Today I’ve invited Terry Waugh back on the podcast to talk about a topic that’s very popular in the Aussie FIRE community. I recently published an article about how we (Mrs. Firebug & I) are Debt Recycling and have received a lot of questions from the community. Terry is one of the most knowledgeable people I know on this topic and he has kindly agreed to join me to answer as many questions as we had time for.
Some of the topics we cover are:
- What is Debt Recycling? (02:28)
- What are some of the ways you can DR and how does it work? (03:48)
- What happens if you need to sell some shares due to an unforeseen event? (21:26)
- What happens if you don’t have a lump sum to invest? Can you DR with dollar-cost averaging? (23:04)
- Are there any products on the market that make DR any easier? (26:42)
- Can you explain your tip “Repayment needs to be done once in full”? (28:30)
- Can you use a fixed loan with DR or does it have to be variable? (29:30)
- Is DR more or less effective if the interest rates were to rise? (31:27)
- Can you still claim the interest if you redraw the money to increase leverage on a marginal loan to maximise purchasing power? (33:59)
- Does the loan need to be in your name to get the total deductions? (35:37)
- What happens if you refinance? (37:40)
- What happens if you sell the PPoR later down the track? (41:07)
- What happens if you convert the PPoR to an IP later down the track? (43:59)
- Can you sell a chunk of your portfolio in order to pay down the loan, redraw it back out and then buy the exact same shares as before? (47:15)
- What happens if the income from the trust is not enough to cover the interest on the loan? (49:14)
- If your PPoR loan is P&I do you have to structure the loan agreement to the trustee as P&I as well? (51:06)
- Can you DR with a trust if both the borrower and the trustee are the same person? (52:53)
- Debt Recycling an investment property (54:03)
slight modification to the question “Does the loan need to be in your name to get the total deductions?” – Terry said that if Homer has the loan, and Homer and Marge invest, they are both able to claim the income and interest deductions according to their split of investment ownereship… BUT, what if the loan were in both Homer and Marge’s name (which would often be the case for a jointly owned home), but Marge wanted to invest – If the investment was in Marge’s name, but the loan was in both Homer and Marge’s name – could Marge claim 100% of the investment and associated portion of the loan?
So you are asking if Homer and Marge are the borrowers and Marge is the investor who can claim the interest?
In situations like this the investor will claim 100% of the interest, assuming there is income and the investor is not acting as trustee. Marge in this case.
Some tax advisors think an onlending agreement is needed so Homer can lend his 50% of the borrowings to Marge so she can claim in full, but I don’t think this is needed where both are on the loan. But seek your own tax advice on this.
Where one is on the loan and both are investing then both would claim the interest.
Where one is on the loan but the other investing then neither can claim the interest, but a written loan agreement can fix this.
Where one is on the loan and a trust or a company is investing then a written loan agreement is needed. This seems to be the case even where the lender is lending to themselves as trustee.
Thank you both for the great episode.
I had previously written off the thought of debt recycling an investment property but his last scenario about debt recycling a property you are thinking of selling has re-sparked my interest.
I have been contemplating selling one or 2 IPs and putting the funds into ETFs such as A200, but now I am thinking of debt recycling them now and selling the IPs during the next Perth mining boom.
I am not sure if this would provide much benefit. If you are debt recycling an existing investment property loan it would generally already be deductible interest. So if you use cash to buy income producing shares or debt recycle to buy them it would produce the same result. It would be different if the shares were to be held by a different entity though.
And then when the property is sold you will need to discharge any mortgage against the property which usually means paying out the loan and if the loan was used the buy the shares the interest deductions would be lost.
Perhaps there is no harm in doing it though and when you sell the property you might be able to keep the loan open by changing the security over to another property – the main residence maybe which might have more equity at that point.
Hi Terry ,
Can we release equity from investment property to buy shares?
If investment property loan is on my name when we release equity can we invest it as joint account in ETFs?
Great Episode, Thank you for awesome content. I just have a quick question, eg lets say debt recycling money is used to buy a 60/40 portfolio of 2etfs. For tax deduction interest on the loan is deductible against the income from whole portfolio or 60% against etf1 and 40% against etf2 income?
Generally yes. But it might not be in the first and last month or ownership if purchased at different stages.
e.g. if you borrowed on 1 July to buy AAA and then 15 July to buy BBB it wouldn’t be a straight 60/40 split.
But that probably won’t matter if you get it wrong where the 2 lots of shares are owned by the same person and that is because overall the claimed interest would be the same.
Thx a lot Terry. Much appreciated 🙏🏽
Thanks for great info – much appreciated. In regards to the investment requirement of being income producing. What if the borrowed money bought an ETF such as A200 or VAS. Some of the companies in these ETFs would not pay dividends. Is the ETF counted as one dividend/ income paying investment or should you buy individual companies eg a dividend paying bank? Thanks Wes
You are borrowing to buy the ETF so as long as that pays income the loan interest should be deductible.
