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How can you tax deduct your home loan?
Tax Deduct Your Home Loan
If you have an offset account and use the equity in your home for investment purposes, you should be able to claim a tax deduction. Right? Don’t worry if you answered Yes. We did as well. Until this interview with Geoff Stein of Brown Wright Stein Lawyers in Sydney.
Here is what we learned but please listen in as Geoff explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Tax Deduct Your Home Loan
It is a very common conversation all over Australia. You call your banker because You finally paid off your home loan – your offset account equals your mortgage account – and so you call your banker to close it. And what will your banker most likely say?
“Keep the offset account and mortgage as is. You might want to buy an investment property and then you already have your financing in place. Just withdraw the funds from your offset account when you are ready.”
And you might think that – since you use the funds in your offset account for investment purposes – you can tax deduct your home loan. That’s what we thought as well. But wrong.
Solution
Let’s start with the solution. Because almost all scenarios we go through below result in that you can’t tax deduct your home loan. And you can’t because the mortgage was originally set up for a private purpose.
But there are two ways out.
The first one is to pay off your mortgage and then to redraw again from the same mortgage, still with your home as security, but the redraw is now for an investment purpose. Then you can tax deduct the interest
The second option is to split your current mortgage and allocate one part to your home and one part to your investment asset. You can now tax deduct the interest, but only the portion for your investment asset.
You could also leave your mortgage as is and get a separate investment loan – possibly with your home in the asset pool held for security – and then you can tax deduct the interest for the investment loan as well.
So this is the solution. But here are the scenarios we went through – most to non avail.
1 A – Use Full Offset Account To Invest
Let’s say your mortgage is $3m and you have $3m in your offset account. So fully paid off. No interest. Now you withdraw the $3m to buy an investment asset. Can you tax deduct the interest?
You can’t, because offset and mortgage are two separate accounts. The offset account is a savings account. And the mortgage is – well – a mortgage. And your mortgage was set up to finance your home, so no tax deduction available, even if you use your offset to invest.
1 B – Use Part of Offset Account To Invest
Same as before, but now your offset account is only $2m. You withdraw $2m to buy an investment asset. Can you tax deduct the interest?
The answer is still no. Same reasoning as before.
2 – Use Offset Account To Buy a New Home
As before, both the mortgage and offset account are $3m, so the balance is nil. You withdraw $3m to buy a new main residence and rent out your old home. Can you tax deduct the interest?
No you can’t. For the same reason as before. The purpose of the mortgage was to buy a family home and that is not tax-deductible.
3 – Use Offset Account + Investment Loan To Invest
Mortgage is $3m. You withdraw $2m from your offset, get a $3m investment loan and invest it in a $5m investment asset. Can you tax deduct the interest?
You can tax deduct the interest on the investment loan, but not the interest on the mortgage.
4 – Same But Use Investment Loan To Repay Mortgage
Same as before, but now you use the investment income to repay your private mortgage. Can you tax deduct the interest?
The conservative view is that you can’t tax deduct the investment loan interest if you don’t use the proportionate proceeds to pay off the investment loan. The more progressive view is that you can. No clear guidance here at the moment from the ATO.
5 – Same But Sell Part of Investment Asset To Repay Mortgage
Same as in 3, but you subdivide the investment property, sell a section and use the sales proceeds to repay the $2m ‘private’ loan. Can you tax deduct all interest?
Same issue as before. The conservative view would be that you have to use the sales proceeds proportionally to pay off the investment loan.
6 – Use Offset Account + Super To Invest
You withdraw $3m from your offset account and buy a $4m asset together with your SMSF, so you own ¾ of the asset and your SMSF 1/4. Can you tax deduct the interest outside of super?
Yes you can, provided that your withdrawal from the offset account is as a split loan or as a redraw from your mortgage. It doesn’t matter who you invest with. It can be your SMSF, your best friend or your next door neighbour. It is still an investment.
7 – Use Offset Account To Invest and Sell to SMSF
You withdraw $3m and buy a $3m asset. You contribute the investment income into super and the SMSF uses those contributions to buy part of this asset over time. Can you tax deduct the interest outside of super?
When you originally invested the money through a split loan, redraw or investment loan, you borrowed to invest. Then you are entitled to a deduction on the interest. No issue at that point in time.
But when you use the investment income to contribute to super rather than repaying the loan, then you need to call the purpose of the loan into question. If you can trace the purpose back to the investment, the interest is deductible. Otherwise not.
To avoid any issues. Wait until the investment loan is paid off and then sell or in-specie contribute the asset into super.
8 – Use Offset To Invest And In-Specie Contribute to SMSF
Same as scenario 7, but instead you in-specie contribute parts of the asset each year. Can you tax deduct the interest outside of super?
Same as before. It all depends on the purpose of your borrowing.
9 – Use Offset To Contribute To Super and SMSF Buys Asset
You withdraw $1m over 8 years ($125,000 each year) and contribute to super. Your SMSF buys a $1m asset. Can you tax deduct the interest outside of super?
No you can’t. The purpose of the borrowing is to make a contribution to super. And that is a private purpose, hence non deductible.
10 – You Move Interstate + Rent Out Your Home
You move interstate, leave the mortgage as is, claim the 6-year absence rule for CGT purposes and rent out your home. Can you now tax deduct the interest?
No tax deduction. The mortgage was originally set up for a private purpose. Your temporarily renting out your home doesn’t change that.
11 – Move Cash From Investment Offset To Business Account
No issue. As long as none of this money touches any private loans, you can move money around between investment and business loans as you see fit.
Side Questions
During the interview we also touched on quite a few side questions.
A – Concessional Or Non-Concessional In-Specie
Can an in-specie contribution be partly concessional and partly non-concessional? Or is it always non-concessional?
When you are making an in-specie contribution it doesn’t matter whether it is a concessional or non-concessional contribution, as long as you stay below the caps. Just make sure you comply with the rules for in-specie contributions.
Any in-specie contributions of property would trigger capital gains tax for the seller. The SMSF receives the asset with the sales price (current market value) as new cost base.
B – Stamp Duty for In-Specie
Does the in-specie contribution of an asset (held in individual names) into an SMSF (to the owner’s member account) incur stamp duty in NSW?
If you transfer real property, there is ordinarily a stamp duty liability. In NSW there is no exemption but the duty is a fixed amount which is $500 where you can show that a superfund has allocated that asset to the member who transferred it.
C – Stamp Duty for Subdivision
Is there stamp duty in NSW when an apartment block is subdivided into individual apartments?
Assuming that you have one owner, then the subdivision doesn’t trigger stamp duty.
If you got two or more owners, the subdivision itself does not create a stamp duty event as long as the proportion of ownership doesn’t change.
Let’s say you have subdivided an apartment block into 6 apartments and the two owners want to take 3 apartments each. If the apartments have the same value, then there is no stamp duty event. If there is a difference in value, then you pay stamp duty on the difference in value.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 15 March 2021
Tax Talks spoke to Geoff Stein - Partner at Brown Wright Stein Lawyers - for more details.
