Each time you receive a letter or notification from the bank informing you on a revised interest rate, you start to question whether you should reduce your loan amount or pay it off completely. After all, many like to retire and live on rental income from properties.
Tax deductible debt
When you take a loan to finance the purchase of a rental property, the interest on the loan is tax deductible. Once you pay off the loan, any future loan taken will only be tax deductible if it was used for a taxable asset. When you are a non-resident for tax purposes, you are only taxed on taxable Australian property.
Actual cost of interest charge
As a non-resident for tax purposes, you are not entitled to any tax-free threshold and taxed at progressive rates from 30% to 45% (from 1st July 2024).
Therefore, any tax-deductible interest cost will offset a starting tax rate of 30%.
For example, if your net rental is $30,000 and your interest cost is $30,000, you will not incur any tax payable. Should you pay off the loan, you will not have any interest and your taxable income is $30,000. At 30% tax rate, you have an income tax payable of $9,000.
Thus paying $30,000 of interest effectively saves you $9,000 of income tax payable. This means your actual cost of interest is $21,000.
At the time of this article (July 2024) the variable interest on loan 6.34%. With a $30,000 interest rate and at the above rate, your outstanding loan balance will be $473,186. Therefore, your effective interest rate taking into account the tax deductibility of interest is $21,000/$473,186 = 4.438%
Is the property you pay off your future family home?
If it isn’t, this means you have less for your future family home. The last thing you want is to have a debt free investment property and a loan on your main residence.
Getting that dream home : Set up an offset account
Always take a loan on your dream home first instead of paying cash. Set up an offset account which is linked to your loan. Should you change your mind and decide to rent out the property and live somewhere else, you can always withdraw from your offset savings account and utilized the cash. The benefit of that is the loan remains tax deductible as there is no change.
For example, if you have a home loan of $800,000 and $700,000 in your offset account, you will only be charged interest on $100,000. If you have $800,000 in your offset account, there will be no interest payable.
Conclusion
Interest rates fluctuate. Once you pay off a debt on an investment property, the interest will not be tax deductible if you used it for personal or private purposes. This is also subjected to bank lending regulation and policy at that time. Having an unencumbered property does not guarantee you a bank loan as Australia looks at serviceability. Thus, many are forced to explore sale of property even though they do not require the full sale price. Should you need the funds urgently, the turnaround time from marketing a property, contract and settlement will be a minimum 1 month.
Referencing back to the example in the article, the net return you would need to beat is 4.438% per annum. As interest rate fluctuate, it effectively translates to a net return equivalent to 70% of your current loan interest rate.
Therefore if you are able to outperform this amount, it makes sense to continue your tax deductible debt and use the cash to invest in alternative assets and build a diversified portfolio.
If you would like more information or guidance on your personal situation, please contact me on diana.chua@sjpp.asia or +65 8807 2552 for complimentary initial consultation.
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances. You are advised to seek independent tax advice from suitably qualified professionals before making any decision as to the tax implications of any investment.
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