Lending restructures
Question from Jimmy updated on 22nd July 2019:
We have recently been approved finance to buy our new home - based on the LVR's of our two rentals, our own home and the new home. We planned to sell the home in which we currently live which is almost mortgage free and pay down most of the mortgage on the new home.
However, we have been toying with the idea of keeping the current home as our third rental. Should we: a) set up a LTC to buy the property or b) discuss with the bank a restructure of the lending so that we put most of the lending back onto the new third rental, thereby lowering our mortgage and being able to deduct interest on the rental as an expense against income. Or would this be seen as tax avoidance?
Our expert Matthew Gilligan responded:
A taxpayer’s ability to deduct interest hinges on the purpose they use the money for – ie: the focus is not on what properties your lender holds as security, but on who (or what entity) is borrowing the money and what for.
Let’s consider your second scenario first. If you personally borrow the new funds and secure as much as possible against your existing home (to be rental), but continue to hold that property personally, you will not be able to claim the interest on the new borrowing as deductible. This is because when you personally borrow that money you will not be borrowing it to buy a rental – you already personally own it. The fact that the borrowing is secured against the existing home does not alter the fact the money is not used to buy a rental.
However, if your existing home is sold to an LTC, there is an opportunity for the LTC to borrow money to buy the property from you. This generates a different tax position. The LTC can be seen as borrowing money to buy a rental. Accordingly, interest can be claimed by the LTC on the funds it borrows. So your first option of setting up an LTC and moving the property into it is likely to be the more attractive tax-wise.
However, there are potential tax consequences of selling property into new entities. Seek specific advice before proceeding with this transaction.
Matthew heads GRA's specialist property and asset planning division. He helps clients create optimal tax structures and build wealth through property. He has an extensive buy-to-hold property portfolio, is currently involved in over a dozen developments, and is author of two books - Property 101 and Tax Structures 101.
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