Making the most of debt?
Question from Margot updated on 5th March 2014:
We have to move for three years and consequently intend to turn our owner occupied home into a rental property for that period of time. Our question is how to make the most out of our current loan structure? We have a principle and interest loan with a revolving credit portion which is interest only and allows us to repay and redraw whenever we like. We have to date keep all of our savings in the revolving credit portion to minimise the interest payments. Now we would like to redraw this money and put it towards a new owner occupied home in our new location. Can we withdraw our savings, returning the revolving credit portion back to its full limit and be able to claim the interest charged on that full limit as an expense against the original property which is now rented?
Our expert Mark Withers responded:
At the point where the home becomes an income earning asset the revenue costs associated with deriving income will become deductible, this will include interest on any debt that funded the acquisition of the property.
Moving forward though, the revolving credit facility, when used as a saving tool as you are may in fact not be tax efficient. This is because each time you reduce the debt you are seen to have made a standalone reduction in the loan balance of the deductible debt. If funds are reborrowed for a private or domestic purpose the interest on these redrawn amounts is technically non deductible. At a practical level it can become very difficult to actually determine what portion of the debt incurs interest that is deductible and what is private when this activity is the norm.
It may be better to alter the way you save to plan to reduce the revolving credit loan with sums that you can afford to leave in the revolving credit without the need to redraw i.e pay your costs out of your monthly income and then make a permanent reduction with what you can actually afford to save. The extra interest you incur will be very minor an any event. The reality of most revolving credits is that they are drawn to their limits all the time and people just can’t apply the necessary discipline to actually use them effectively as a debt reduction tool. It’s all too easy just to use the available credit and the balance often grows rather than falls. This may not be the case for you but it is for many.
Mark Withers and his team at Withers Tsang & Co specialise in advising on property related transactions, valuation and restructure services and tax planning.