possible to trace the uses to which different parts of the borrowed funds are put, it is considered repayments of principal need to be applied proportionately to reduce the balance of the outstanding principal attributable to income producing use and non-income producing use respectively, e.g., if 70% of an outstanding line of credit sub-account debt is used for income producing purposes, 70% of any repayment would be in respect of that part of the outstanding debt. However, there are two exceptions.



The whole ruling can be viewed at http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20002/NAT/ATO/00001

In short what the borrowed money was used to buy determines deductibility not where the loan is secured so as the draw from the loan was used to pay off a house that is not income producing that portion of the loan is not tax deductible.

Worse still you will now have a mixed purpose loan. Any repayment will have to be pro rataed between the non deductible portion and the deductible portion. This is discussed at the beginning of TR 2000/2. It means that you won’t be able to concentrate on paying down your non deductible debt like you could if it was in a loan separate from your deductible debt.

You should also look at the $150,000 and make sure that is still directly related to the purchase or improvement of the 1.2mil property ie you have not made any redraws from it.

The market value reset when the property first produces income is correction, section 118-192. You don’t have to get the valuation done immediately valuers are capable of giving historical valuations as it is based on sales data which is always available. Though the sooner the better to give the valuer a better idea of the state of the property at the time.

You refinance idea is the way to go.

You might also want to toy with the idea of buying out your wife’s half share of the 1.2mil property by borrowing $600,000. She would have to pay $75,000 back on her share of the $150,000 loan but the remaining $525,000 is more than enough to pay out the non deductible loan. There is a catch. At first glance this appears to be a scheme with the dominant purpose of a tax benefit so the ATO could use Part IVA to disallow you a tax deduction for the interest on the $600,000 loan so you would be worse off. It is best to get a ruling from the ATO before you do this, asking whether they would apply Part IVA to the arrangement. You would need to have another dominant purpose for the arrangement. ID 2001/79 is based on a private ruling where the taxpayer wanted to keep the property and his wife wanted to sell it so he bought out his wife to resolve the dispute. Make sure you specifically request an answer as to whether they would apply Part IVA to the arrangement.

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