Moving debt around

Question from Jeff updated on 12th September 2014:

We have one mortgage that is split in two. One part is for the home we live in and the other part is for our rental. Our rental is under a partnership structure and we have just completed our first tax return. Our rental has increased $43,000 in the last year and the bank are happy to bring this equity across to reduce the mortgage on the property we live in. My question is can we bring $43,000 across increasing the mortgage component on the rental and reducing the mortgage on our home tax free. Additionally, can we start claiming a higher loss from our rental as a result of increasing the mortgage amount by $43,000? What usually happens in these situation and what is the best approach?

Our expert Mark Withers responded:

Dear Jeff, it is likely that the bank will have cross collateral security over both properties for all the debt plus your personal guarantees so from a security point of view it is unlikely that much can be achieved by altering the mix as you suggest. From a tax perspective, deductibility of interest is determined by the use to which the borrowed money was put, so for interest to be deductible the borrowed money must have been used to fund the acquisition of the property that is producing taxable rental income. Your proposal to refinance more of the personal debt onto the rental property does not alter the use to which the money was put so does not give rise to the ability to deduct more interest. I do not see the refinancing exercise triggering any income tax liability though. It may be possible to restructure the overall arrangement to give better tax efficiency though, that would probably involve the creation of an entity that debt funds the acquisition of the rental property so that you free up capital to repay the personal debt. Any restructure like this must be undertaken only after seeking professional advice as it must not constitute tax avoidance, a topic which is keeping IRD particularly exercised at present.

Mark Withers and his team at Withers Tsang & Co specialise in advising on property related transactions, valuation and restructure services and tax planning.

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