Best investment loan structure for those investors who also have personal debt.
Most investors in Australia have a home loan. Most investors use the equity in their home property to help them on the road to wealth with their first investment property or share acquisition. In the past most investment loans were standard long term facilities with an initial interest only period of say 5 -10 years after which they converted to principal and interest. Most properties are negatively geared with investors using their personal income to subsidise the shortfall between interest on their investment loan as well as other costs associated with the property and their investment income.
If you are one of those investors with both a home loan and a negatively geared investment property then there is a much more tax effective way to structure your investment loan. Until recently there has been considerable confusion amongst property investor tax payers about the deductibility of capitalised interest on an investment loan. The Australian Taxation Office has been promising clarification on this for some time. There have been 2 recent developments that at least seem to be giving some guidance as to the ATO’s direction on the deductibility of capitalised or compound interest on an investment loan or a investment line of credit.
The first was a favourable Private Ruling issued to a taxpayer who had a home loan and an investment line of credit with one lender and an investment loan with another lender. The taxpayer wanted to use as much of his personal income as possible to repay his non-deductible home loan debt as quickly as he could.. He did not want to have to subsidise the investment loan by using his salary to pay the shortfall in interest. Rather he wanted to capitalise the shortfall interest on his investment line of credit and let this accrue while using the surplus cash flow he now had to make additional repayments to his home loan. He also wanted to utilise the investment line of credit to meet any unexpected maintenance costs, rates and the like that attached to the investment property. This allowed him to apply further extra repayments to his home loan and as a result he expected to repay this in full within 10 years, as opposed to the normal 30. Under this structure and in these circumstances the ATO considered the compounding interest to be deductible and Part IVA was deemed not to apply to deny that deductibility.
In September 2008 a Draft Taxation Determination was issued by the ATO which addresses the question: “Is the deductibility of compound interest determined according to the same principles as the deductibility of other interest?†This question has arisen because since Hart vs The Commissioner of Taxation 2002, the ATO has been unclear as to how the character of compounding interest is determined. Hill J in the Federal Court considered there were 2 tests proposed:
1. the purpose of the borrowing
2. the use to which borrowed funds are put.
Hill J was of the view that “Generally, where interest is borrowed to finance the acquisition of an income producing asset it will make no difference which formula is used.â€
In the Draft Determination the Commissioner accepts that the principles governing the deductibility of compound interest are the same as those governing the deductibility of ordinary interest. “The Commissioner accepts that this is the law following the Full Federal Court ‘s decision in Hart.â€
Any investor with a home loan who wants to purchase an investment property should ensure that any investment loan he arranges includes a capitalising investment line of credit. There are a limited number of lenders offering this type of product but certainly they are available in the market.
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