Ask Ban Tacs Question
Hi Julia
Background:
I have a property that was purchased originally as my place of residence- and I lived in it for about 2 years, before moving and then renting it out. The loan secured over this property is for a total of $297000. The loan was originally a line of credit loan. After paying a significant portion of this loan off with wages and sale of shares (I got the loan down to $98000). I had then subsequently split the loan into 3 loans.
Loan 1: ($98000) The original loan amount owing on the house which was switched to be a fixed interest in advance loan.
Loan 2: ($151000) A new loan amount that was withdrawn using equity to purchase shares. This loan has been predominantly fixed interest in advance.
Loan 3: ($48000) A new loan that was also withdrawn using equity from the house to purchase shares. It is a standard variable loan with an offset account.
I have been claiming full interest on the share loans and also the interest on the house loan (from when it became a rental). I don’t believe any interest has been capitilised.
I have zero non-deductible debt at all (I am renting), and no other debt other than these 3 loans.
After reading your book, I have two concerns:
1) Looking back there is about $8000 of transactions on the original LOC loan (the $98000 house loan) that would not be considered tax deductible expenses. These were made prior to the house becoming a rental. Since then, the loan has been fixed (interest in advance) with no payments in or out.
2) Some of the shares on the $151000 loan have been transferred to another broker account- still my shares in my name only. Also, some shares that were originally purchased have been sold- although those proceedes were then used to buy more shares that are "incoming producing" as well. But this has become a bit confusing to keep track of now.
My question:
Basically, I really want to reduce the complication here.
At the moment I am looking to rebalance my share portfolio and sell some shares. So, to simplify things can I use the proceedes of selling shares and pay all these loans down to $0. Then redraw the total amounts ( of 98000, 151000 and 48000) so I can then send these seperate amounts directly to individual share accounts to purchase the new shares. Do these loans then become "new borrowings"? Is this allowed, and not considered a scheme? – and does getting the balance down to zero on a loan allow all the interest on that loan from that day on to be tax dedcutible (if the loan is fully drawn and transferred directly to purchase the ‘income producing’ shares?). I can then keep these loans and associated share broking accounts more simple, clear and direct.
Answer
The basic rule is what the money was used to buy determines whether the interest on the loan is tax deductible. The nexus is important, you need to be able to show a clear link between the borrowings and the purchase. In Domjan’s case (AAT 2004) it was a bit extreme but the AAT decided because Mrs Domjan took the money from her loan and put it into her cheque account so she could write a cheque, the nexus was lost and that borrowing was not tax deductible because she had mixed the borrowed money with private funds so there was no way of saying that it was the borrowed money that paid for the deductible expense.
In regard to the shares fortunately TR 2000/2 http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20002/NAT/ATO/00001 will allow you to attribute to the borrowings whatever you do will the proceeds of the sale of the shares. So as long as you can again show a nice tidy connection between the sale proceeds and the purchase of more income producing shares then you can continue to claim the interest on that loan. Here is a quote from the ruling:
37. Where the funds borrowed under a line of credit remain outstanding, we believe the deductibility of interest is to be determined by considering the ongoing application of those borrowed funds. Interest is considered to be the cost of retaining the use of the outstanding line of credit funds in the period in which that interest accrues. Where borrowed funds are recouped from the sale of an income producing asset purchased with that money, the connection between the interest expense and the income producing use of that asset will be broken when the asset is sold. Interest on those borrowed funds will only be deductible after that time if it can be established that the accrued interest continues to be incurred in the course of deriving assessable income or in carrying on a business. For this to be the case under a line of credit, there would need to be a sufficient connection between the accrual of interest in a period and any new application for income producing purposes of those recouped borrowed funds. Deductibility of interest on those borrowed funds will be determined by a consideration of the advantages sought from that new use to which those funds are redirected.
Further reading of this ruling makes it clear that once you pay down the loan and draw money back out that is a fresh new loan
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.
So in short your strategy is a very good plan and do not be hesitant to claim a tax deduction for the loans for the shares that you have traded. Once you redraw on all these loans to buy shares all of the interest will be tax deductible.
The downside of this strategy will be paying CGT on the sale of the shares.
Your only concern is that redraw of $8,000 makes part of the interest on the current $98,000 loan not tax deductible. What portion all depends on how much you owed at the time you drew the $8,000 out. You see after that point all repayments are apportioned on that same basis between the house borrowing and the private borrowing so whatever percentage applied originally would still apply to the current $98,000 balance. For example if you owed $200,000 when you drew out the $8,000 then 96% of the loan is for the house (192,000/200,000) which means that only 96% of the $98,000 is for the house. Of course once you pay it down completely and redraw for shares all of it will be deductible. Here is am just considering the deductibility of your current interest bill for the $98,000 loan.
