Property Investment - Competent - 500 Words - Reading Time 4 Minutes
When you own a rental
property you will want to take advantage of the help you get from the tax
deductions associated with negative gearing. And one of the biggest expenses to
claim as a tax deduction is the interest on the property. However, over the years,
I have seen a lot of investors get the structure and use of their loan wrong
and as a result they end up with a loan and a big
In my current blogs, I
will explain some of these mistakes so you can ensure that you can avoid them
and get the maximum tax advantage on your investment property. It is important
to understand that it is how you use the proceeds of the loan that determines
the tax deductibility. Keep this principal in mind and it will help you keep
your loan interest deductible.
Mistake No 2 - Paying down the loan and then redrawing.
Just like the first mistake I highlighted recently, this
relates to the use of the money. Let’s look at an example.
John has a rental property and the loan on the property has
a balance of $300,000. All the interest on this loan is tax deductible as it
was used to buy a rental property. John receives an inheritance, but is not
sure what he wants to do with the money. While he is deciding, he pays $100,000
off the rental property loan to reduce his interest bill. The loan balance is
now $200,000 and all the interest is still tax deductible.
Shortly after, John sees a nice boat he would like to buy.
So he redraws $100,000 from the rental property loan to buy the boat. The loan
balance is now back up to $300,000. However, from now on only the interest on
the $200,000 will be deductible, as the other $100,000 has been used for a
private purpose - to buy a boat. From now on only two thirds of the interest
will be tax deductible.
How to avoid this outcome - and still save the interest on
the loan:
Once you have paid money off the loan, it is really
difficult to correct this situation. However, with some forward planning, John
could have saved the interest on $100,000 of the loan without impacting on the
tax deductibility of the interest. He could do this by opening an offset account
with the bank.
An offset account, is a separate bank account set up in such
a way that the bank will offset the balance of the account with the balance in
your loan account and just charge you the interest on the difference. In John's
case, he would still have a loan of $300,000 and an offset account with
$100,000 in it. The bank only charges interest on the difference - being
$200,000. However, when John takes the $100,000 out to buy his boat, he takes
it out of the offset account and does not change the loan balance of $300,000.
From then on the bank will start charging interest on the full $300,000 again,
- but this time it will all be tax deductible.
