We received a query from a client last month proposing a strategy involving his investment property and associated offset account.
Currently, his investment property loan is “interest-only” and he deposits the rent into his loan account.
He then transfers the rent to the investment loan offset account to pay the interest, before transferring the balance back to the loan account.
There is nothing wrong with this strategy up until the last step of transferring the balance back to the home loan account.
The problem is that this action doesn’t actually recreate a tax deduction.
The drawing of the funds from the loan to and subsequent depositing into the offset account is considered “borrowing for private purposes” because it is going to be mixed with private funds.
For example, let’s say you owe $250,000 on a rental property loan and the interest for the month was $1,500. If you were to deposit the $1,500 bringing your outstanding balance back down to $250,000 then draw the $1,500 back out you, will owe $251,500 on that loan – $250,000 will be for a deductible purpose and the $1,500 will be non-deductible.
Then when next month’s interest bill comes, 1,500/250,000 of the interest will not be tax deductible.
The next $1,500 you pay into the loan cannot be applied solely to the non-deductible $1,500 portion as it must be apportioned between the deductible and non-deductible portions. These principles are clearly set out in Taxation Ruling 2000/2.
An alternative is to deposit the rent in the offset account until it is needed to pay the interest.
If you would like to discuss the tax implications of any proposed “interest saving strategies”, please contact Ellingsen Partners.