Making Interest Tax Deductible

[bellenuit]

I have a situation where I am about to do some renovations to my home (PPOR) that will require about $100K to fund. Even though I have a large share portfolio that if partly liquidated could fund the $100K, I want to keep the shareholding intact and borrow the money required for the renovations. However, if the purpose of the loan is not for investment, the loan interest would not be tax deductible.

Although in principle I believe that following is an acceptable way to fund the renovations whilst maintaining my shareholding and still be able to claim a tax deduction on loan interest, I am not sure if the mechanics of what I am doing would be acceptable to the tax office.

I use a CommSec Cash Account (CCA) for settling my share sales and purchases. I plan to open a line of credit (LOC) with a lender that allows me to borrow up to $100K say. When a bill comes through from the builder, I plan to sell some shareholding I have (preferably one that is in the red to avoid CGT) that realises approximately the amount owed to the builder. More or less at the same time I buy back the same shareholding to maintain my same position in that company. I then transfer from my LOC an amount exactly equal to the purchase cost to the CCA.

When settlement occurs T+3, there will be sufficient funds in the CCA to meet the purchase and once the share sale settles, I will have sufficient funds to pay the builder's bill directly from the CCA.

Now since the purpose of my drawdown on the LOC was to buy shares, I would assume that the interest on it is tax deductible. The builder was paid using the proceeds of a share sale, not from the LOC. However, having everything flow through the CommSec Cash Account creates perhaps some ambiguity that the ATO might disprove of. For instance, even though the transfer from the LOC to the CCA was for exactly the amount of the purchase transaction, once in the CCA it gets mixed up with whatever funds may be sitting in the CCA at the time (dividend payments, proceeds from unrelated sales etc.). When the purchase transaction settles, could the ATO simple say that the purchase was satisfied by other funds that may be in the CCA and thus the LOC drawdown was simply transferring funds between accounts and not related to the share purchase?

If the above process is acceptable, it would seem a tax friendly way of being able to borrow to fund a non-investment expense so long as one has an equivalent amount tied up in non-geared share investments.

 

[drsmith]

I use a CommSec Cash Account (CCA) for settling my share sales and purchases. I plan to open a line of credit (LOC) with a lender that allows me to borrow up to $100K say. When a bill comes through from the builder, I plan to sell some shareholding I have (preferably one that is in the red to avoid CGT) that realises approximately the amount owed to the builder. More or less at the same time I buy back the same shareholding to maintain my same position in that company. I then transfer from my LOC an amount exactly equal to the purchase cost to the CCA.

That to me reads a lot like a wash sale which the ATO now frowns upon.

http://law.ato.gov.au/atolaw/view.htm?Docid=TPA/TA20087/NAT/ATO/00001

 

[gordon2007]

I have a situation where I am about to do some renovations to my home (PPOR) that will require about $100K to fund. Even though I have a large share portfolio that if partly liquidated could fund the $100K, I want to keep the shareholding intact and borrow the money required for the renovations. However, if the purpose of the loan is not for investment, the loan interest would not be tax deductible.

Apologies in advance for sounding a bit too righteous, but sounds to me as though you want your cake and eat it too. If you can partly liquidate then do so? Why try and do dodgy tax maths just to save a few dollars and get yourself in potential trouble?

Just sounds to me you're asking advice on how to cheat the tax system.

 

[bellenuit]

Apologies in advance for sounding a bit too righteous, but sounds to me as though you want your cake and eat it too. If you can partly liquidate then do so? Why try and do dodgy tax maths just to save a few dollars and get yourself in potential trouble?

Just sounds to me you're asking advice on how to cheat the tax system.

The intention is not to cheat the system, but to reduce tax. In principle it is all above board, as for example....

I take out a loan of $100K and buy $100K of shares, that match part of my existing holding. There can be no issue with that, as it is just gearing to buy shares and the interest is tax deductible.

I then sell some of my existing shares that match roughly what I bought. Again, that is completely legit. I now have approximately $100K in cash and a loan of $100K whose interest is tax deductible.

When I receive the builder's bills, I pay them from the cash.

What I am trying to do is in principle exactly the same as these three steps, except I want to do it piecemeal as the builder's bills come in. What I am trying to ascertain is whether anyone has done something similar to what I am proposing, but ran foul of the ATO because of possible ambiguity in the source of the funds to purchase the shares because of everything going through the CCA account.

Because the interest I pay on the LOC is higher than interest I receive from having cash sitting in a savings account, it is obviously better to do it piecemeal as funds are needed to pay the bills than to do it upfront.

Regarding DRSMITH's suggestion that it may be seen as a wash transaction by the ATO, I thought wash transactions only applied to sales made just before the end of tax year and immediately purchased in the next tax year, but I may be wrong.

My intention of selling stocks that may be in the red is not so much to avoid CGT, but large CGT gains realised might negate any advantage of the savings I might make.

 

[Junior]

The intention is not to cheat the system, but to reduce tax. In principle it is all above board, as for example....

I take out a loan of $100K and buy $100K of shares, that match part of my existing holding. There can be no issue with that, as it is just gearing to buy shares and the interest is tax deductible.

I then sell some of my existing shares that match roughly what I bought. Again, that is completely legit. I now have approximately $100K in cash and a loan of $100K whose interest is tax deductible.

When I receive the builder's bills, I pay them from the cash.

What I am trying to do is in principle exactly the same as these three steps, except I want to do it piecemeal as the builder's bills come in. What I am trying to ascertain is whether anyone has done something similar to what I am proposing, but ran foul of the ATO because of possible ambiguity in the source of the funds to purchase the shares because of everything going through the CCA account.

