Don’t use Cash in Offset account to Invest

If cash is used to invest there is no interest to deduct.

However where money is taken from an offset account the interest on the loan that the offset is linked to will increase but the interest on this loan will still not directly be deductible.

There are 2 scenarios relating to this:

  1. Offset Main residence loan

If the offset account is attached to the main residence any removal of the cash will cause the non-deductible interest on the loan to increase. This interest will not be deductible because the loan is associated with a private purpose – the purchase of the main residence in this case.

E.g. $500,000 home loan with an offset attached containing $100,000 will mean interest is only charged of $400,000. If the $100,000 cash is used to invest, then the interest will be charged on the full $500,000. This will mean approx. $5000 per year in extra interest and lost deductions ($100,000 x 5%). For someone on the top tax rate this is like throwing $2,350 per year in the bin.

  1. Offset on an investment property loan

With an offset attached to an investment property the situation is similar – withdrawing of the cash will not be using borrowed money so there is no interest to claim. But indirectly there will be increased deductions because the interest on the investment loan will increase and the interest on this loan will be deductible against the investment property to which it relates.

E.g. $500,000 loan with a $100,000 offset balance. Loan relates to the purchase of 123 Smith St. $100,000 cash is withdrawn to buy 456 Jones St.

The interest on the loan for Smith St will increase by $5000 per year approx. The extra interest will be deductible against Smith St not Jones St.

Does it matter whether you use offset cash from an investment loan or borrow?

Immediately it won’t really matter. But longer term it will matter because if one property is sold there will be different consequences. Also there are advantages in borrowing as it will keep cash available for private expenses and will increase tax deductions if it is used for private expenses.

Also there will be different consequences if properties have different owners. $100,000 withdraw from an investment property offset in the name of Spouse A v $100,000 borrowed by A and on lent to B.

So think carefully before you go using offset account money.

Update – I just thought of something else relating to using cash in offset accounts and wrote something in a another thread on the issues of whether to use cash or to pay down a loan and reborrow

Unless you have available equity, and cannot borrow, you would only have 2 choices

  1. Use the cash to invest directly, or
  2. Use the cash to pay down the loan and reborrow to invest.

Which option you choose will depend on the situation.

If you plan to never move into the property relating to the existing loan again then paying it down may not give any extra advantages. Same tax consequence if you use cash or pay down and reborrow.

If there is a possibility that you may move into the new property at some point then you would want to reduce this loan size by using the cash in the offset account directly.

If there is a chance you could be selling one property at some stage then there will be different consequences as well.

If the properties will have different owners – .e.g. property A owned by you and property B owned by you and your spouse then there will be different tax consequences as your incomes will differ now and in the future.

 

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au

 

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