How does a tax subsidy on investment loans work | Review of northern beaches
Borrowing to invest is a tax-efficient way to build up wealth.
We have a tax system that is unfavorable to saving because the tax office takes up to 47 percent of the interest you earn.
On the other hand, if you take out a loan to buy a property or shares, the tax authorities subsidize up to 47% of the interest; however, provided you keep the asset for at least a year, you pay capital gains tax at a maximum rate of 23.5 percent.
At first glance, the tax treatment is straightforward. If the purpose of the loan is to purchase income producing assets, the interest will be tax deductible.
A common question I get is: “suppose I move from my existing house to another house and rent the original house, can I take out a loan against the original house for the mortgage on the new one? and claim the interest as a tax deduction? ”
The answer is an unequivocal no, because the “purpose” of the loan is for private use – to buy a new house to live in – and it has nothing to do with the property used as collateral for the loan.
However, a loan can change character. The interest on your home loan will not be tax deductible as long as you live there, but if you leave the property and rent it out, then you can claim the interest and other expenses as a tax deduction and at the same time have to declare the rental income. as taxable income.
The cream on the cake is that you can then be away from that home for up to six years without losing the capital gains tax exemption – provided you do not claim any other property as your primary residence during that time. .
There is confusion about home loan accounts with a line of credit or a repurchase facility, and offsetting accounts. It is worth taking the time to understand them as they are very different animals and getting it wrong can be very expensive.
A compensation account is simply a savings account in which interest is deducted from your loan interest instead of paid to you as taxable income.
At any time, funds can be withdrawn from the clearing account without tax consequences. In contrast, every time you withdraw from a repurchase facility or line of credit, you are establishing a new loan.
Suppose a couple has a loan of $ 400,000 on their house and the goal is to eventually move to another house and rent the original.
Over the years, they have accumulated $ 350,000 in their compensation account, which means that they actually owe only $ 50,000 on their property. When they move out, they simply take the $ 350,000 out of the clearing account and use it as a deposit on the new home. This leaves them with a debt of $ 400,000 on the original property – now leased – and they can claim any interest on it as a tax deduction.
Their neighbors also had a loan of $ 400,000, but worked hard to reduce the debt to $ 50,000. If they move out, their debt on the currently leased property will be frozen at $ 50,000.
While they could withdraw funds from the original loan to buy their dream home, the interest will not be tax deductible. They will have a huge non-deductible debt on their new residence, as well as taxes on the rents of the original property.
An investment line of credit can be a particular trap if borrowers do not strictly separate their business and personal expenses. Unfortunately, far too many borrowers deposit their paychecks into the investment loan account and then withdraw funds each month to cover their day-to-day expenses.
They do not realize that the salary deposit is treated by the tax authorities as a final debt reduction, and each withdrawal as a new loan. Because the withdrawals are used for private purposes like paying for groceries, the loan very quickly loses its tax deductibility.
The lesson in all of this is that you need to keep your investment and private borrowing separate and still use a clearing account if you ever intend to rent a property that is currently being used as your own residence.
Noel answers your questions about money
My wife put extra money into her super account over a year ago, but submitted her late “Notice of Intent to Claim” and her fund indicated they couldn’t provide it to her. ‘acknowledgment of receipt because it can only accept notices for the current financial year or previous financial accounts. year. Is there an option to claim this deduction in the next fiscal year or is it too late?
I’m assuming your credit union refused to accept the “Notice of Intent to Claim” because the contribution may have been made before the start of the 2020-21 fiscal year. If this is the case, the fund cannot accept the notice of intention to claim because it is out of time.
The intention to claim must be notified to the fund and recognized before the first of the following events: Filing of the tax return for the contribution year, the end of the following financial year, or; before the rollover, withdrawal or start of an annuity.
Unfortunately, there is no discretion to allow a tax deduction in the following fiscal year, as the tax deduction can only be made in the fiscal year in which the contribution is made. I’m sorry to say it’s too late.
I am 66 years old with an income of $ 45,000. My wife is 59 and earns $ 50,000 a year. We want to sell investment property and should realize a capital gain of $ 200,000. How can we use super to avoid certain capital gains taxes?
If the capital gain is $ 200,000 and you have owned the asset for more than a year, you will be entitled to the 50% reduction, which means the taxable gain will be $ 100,000.
If the property is in common name, capital gains tax will be levied by adding $ 50,000 to the taxable income of each of you in the year the contract of sale is signed. You can alleviate part of this situation by paying personal contributions at preferential conditions to the retirement pension.
These are limited to a total of $ 27,500 per year, so any employer contribution should be taken into account when deciding how much contribution to pay. Be sure to contact your accountant, as catching up on super contributions can also be an option.
Can you tell me if I am authorized to open a superannuation account? I am 68 years old, retired and have not worked for many years – I receive a partial pension from Centrelink, which I want to hang on to.
My husband is the same age and also retired and receives the same Centrelink pension.
We have a vacation unit that we would like to sell and split the proceeds of about $ 400,000 between us. I want to maximize my investment when my husband needs more income.
Thanks for any suggestions you may have. All I know is there’s no point in putting it in the bank.
I have good news for you – provided the proposed legislation passes, you will be able to pay up to $ 330,000 in superannuation starting July 1 of next year as a non-concessional contribution.
The work test is abolished from July next year, except for people aged 67 to 74 who wish to make deductible personal super contributions.
This means that most people will be able to contribute to Super in one way or another until the age of 75, whether or not they are working.
The only limitation is that once you have $ 1.7 million in Super, you can no longer make any non-concessional contributions other than the special downsizing contribution which does not apply here.
Just be sure to check the capital gains tax consequences before signing a contract.
- Noel Whittaker is the author of Retirement Made Simple and many other books on personal finance. Email: [email protected]