But some of these ETFs have capital gains as a component of the income so strictly speaking the interest might need to be apportioned. But I am not sure if the ATO would go into that a minute detail when the percentage is usually pretty small
Enjoyed this pod and always dismissed debt recycling as not required however it has perked my interest as a tax play.
So my questions are:
If my wife and I own our PPOR outright, firstly can I go back to the bank and obtain a loan against our property?
Secondly if a loan is granted in our names for example 700K can I then use the money released by the bank to pay down the loan to $0 then send this money directly from the loan to our brokerage account to purchase income producing assets such as shares and then claim the interest on that loan when it is back out at $700K as a tax deduction paying the minimum?
Does this sound correct, would appreciate any feedback Terry.
If you own the property outright there is no loan so no non-deductible debt I presume. If so you have nothing to recycle.
If you wanted to though you could borrow against the property to invest. In that case there would be no reason to pay the down to zero again – unless perhaps it was accidently mixed.
Thanks Terry that does make sense though it did initially seem to simple. Will keep researching👍
I should point out that there is another AFB thread on debt recycling here
I have answered a lot of questions there too
I had a question re debt recycling. Thanks for a great podcast.
If you have 5 different shares and if you sell 1 set of shares – do you need to put the money back into the loan and redraw to buy another share? Or can you just sell that share and repurchase another from the brokerage account?
Phillip you could do either but if you sold and then used the cash to reinvest the interest would no longer be deductible. You should repay the amount you borrowed into the loan and redraw to reinvest if you want to claim the interest going forward.
I was able to deduct interest from a car loan because the proceeds were used to finance equity investments. In my experience, and from my discussions with the ATO on this topic, they acknowledged that money is fungible and it may not be possible (and ultimately, not necessary) to draw a direct link between which funds came from the car loan into which investments.
In the end, there was no issue with deducting the interest, even though money didn’t specifically flow from the loan to an empty account and on to a trading account. In fact, my position was simply that I had the option to sell shares to finance the car, but by taking the car loan, I was maintaining my investment portfolio. There was no need to manufacture transactions to illustrate the point.
I’m sure my accountant would be happy to charge me more money for advice that would give me near 100% confidence in the tax outcome, but I was happy enough to be pretty confident based on free ATO dialog, and to avoid paying tax advice fees.
It wouldn’t turn out like that if audited. You can basically claim anything you want and it won’t be an issue unless the ATO check on it. Even if audited they may not dig deep enough to undercover it.
You also can’t really rely on anything the ATO tell you on the phone. You would need a private binding ruling and then it might not even be reliable if your circumstances change and your situation differs from what was described on the ruling application.
Security for the loan is not relevant to the claiming of interest. You could borrow against a car to buy shares with the interest deductible or you could borrow against shares to buy a car with the interest not deductible (or perhaps deductible in part if it is used for business).
In the AAT case of FCT v Domjan from many years ago the taxpayer was denied deductions of interest in full because she withdrew from a loan and put the money in a cheque account to pay a tradesperson for something in relation to her investment property.
TerryW, you might be right. Maybe an audit would have led to a different outcome. Or maybe it wouldn’t.
But what’s the chance of an audit anyway? And if audited, is it a 20% chance of having to repay or is it 80%? Hard to say. One thing we can say for sure is that the adviser fees are 100%.
The trouble is that most tax advisers are not factoring in these probabilities, and there’s no incentive to tell clients to do things the easy way or to take a chance. Much better to create more work and earn more fees.
I mean, really! Clearing out your account for a few days so when you deposit and then withdraw the same $2883.43, there’s no doubt that it’s the same money. I really have trouble believing the ATO would require that.
Surely it is best practice to structure things so that it complies with the law?
Say you have a $150k loan that is 100% offset by $150k in offset accounts and therefore you aren’t paying interest. If you wanted to invest $50k in EFTs using debt recycling, would you need to pay the loan down to $0 with the funds out of the offset? If you drew $50k to buy EFTs would you be able to also move $100k back into the offsets? Is there a better way to structure this?
Nathan, I am not sure if that would be debt recycling or not as there is no current non-deductible interest. But you would certainly want to pay it into the loan and borrow it back again to invest.
If you just put $50k into the loan and pulled it out again it would be a mixed loan.
So you would need to either
a) pay the loan off in full and redraw $50k to invest, and have $100k available for later,
b) split the loan into a $50k split and $100k split and pay the $50k off.
Make sure you seek your own tax advice on this
If an investment property purchased as couple , home loan under couple but the rental agreement is only on one name .
So can one person ( who is on the rental contract) claim the entire loss ?