2 big reasons you should have an offset account for your residential loan

residential loan offset account accountant bankstown

Loan offset account could help you to save up to tens of thousands of dollars on tax or interest. Below are the two main reasons.

Reason 1: Offset account could help you to save $$$ on tax

Firstly, what is an offset account? An offset account is linked to your residential loan account. It can be used as any saving account. But the balance of an offset account can be used to offset the loan balance, and you only need to pay interest on the difference.

For an example, if your loan balance is $500,000, you have $200,000 in your offset account, you only pay interest on the difference of $300,000.

Some banks do offer redraw facility to you on your loan, where when you overpay your loan, you can redraw the overpaid amount any time. So, what is the major difference between the two choices?

  • If you had an offset account for a rental property, you could spend the money in your offset account for other private purposes, and still claim the interest on the full balance as deduction to reduce rental income. For an example, if you spend $50,000 from the offset account to purchase a private car, you can claim the interest on the loan balance of $350,000 ($500,000 minus $150,000). 
  • If you didn’t have an offset account and paid the $200,000 directly to the loan account, your loan account balance will be changed to $300,000. At this point tax office will only allow you to claim interest on this $300,000. If you redraw $50,000 to purchase a car for private purpose, tax office will not allow you the deduction on the extra interest incurred on this redraw (due to private purpose). So the interest deductions will be fixed on the $300,000 only.

This could be more important when you are changing the purpose of your own residential property. For an example, a couple brought a property at $1,000,000 with a $800,000 loan. They worked really hard for 5 years and paid all their income directly back to their loan account. At this point they only had $200,000 left in the loan. Now they want to purchase another property to live in, and change this property to an investment property. Unfortunately, now they can only claim the interest on the $200,000 as deductible. If they redraw any amount from the loan account to pay for the down payment on the new property, it will be treated as ‘private purpose expense’ and not deductible based on tax law requirements.
Reason 2: Offset account could help you to save your interest

The beauty of an offset account is, as soon as you have the money there, for as long as it can be, it will help you to save interest. At the same time, you can use it almost like any other saving account. The only limitation is you can only have an offset account for a variable loan. In the current environment, some people might feel that they prefer a fixed rate loan versus standard variable. The best tactic might be a combination of both. For an example, if you have a loan balance of $500,000, if you are confident that you can pay off $200,000 in 3 years, maybe you can split the loan to 2 parts: $200,000 in standard variable, and $300,000 in fixed rate. For the variable loan, you can set up an offset account ant try to save as much as possible to this account. In this way, not only you can reduce the balance of the loan as quickly as possible, but you are also securing the fixed rate for part of the loan. Of course there is another possible add-on benefit: since we never know which direction the interest rate will move. What if you have fixed the interest rate to 5% for 3 years, then 2 years later the interest rate drops to 3%? By having part of your loan variable, you can still partially benefit from this interest cut.
As you might already know, Australian tax system is very complicated. This is only a top-level advice. Before you make any major investment decisions, such as buying or selling a property, investing on share market or cryptocurrency, you need to talk to an experienced tax agent to help you to understand related tax law requirements. This can potentially save you up to tens of thousands of dollars by avoiding some of the common mistakes and utilizing all possible tax planning opportunities.
P.S.: We have a free mortgage calculator on our website that will help you to calculate how much you will need to pay per month up to the end of the full term of the loan. You can also vary the interest rate and payment amount to see how soon you can pay if off under different scenarios. You can find it here: Impact Taxation Mortgage Calculator.  Should you have any questions with it please don’t hesitate to let us know.  

Best Regards,

Brenda Ferguson
Managing Director


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10 things you should consider before buying a property

Are you considering buying a property? Do you know you could miss opportunities to save thousands, or tens of thousands of dollars if you don’t plan well before the purchase?

Below are a few key considerations:

1. How should you set up your loan structure? If you don’t have a loan offset account for a rental property, after you make extra payments directly to the loan account, you can only claim interest deduction on the remaining balance of the loan. For tax purposes, this deductible balance can’t be changed even if you redraw the overpaid amount later. A good loan structure could also help you to stabilize interest rate and speed up loan repayment by combining a standard variable loan (with an offset account) and a fix rates account.

