Lending Restructuring

[thefox001]

I need some help from the experts here please! At the moment I have 3 investment properties and a property that is my home. Each of these has some degree of lending associated with it. All are just owned in my name (no company/trust structures). Here is a rough summary of my position:

	Value		Lending
Investment Property 1	$400,000		$100,000
Investment Property 2	$400,000		$310,000
Investment Property 3	$400,000		$268,000
Home	$500,000		$250,000
	$1,700,000		$928,000

IPs are interest only, home is I+P. At the moment I claim a tax deduction on the interest associated with the IPs. My lending is all coming off fixed term soon, and what I want to know is if I can re-structure my lending so that all of the lending is attributed to the IPs, so that it all becomes tax deductible. For example, keeping my total lending the same, could I say that my portfolio was actually like this for a tax perspective?
What would the IRD think of this?

	Value		Lending
Investment Property 1	$400,000		$309,333
Investment Property 2	$400,000		$309,333
Investment Property 3	$400,000		$309,333
Home	$500,000		$0
	$1,700,000		$928,000

[fuzzlevalve]

The answer is yes you probably can but only your accountant can advise as your position is unique, just like everyone else. Rosco or anthonyacat on here could both help you.

[Rosco]

Hi the fox001,

A restructure is possible, but you need to go through it fully with an expert to see worthwhile or not. Things to consider

1) Are any of the rentals caught by 2 year brightline?
2) If you restructure, then all rentals would be under 5 year brightline - so if you were looking to sell, it probably wouldn't make sense
3) Is there a commercial and feasible reason for the restructure, rather than just tax minimisation? Being too clever isn't always a good thing
4) What would the costs of the new structure, and ongoing costs be, compared to the benefit? With the likely new ring fencing rules, it mayb not be worthwhile!

Ross

[Bob Kane]

Is this one of the disadvantages of owning the IPs in your own name?
If the IPs were in a company and ran at a loss then you could use the company current account to 'move' the home mortgage to the company and become deductible.

[Anthonyacat]

Is this one of the disadvantages of owning the IPs in your own name?
If the IPs were in a company and ran at a loss then you could use the company current account to 'move' the home mortgage to the company and become deductible.

Bob"s hit the nail on the head here. If these were initially bought in a company, there would be a shareholder loan that could be repaid by further company borrowing, then used to pay off the private mortgage.

With the situation as it is, I have nothing further to add to what Ross has said above, but am happy to discuss the situation via email if you so desire.

[thefox001]

Thanks all for your responses.

[murraythompson]

Hi everyone

Just wanted to add a little bit that has been missed out from the post so far...

Yes, you could move all the borrowings to a company and as a company, there is a section in the Income Tax Act that says all interest in a company is deductible.

However (and it is a big however), the accounting entry that would need to be done could make your shareholder Current Account in Debit. The shareholder Current Account is the loan from the shareholder to the company. Normally it would be in Credit, but the process of transferring a private house (with the attached borrowing) would increase your drawings. If you have a Debit Balance, you then need to charge yourself interest on a debit current account balance, which would negate any extra interest deductions.

With the figures you give in the above situation, you may still have a credit current account balance (which is great), but the houses now belong to the company. Any capital gains can't be paid out as a tax-free dividend to you (unless you already have a qualifying company setup). The company would have to be wound up to get any profits on sale tax-free.

And as someone has pointed out, transferring it into a company would be a change in title. There is now an automatic 5 year period that any gains would be income from the date that you do the transfers.

If you were to keep it in your own name - sorry - the purpose of the borrowings is look at. So, the interest on your home is not deductible. Best advice - pay off your own mortgage first (if you can afford larger repayments), then focus on the rental property mortgages.

[kipkip]

Hi Ross,

Just want to understand more re point 4 - why would the new ring fencing rules could make it not worthwhile?

[Bob Kane]

If you have a Debit Balance, you then need to charge yourself interest on a debit current account balance, which would negate any extra interest deductions.

Do you?
Could you expand on this please?

[Anthonyacat]

Do you?
Could you expand on this please?

A shareholder current account in a regular (not LTC) company should always remain in credit if at all possible. If it's overdrawn, this is a loan from the company to the shareholder, and interest must be charged at IRD prescribed rates - currently I think 5.77%, but a decade ago it was over 10%. This interest is taxable to the company, and generally non-deductible to the shareholder. And it compounds pretty fast.

EDIT: Went looking for a link to a reference from IRD or the Income Tax Act, but it's late and I'm tired. Pretty sure it's part of the FBT rules.

[Bob Kane]

Thanks Anthony.
And that doesn't apply to a LTC?

[Anthonyacat]

Thanks Anthony.
And that doesn't apply to a LTC?

Yes, LTCs are considered transparent for tax purposes, so it can't charge the shareholder interest. There are however still downsides of overdrawn current accounts for an LTC in terms of loss limitation.

[Rosco]

Hi everyone

Just wanted to add a little bit that has been missed out from the post so far...

Yes, you could move all the borrowings to a company and as a company, there is a section in the Income Tax Act that says all interest in a company is deductible.

However (and it is a big however), the accounting entry that would need to be done could make your shareholder Current Account in Debit. The shareholder Current Account is the loan from the shareholder to the company. Normally it would be in Credit, but the process of transferring a private house (with the attached borrowing) would increase your drawings. If you have a Debit Balance, you then need to charge yourself interest on a debit current account balance, which would negate any extra interest deductions.

With the figures you give in the above situation, you may still have a credit current account balance (which is great), but the houses now belong to the company. Any capital gains can't be paid out as a tax-free dividend to you (unless you already have a qualifying company setup). The company would have to be wound up to get any profits on sale tax-free.

And as someone has pointed out, transferring it into a company would be a change in title. There is now an automatic 5 year period that any gains would be income from the date that you do the transfers.

If you were to keep it in your own name - sorry - the purpose of the borrowings is look at. So, the interest on your home is not deductible. Best advice - pay off your own mortgage first (if you can afford larger repayments), then focus on the rental property mortgages.

Hi Murray, a few points.

1) Often would sell from personal name to LTC, not a normal company. With LTC, very easy to get capital gains out!

2) Overdrawn current account?? Properties would be sold for $1.2 million, and the company would most likely only borrow $928k from the bank. So the company would still owe the shareholder $272,000. A long way from an overdrawn current account!

Ross

[Rosco]

Hi Ross,

Just want to understand more re point 4 - why would the new ring fencing rules could make it not worthwhile?

Hi Kipkip,

Normally you would look at the cost vs benefit, and the benefit would often be tax refunds due to extra interest deductibility. Obviously want benefit to be more than cost!

When ring fencing is in, you might have a tax loss, but no immediate tax refund(should still get use of the losses if a long term investor). So it could in theory be 10 or more years until you get an advantage from the restructure, as no tax refunds.

Ross

[Bob Kane]

Yes, LTCs are considered transparent for tax purposes, so it can't charge the shareholder interest. There are however still downsides of overdrawn current accounts for an LTC in terms of loss limitation.

Thanks Anthony.

Perry, I'm catching a glimpse of something and it might be that elusive tax advantage that property investors are suppose to get.
Can you review what's been said about LTCs and the current account and determine if it's a tax advantage?