Why Loan Structure Matters for Tax Benefits

Investing in property is a fantastic way to build wealth; however, many miss out on tax savings because of an incorrect loan structure. The appropriate loan can decrease your tax liability, enhance cash flow, and, thus, enable you to grow your portfolio faster. If you do not structure it correctly, you might pay more interest and miss out on key deductions.

Why This Matters for a Property Investor in Australia

• This is also considered essential by the Australian Taxation Office, which allows for tax relief on interest paid for investment loans.
• Mistakes in loan structure often mix personal and investment debt, thus lowering your tax reductions.
• The correct setup may improve borrowing capacity and cash flow.

Best Structure Options to Follow:

The best strategies for structuring your investment property loan

Picking the Best Loan Type

Your loan will determine your level of tax advantages and the prospects of long-term investment success.

• Interest-Only Loans: Loans that allow for interest-only payments for a certain period will result in lower repayments and a higher tax-deductible interest rate. This type is suitable for clients who would wish to free cash for further investment while still attaining maximum deductibility on the interest expense.
• Principal and Interest Loans: This type of loan reduces the loan balance with time, but as the principal reduces, the tax-deductible interest reduces as well. This loan is better for investors who are concerned with long-term stability and wealth accumulation rather than short-term tax benefits.
• Fixed vs variable rate loans: A fixed loan provides stability in repayment but always has break fees. Interest rates influence a variable loan, which offers flexibility. Many investors prefer a split loan, which combines both fixed and variable rates for balance.
• Offset Accounts: A linked offset account reduces the interest payable on a home loan while keeping investment property loan interest fully deductible. This pays investors off by minimizing personal debt while maximizing tax benefits on their investment property.
• Redraw Facilities: Although redraw facilities provide the ability to access redraws, the usage of redraws for personal expenditures may lead to a loss of tax deductions. Investors should be careful so that they do not combine their personal and investment transactions using redraw facilities.

Maintain differentiation between personal and investment loans

Bundling personal and investment debt could result in a tax benefits loss.

• Do not cross-collateralize: Having multiple loans secured against the same property will reduce your flexibility to refinance and increase the risk associated with your financial arrangements. Keeping your investment loans independent will maintain your control over the individual assets and avoid unwanted lender restrictions.
• Keep Separate Loan Accounts: Maintaining personal and investment loans in different accounts simplifies tax reporting and ensures full deductibility of interest on investment loans. This method helps monitor expenses and avoids mixing personal finances with investment-related costs.
• Avoid Using Investment Loans: Do not withdraw funds from the investment loan to finance personal expenses, as part of the interest will no longer be fully tax-deductible. For instance, you could withdraw funds for a holiday or even a new car. This should never occur. The person's and their investment funds have to remain distinctly separate.
• Offset Accounts Over Redraw Facilities: An offset account reduces non-deductible home loan interest without affecting the deductibility of investment loan interest. This structure is tax-efficient and provides flexibility in managing personal and investment finances separately.
• Check with a Mortgage Broker: Professional mortgage advice guarantees the structuring of loans to optimize tax benefits and align with long-term investment goals. Consultation with a broker will help the investors avoid expensive mistakes and optimize loan setup.

Know the difference between negative gearing vs positive gearing

Both are tax implications that impact your cash flow strategy.

• Negative Gearing: When the loan expense exceeds the rental income, it results in a loss. You can offset this loss against your taxable income. It remains one of the favorite tools for high-income earners as it reduces the overall tax liability while they receive long-term capital growth.
• Positive Gearing: When rental income exceeds loan expenses, investors earn a profit that is subject to tax. However, this strategy improves cash flow and financial security, making it suitable for those seeking passive income rather than immediate tax deductions.
• Who Does Negative Gearing Benefit? Those investors in the highest tax brackets benefit the most since their property losses can be offset against taxable income, reducing what they pay in taxation while holding assets that increase in value over time.
• Who Does Positive Gearing Benefit? Anyone who wants to focus on cash flow or financial stability is going to like positive gearing because they can get consistent income without relying on outside funding for loan repayments and maintenance costs.
• Consider Long-Term Goals: Investors should align their loan structure with their financial objectives. For those planning early retirement or financial independence, a combination of both gearing strategies may provide a balance between tax efficiency and income generation.

Maximize tax deductions for loan interest and expenses

You can deduct eligible interest and expenses to save thousands of dollars annually.

• Interest on Investment Loan: If you spend the borrowed amounts on income-generating properties, you can fully deduct the interest on an investment loan. Investors must maintain proper documentation to comply with ATO regulations.

• Loans Set Up Fees: Loan establishment fees associated with setting up an investment loan can be capitalized and deducted over five years to reduce overall taxable income and efficiency in financial savings.
• Lenders Mortgage Insurance: LMI costs that have been incurred when borrowing 80% of the value of a property can be deducted over five years, which eases the pressure on the finance burden for the investor.
• Depreciation on Property & Assets: Investors can cover depreciation on all property structures and assets, such as appliances and fixtures, which is tax-deductible. A depreciation schedule from a qualified quantity surveyor maximizes these claims.
• Property Management Fees: All management fees paid to a property manager on account of tenant management, maintenance, and rent collection are tax-deductible, making professional property management financially viable.

Statistics & Data about Investment Loans in Australia

• In Australia, 70% of property investors pay interest only in the first few years.
• We expect Australian home loan interest rates to range from 5.5% to 7% in 2024.
• Negative gearing perks have accrued to more than 1.3 million Australians, who primarily have high incomes.
• Refinancing activity saw a 15% rise in 2023 due to rising interest rates.
• Over time, properties with positive cash flow have proven to outperform those with negative cash flow. Property Investment Professionals of Australia.

Conclusion

Structured properly, the loan for your investment property can make a huge impact on your tax benefits and growth in finance. We, at OM Financials, specialize in getting the best structures of a loan for Australian property investors to help them achieve long-term success.

Contact us today at +61 478 876 967, book your appointment here on our website, or visit OM Financials for more. Need guidance on your loan structure? Our team is here to assist you.