Because the interest I pay on the LOC is higher than interest I receive from having cash sitting in a savings account, it is obviously better to do it piecemeal as funds are needed to pay the bills than to do it upfront.

Regarding DRSMITH's suggestion that it may be seen as a wash transaction by the ATO, I thought wash transactions only applied to sales made just before the end of tax year and immediately purchased in the next tax year, but I may be wrong.

My intention of selling stocks that may be in the red is not so much to avoid CGT, but large CGT gains realised might negate any advantage of the savings I might make.

Sounds like a bad idea to me. If you don't want trouble the share portfolio should be kept completely separate from you other assets.

A separate line of credit should be used for the reno's.

 

[skc]

bellenuit - I actually think the idea is good and there is nothing wrong in principle from my point of view. I would have done the same in your shoes. Of course I am not the ATO so who knows how they will view it.

There might be a few things you may consider to make it clearer on what you are doing.

E.g.

- Sell the shares earlier before the builder's bill
- Buy back shares that are different to what you've sold (if possible). E.g. if you have some CBA, buying back ANZ might not make a huge difference to your portfolio's risk and performance, but negate the chance of being accused of a wash sale.
- Pay the builder from a different account.

It would be foolish to not reduce your tax bill when you have equity invested in shares and a non tax-deductible loan.

 

[bellenuit]

bellenuit - I actually think the idea is good and there is nothing wrong in principle from my point of view. I would have done the same in your shoes. Of course I am not the ATO so who knows how they will view it.

There might be a few things you may consider to make it clearer on what you are doing.

E.g.

- Sell the shares earlier before the builder's bill
- Buy back shares that are different to what you've sold (if possible). E.g. if you have some CBA, buying back ANZ might not make a huge difference to your portfolio's risk and performance, but negate the chance of being accused of a wash sale.
- Pay the builder from a different account.

It would be foolish to not reduce your tax bill when you have equity invested in shares and a non tax-deductible loan.

SKC,

I agree. Probably better to play it safe and remove any source of ambiguity.

JUNIOR

Yes, I agree that assets shouldn't be mixed and the LOC in my case is used for share purchases only (the builder is paid in cash). However, the CCA account is the one that could cause the problem as all transactions flow through there and the ATO may question the intent of the money flow.

It probably means setting up some new accounts, but it will be safer to keep things clean as SKC said.

 

[DocK]

Had you considered taking out a margin loan instead of a LOC? That way share sale proceeds could be directed to the CCA (and then used to pay for renovations) but share purchases would be made via the margin loan - keeping the transactions more separate while still allowing the interest paid on the margin loan to be tax-deductable. Int rate would be a little higher I suppose, but it may be worth paying slightly more for the sake of clarity.

 

[bellenuit]

Had you considered taking out a margin loan instead of a LOC? That way share sale proceeds could be directed to the CCA (and then used to pay for renovations) but share purchases would be made via the margin loan - keeping the transactions more separate while still allowing the interest paid on the margin loan to be tax-deductable. Int rate would be a little higher I suppose, but it may be worth paying slightly more for the sake of clarity.

DocK.

Yes, I have considered a margin loan, but the higher interest rate makes it less attractive. I also think transaction costs to buy shares are higher (at least with CommSec, when I last checked their Ts & Cs).

 

[drsmith]

Regarding DRSMITH's suggestion that it may be seen as a wash transaction by the ATO, I thought wash transactions only applied to sales made just before the end of tax year and immediately purchased in the next tax year, but I may be wrong.

I refer to the following section in the linked ATO information above.

3. Reinstatement of the taxpayer's interest is commonly achieved by a taxpayer selling a CGT asset and creating a trust over the asset or transferring an asset to a trust. We are concerned where this is done with the sole or dominant purpose of generating a capital or revenue loss to offset against a capital gain or assessable income when in substance there is an intention to acquire the same or substantially the same asset or the taxpayer still benefits from the asset.

In bold is how I suspect the ATO would see it.

 

[choice1]

As with anything with the ATO just make sure you keep detailed documentation with reasons for selling each stock. Buying back stocks in the same sector like SKC mentioned is a great way to do this.

EG. ANZ under performing, commbank offering a higher yield. Sold ANZ xx/xx/xx purchase commbank at price $xx.xx etc.

Having a reason for using a line of credit that isn't just to lower your tax bill is probably useful too. Maybe write something about freeing up working capital by gearing your portfolio.

 

[drsmith]

Having a reason for using a line of credit that isn't just to lower your tax bill is probably useful too. Maybe write something about freeing up working capital by gearing your portfolio.

That's unlikely to cut it with the ATO if that working capital is then directed towards private expenditure or anything that does not have the prospect of earning an income for that matter.

No one can blame people for wanting to minimise tax. Kerry Packer would be turning in his grave if people didn't. Rulings such as TA 2008/7 however make it difficult for the taxpayer as there are not strict boundaries, just grey areas subject to interpretation. It is therefore important to consider the ATO's perspective on any argument to be put forward.

This whole discussion is another illustration that our tax system is just too complex and in need of major simplification. In the past I have advocated the elimination of deductions from salary income and marginal rates reduced. This example perhaps illustrates that for individuals, only costs that directly relate to an investment should be claimable against tax and as such should exclude borrowing costs. Perhaps in exchange, individuals could be exempt from capital gains tax. That would simplify things significantly and individuals could then consider investment more on investment merit rather than tax minimisation.