Tax matters Part 1 – People, partners & your property investment
Given that tax time is literally right around the corner, I thought it would be fitting to cover some details about what property investors can and cannot claim when it comes to their borrowing costs.
This can be quite a complex area to navigate and will depend on a number of things, including the ownership and financial structure in which you hold your investments, and the usual things like which income tax bracket you fit into.
I’ll be reviewing your borrowing tax considerations as a property investor over a three part series to make it easier to digest and (hopefully) refrain from the dry accounting speak that will send you to sleep in front of your screen! So let’s start by talking people, partners and the property in question.
Applicants don’t matter
If investing within a family unit, such as a husband and wife, whether the loan is in one name or both will generally have no bearing on who is entitled to the associated tax deductions against the loan, as long as your banking is structured correctly.
In a marital situation such as this, the major determining factor regarding deductibility from the Australian Taxation Office’s (ATO’s) perspective is who owns the asset in question (whose name is on the title).
For example, if the investment property is in the husband’s name but the loan is in joint names, the husband should still be entitled to 100% of the tax deduction. This is because the ATO is open to the fact that the husband and wife are joint applicants on the loan and have therefore borrowed 50% each. The husband obviously uses his 50% for the purchase (in his name) and the wife on-lends her 50% to the husband and charges him the same rate that the bank is charging her.
While this has the theoretical effect of creating a taxable income for the wife from the interest she charges her husband, she is entitled to a tax deduction for the same amount of interest paid to the bank for her share of the loan, thereby offsetting that income. Therefore, the result to her is zero in terms of a taxable income or profit and the deduction is shifted entirely into the husband’s name.
Essentially, this means that if you have two parties entering into a loan, particularly in a marital relationship, the ATO is rarely concerned about whose name the loan is in. Given that it’s often easier to apply in in joint names, as most lenders require the extra security of two incomes for approval, this is a good tip to be aware of.
But you must do two important things
You should do two things to ensure you don’t get any questions from the ATO. First, referring to the above example, the loan repayments should be made from a bank account that is solely in the husband’s name (i.e. the sole owner of the investment).
Second, you should document (on one page) the arrangement you are entering into with your spouse or family member (that is, one person is on-lending 50% of the debt to the other spouse on the same bank terms, so they can buy 100% of the investment).
There are two alternatives for investors to consider when buying a property in one party’s name, even though they require both incomes for the loan. They can have the loan in joint names as outlined above, which is reasonably clean and clear; or they can set up 100% of the loan in the property owner’s name (either husband or wife) and their spouse can provide a personal guarantee.
This latter arrangement is completely acceptable and some accountants will even advise clients to do this, but the downside is that there can be extra costs such as guarantor fees, and lenders will often want the person acting as guarantor to seek independent legal advice, which can be another costly expense.
If the applicants are not in a relationship, such as two mates pairing up to be ‘investing buddies’ with the understanding that only one party will have their name on the property title, this needs to be approached carefully. In this circumstance, I would prefer to see the owner being the sole applicant to the loan. In addition, I would prefer to see the loan split in two.
Loan purpose is paramount
Ultimately, the biggest determiner of whether interest on a loan is tax deductible is the purpose for which the loan funds are used. This is what the ATO looks at first. If the item being financed is used for a purpose which has a direct relationship with earning assessable income, then any interest charge in respect to the loan used to finance that item will be tax deductible.
That’s the first question they ask, followed by who owns the asset, which determines the eligible party who can claim the deduction. In other words if you establish a loan to buy an investment property, which earns an assessable income, and the husband owns 100% of that investment property, then the husband is 100% entitled to a deduction.
Security doesn’t matter
The property used as security for a loan will have no bearing on the loan’s tax treatment. For example, you can establish an investment loan for $300,000 to fund the purchase of an investment property and use your home as sole security for the new $300,000 loan. In this case, the interest on the loan will be tax deductible as the purpose for the loan is ‘investment’. So essentially, the loan purpose matters but security doesn’t.
Buying & borrowing costs – the good news
The good news is that pretty much all borrowing costs are tax deductible. Any costs under $100 are deductible in the year that they’re incurred and any costs over $100 are deductible equally over the term of the loan or five years, whichever is less.
As most mortgage terms are longer than five years, generally the borrowing costs are deductible over the first five years of the loan.
Deductible costs can include expenses at time of purchase such as application fees, title search fees, lender’s legal fees, valuations, mortgage insurance, mortgage stamp duty (doesn’t exist much these days), loan repayment insurance, settlement fees, security or guarantee fees – basically any third party fees that are payable upfront, whether government or bank charges.
Understanding the full range of legitimate tax deductions available to you as a property investor is critical, as a healthy refund at the end of each financial year can certainly assist with that all important cashflow.
For this reason, make sure you consult a professional accountant who is experienced in property investment, tax related matters. It could make a world of difference to your bottom line…and it’s a deductible expense after all!
For more information on how you can manage and maximise your proper investment debt and maintain your cashflow, click here to contact us, or subscribe to receive regular post updates and industry insights.
Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: firstname.lastname@example.org
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