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Re: Servicing monthly loan principal payments using another loan

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Hi,

Assume I have an $100k investment loan (loan A) for a property.
Assume I also have a linked offset account with a $100k balance, so all my monthly repayments are pure principal.
I also have a second loan (loan B) which is not drawn (starting balance $0), I then use a monthly redraw on loan B to pay the principal of loan A.
Over time Loan A reduces, and Loan B accrues. Both loan purposes are for financing an income producing asset.
Is the interest in loan B tax deductible?

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ATO Certified

TaxTime Support

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Hi @Mike741,

 

Thanks for your question!

 

The ATO can only provide you with general guidance on tax law and how it may apply to your circumstances as described.

 

TR 2000/2 may be of use to you, as it does detail deductibility of interest on a line of credit or redraw facility. You may find that, since the purpose of Loan B was not to purchase the income producing asset, but only to make repayments on Loan A, this may mean that the interest on Loan B is not at all deductible.

 

However, if you would like more specialised guidance, you may wish to speak to a tax professional, or seek other options.

 

Hope this helps,

 

Rachael B.

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Newbie

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In light of my question above, I have looked up relevant Tax Rulings & Determinations.

I can merely draw conclusions by inference as none of the documents I sighted cover this case in particular. It may even be too trivial to warrant documentation.

Nevertheless, how do I go about getting formal sanction to avoid issues later on?

Is there a tax expert that can provide proper guidance to make sure I’m doing the right thing?

Who shouldn I turn to? Any help is appreciated

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ATO Certified

TaxTime Support

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Hi @Mike741,

 

Thanks for your question!

 

The ATO can only provide you with general guidance on tax law and how it may apply to your circumstances as described.

 

TR 2000/2 may be of use to you, as it does detail deductibility of interest on a line of credit or redraw facility. You may find that, since the purpose of Loan B was not to purchase the income producing asset, but only to make repayments on Loan A, this may mean that the interest on Loan B is not at all deductible.

 

However, if you would like more specialised guidance, you may wish to speak to a tax professional, or seek other options.

 

Hope this helps,

 

Rachael B.

Newbie

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Hi Rachael and thanks so much for your reply.

Let me just emphasise again that the loan repayments on Loan A are principal only, no interest.

In that light let me ask you these questions:

 

a) I assume that I can re-finance Loan A with a new loan from another bank or even the same bank. This new loan will not have been used to originally purchase the income producing asset, yet it's interest charges are tax deductible. Please correct me if I'm wrong.

 

b) Assume now that it is my Loan B that pays out Loan A. Are the interest charges of loan B still tax deductible?

What happens if I pay back only 50% of Loan A with Loan B. Are the interest charges of loan B tax deductible?

 

c) Assume now that I pay back loan A with Loan B, but do it in several installments. Is the interest of loan B tax deductible?

Again the assumption is that loan A incurs no interest, so non of the amounts refinanced through loan B include any interest, irrespective if they are called "refinance", "installments" or "repayments".

 

At what stage (a-c) would you say that that interest from Loan B is no longer tax deductible?

 

I understand that I cannot collect Loan A interest charges & other outgoings from the rental property in loan B and then expect the resultant interest to be tax deductible.

 

Best Regards

ATO Certified

TaxTime Support

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Hi @Mike741,

 

Thanks for getting in touch again!

 

I'll try to provide you with general guidance, but otherwise please refer to the information I provided in my earlier post, or you can see our rental properties guide.

 

It does not really matter what you do with Loan A, because the crux of the matter is that in all of the hypothetical scenarios you've proposed, Loan B does not have a satisfactory connection to the actual investment, so the interest will not be deductible. The interest is generally only ever going to be deductible from the loan that is directly connected to the income producing asset. i.e. the loan that is used for the purchase of the investment property and secured against it.

 

TR 95/25 details the following points which you may find helpful:


(a)

The interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature. The test is one of characterisation and the essential character of an expense is a question fact to be determined by reference to all the circumstances.

(b)

The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower. However, regard must be had to all the circumstances, including the character of the taxpayer's undertaking or business, the objective purpose of the borrowing, and the nature of the transaction or series of transactions of which the borrowing of funds is an element. In some cases, the taxpayer's subjective purpose, intention or motive may be relevant in deciding the deductibility of interest.

(e)

Interest on borrowed funds will not be deductible simply because it can be said to preserve assessable income producing assets.


You may also wish to review TD 2012/1, which relates to "Investment loan interest payment arrangements". If you still need additional guidance, I'd strongly suggest speaking to a registered tax professional.

 

I hope you find this helpful, but please let me know if there's anything else I can assist you with.

 

Thanks,


Rachael B.

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