2. Timing of renovation. You might want to do a renovation right after you have bought the rental property. But do you know for any genuine repair & maintenance included in the renovation, you can claim an outright deduction against the rental income when the property is available for rental? If the work is done before the date when the property is available for rental, you can only claim the deduction against future capital gain when the property is sold. Depend on when you are going to sell, it could take years or up to decades before you can claim the deduction.

3. How should you split ownership? You might want to share the property ownership with a family member. For tax purposes, the percentage of ownership is based on the legal title, regardless of who is paying more on the mortgage. If the property will give you a tax profit, you might want to allocate more
ownership to the low-income earner to utilize the lower marginal tax rate. If it is giving you a tax loss, you might want to allocate more ownership to the high-income earner to utilize the loss. The goal is for the family to pay minimum tax together.

4. Should you use a family trust to purchase the property? There are many pros and cons related to a family trust. The advantages include tax savings on rental profit or capital gain, asset protection and succession planning on family wealth. However, family trust can’t distribute losses. All losses are trapped in the trust to be used to offset future trust profit. Therefore, you can’t utilize any rental loss in a trust to offset other income such as salary & wages. Family trusts also attract high accounting fees on initial setup and annual fees on financial statements and tax returns. State governments also charge much higher land tax on family trusts.

5. Will the income level change in future years for different owners? You might want to forecast the possible income for different owners to understand total tax payment / savings related to the property. This could also impact on your decision making on point 3 and 4 above.

6. Understand when you can treat your property as main residence to receive an exemption on capital gains tax. When eligible, even if you have received rental income, you could still treat your rental property as main residence and receive the exemption. To be eligible, you will need to treat it as your main residence at the beginning. Please check out this ATO link: Treating former home as main residence.

7. Decide whether you need to purchase a depreciation report. Most taxpayers don’t know that the depreciation on the building will need to be added back to calculate capital gains tax when the property is sold. When the property is held for more than 12 months, after applying the capital gains tax discount of 50%, it will effectively cut the tax rate by half at the time of sales. This makes depreciation deductions desirable for high income earners. However, for low-income earners it might not be ideal to claim depreciation as a rental deduction since they could be paying more on capital gains tax in the future. It could get more complicated if the property is under joint ownership between high and low income earners.

8. You might want to consider Centrelink payments for future or existing owners. Most Centrelink payments are income and asset tested. Before attaching a rental property to a family member who is receiving, or plan to receive government benefits, you might want to check the testing thresholds first to see if the Centrelink payment will be impacted. This is also applicable when you are making distributions from a family trust to different family members.

9. Have you considered using your SMSF (selfmanaged super fund) to make the purchase of a rental property? There are a lot of tax saving opportunities with a SMSF since the income tax rate is only 15%. And the capital gains tax rate is effectively only 10% after factoring in the 1/3 discount. The major downside with a SMSF is normally you can’t get the money out until you retire or on compassionate grounds (SMSF does have more flexibilities compared to normal retail super fund. But the choices are still very limited). It could be expensive to set up and operate a SMSF too. There are also strict legal requirements on the trustees. Penalties on incompliance could be severe. Tax law around SMSF is very complicated too. You will need to find a good tax accountant specialized in SMSF to help you to understand the structure, also do a cost-benefit analysis before setting it up.

10. Consider internal ownership changes. For your existing rental properties, you can also consider whether you should transfer the ownership between family members, or between different business structures (this is not applicable for SMSF). You might want to do this when the income level changes with family members, or rental property changes between tax profit and loss. Before the change, you need to consider the cost of transfer including capital gains tax, stamp duty, conveyancer fees, etc. Again, a cost-benefit analysis is a must before the change.

Last but not the least, did you combine all the above strategies and compare your choices? If you haven’t yet, how would you know that you have picked the best strategy to minimize your taxes? We can help you to factor in all considerations, compare different scenarios, also present you with a Property Prepurchase Report with all our findings to help you to make a decision. Contact us today to book in a consultation with an experienced tax accountant!

This is general advice only and does not consider your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from your financial adviser and seek tax advice from your accountant.

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