For a long time, the holy grail of residential investment property finance has been to capitalise interest on a tax-deductible loan and to accelerate repayment of non-deductible debt, using rental receipts from an investment property.
This strategy famously suffered a setback in 2003 when the ATO won its case against HART under Part 4a. This was a pretty egregious example of “split loan” financing, where the borrower was actually paying an interest rate premium for the privilege and the entire structure was very open to being considered as primarily a tax minimisation exercise (and hence struck out under Part 4a).
But the legal issues were clarified somewhat by a subsequent public ruling (TD2008/27) that the deductibility of compound interest should be treated the same way as ordinary interest.
Some advisers believed that the key to a successful implementation of the strategy was to use different lenders for the different loans, but this often presented practical difficulties.
In June 2011, the ATO issued a draft ruling (TD2011/D8) stating that it could apply Part 4A to any “scheme” relating to the financing of investment properties whose primary purpose is to reduce tax liabilities or “to pay off your home loan sooner.” Whether it would attempt to do so will depend on the circumstances of each individual case.
Since ANY arrangements to finance the purchase of an investment property are effectively “a scheme,” the ATO are clearly trying to cast a wide net. Note also that a draft ruling is not a piece of legislation. Far from it, it is nearer to being a discussion document, an invitation for industry participants to comment. And comment they certainly have.
But what the ATO is clearly saying is that it doesn’t like the capitalisation of interest on deductible loans at all. It cannot proscribe it. Otherwise, every business overdraft operated by any company for the last century would have to be unwound. But it is actively on the lookout for anything that looks sufficiently like a split loan arrangement that it can be said to be primarily for tax minimization and therefore subject to rejection under Part 4a.
There has never been any question that the legitimate expenses of owning an investment property could be charged to the deductible loan account. These expenses include management fees, strata levies, insurance premiums, repairs, etc.
Nor can there be any suggestion that finance arrangements that assist with the management of the investor’s cash flows are vulnerable under Part 4a.
So, if an investor dips into the offset account linked to an investment loan for purposes that are not investment related (like going to Coles), that is presumably ok, right? If they then make an additional payment to their non-deductible mortgage because they have more of their PAYG income available to them as a result of having dipped into their investment loan offset account, is that still ok?
We are at a stage in the game where there is a huge amount of ‘grey area” in what is and what is not allowed, in terms of finance structuring for investment property acquisition.
Structuring finance definitely is not a walk in the park.. With twists and turns that consist of regulations and grey area all over the shop it’s important to really understand how to best structure finance that’s custom to you and your financial situation. At W Financial we’re second to none when it comes to financing investment property and building successful portfolios. With over $500 million written in investor loans we know the landscape inside and out and would love to help you too.
Michelle Coleman is a first-rate mortgage strategist and mum, and she heads up the team at W Financial. She is without a doubt, a legend of the Australian mortgage broking industry, having achieved over $500M of settlements in her 12+ year career to date, and won numerous industry awards, including #3 MPA Top Broker. Michelle is also a highly experienced property investor. www.wfinancial.com.au
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Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.