Common Mistakes With Interest Deductions - Plus Great Videos

6 December 2018

 

Common Mistakes With Interest Deductions - Plus Great Videos

 

Interest Deduction Example


Personal house loan $300,000.
Then buy a rental property for say $500,000, with a $500,000 loan.  Secured $300,000 over rental, $200,000 over personal house.

Common Mistake 1 - The tax deductibility of the loan depends on what it was used for, and security doesn't matter.  So, as the $500,000 loan is used to buy the rental, all the interest on the $500,000 is deductible!


A couple of years later, the loans are restructured so that they can get a pool for their personal home.

  • Mortgage broker organises a new loan with new bank for $900,000.
  • $500,000 to take over the rental loan, $300,000 to take over personal house loan, plus $100,000 for new pool.


The broker says it will be cheaper if more of the loan is secured over the personal house, as can get a better interest rate.  So, now the loan is secured or allocated (bank/broker words):

  • $700,000 over personal house
  • $200,000 over rental house.


What loan amount will now be interest deductible?


Common Mistake 1 again  -  What is the loan used for?  $500,000 is used to refinance or take over the rental loan.  So interest will still be deductible on this $500,000 or 55.6% of the total loan.  The fact the security is only $200,000 over the rental does not matter!




10 Years Later  -  The rental has jumped in value and is now worth $1,500,000.  The mortgage broker or lawyer (I just heard of an example of this very thing!) suggest that the $900,000 loan is transferred to the rental, so that it is more tax effective.

So, $900,000 is borrowed for the rental, secured solely against the rental (great for asset protection, as personal house is now unencumbered).


What loan amount will now be interest deductible?


Common Mistake 2 -  What is the loan used for?  $500,000 to take over the rental loan, but also $400,000 for private house and pool.  So, the interest is only deductible on the $500,000 part or 55.6% of the total loan, and the interest on the $400,000 is still not deductible.



Could this be done smarter?  Possibly, and see my Restructure Blog  (https://www.cswaikato.co.nz/index.php/latest-news-accounting-hamilton/accountants-hamilton-auckland/183).   BUT there would need to be a commercial reason for the restructure!


TIP

Try to keep your loans separate and the rental debt clear, i.e. in the above example, I would have kept two separate loans, one for the rental and one for the personal house/pool.  This makes claiming interest a lot easier, plus then you can concentrate on paying off the personal/non-deductible loan quicker!



Videos
 
Here are two recent video’s that I have just done in the last few weeks that might be of interest to you:
 

A short video looking at an example of a rental property, the numbers now and over the next 10 years, plus whether I would buy it.

This short video looks at an example of a cheap do-up property:  Is it worth trading, what are the GST and tax implications, and things to watch out for.


  

FREE – If you are a Coombe Smith client, we can send you the rental or trading spreadsheets for free.  Just email This email address is being protected from spambots. You need JavaScript enabled to view it. and ask for one or both


Kind regards
Ross Barnett 

 
 
 
 

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