Borrowing for investment a hot topic
IF the volume of emails is any guide, borrowing for investment is a hot topic with readers. And so it should be. After all, we have a tax system that is biased against saving because the tax office takes up to 46.5% of the interest you earn on money in the bank.
On the other hand, if you take out a loan to buy property or shares, the tax office subsidises up to 46.5% of the interest; yet provided you keep the asset for at least a year, you pay capital gains tax at a maximum rate of 23.25%.
On the face of it, the tax treatment is simple. Provided the purpose of the loan is to buy income-producing assets, the interest will be tax deductible.
The most common question I am asked is “suppose I upgrade from my existing home to another home, and rent out the original one, can I take a loan against the original home 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 home to live in - and that has nothing to do with the property being used as security for the loan.
However, a loan can change character. The interest on your home loan will not be tax deductible while you are living in it, but if you vacate the property and rent it out, you can then claim interest and other outgoings as a tax deduction and at the same time will have to declare the rental income as taxable income.
The cream on the cake is that you can then be absent from that home for up to six years without losing the capital gains tax exemption provided you don’t claim any other property as your principal residence in that time.
There can also be traps if you are using line of credit loans. I will discuss these in detail next week.
Noel Whittaker is a director of Whittaker Macnaught Pty Ltd. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. His email is firstname.lastname@example.org.
Question: My son missed paying $262.03 out of a total of $16,456.21 on his credit card in January and we didn't realize it until the February statement came. We thought he would get charged interest on the late payment of $262.03 only, but he was charged on the full amount for that month. Is that is the usual way that it is done?
Answer: Unfortunately a missed payment of only a few dollars can result in heavy interest penalties and the unfairness of this has been the topic of many articles in recent years. If he has been a good payer in the past, I suggest he contact his bank and ask them to waive the payment in this case. They will usually come to the party.
Question: After 1 July 2009 if I withdraw money from super is it assessed as income to qualify for the super co-contribution?
Answer: To qualify for the co-contribution you must have income from personal exertion. Obviously, withdrawals from super do not qualify.
Question: I am 24 years of age. I live in a unit valued at $300,000 on which I owe about $60,000. I have $15,000 in a managed fund - CFS Geared Australian shares. I have $8,000 in savings and I earn $53,000 a year. I was thinking I might put the $8,000 in the managed fund.. What do you think?
Answer: The basic idea is sound as long as you are aware you should not be placing money into share based investments unless you have at least a five to ten year timeframe in mind. The other issue is to try to maximise your deductible debt while minimising your non deductible debt. This is why a better option may be to pay the $8,000 off your home loan and then borrow for investment. If you do this by way of a home equity loan you should never have to worry about margin calls.