50% Spousal Transfer Strategy to Increase Deductions

 

I have mentioned the ‘Spousal Transfer Strategy’ in a few threads in the past on propertychat.com.au and propertyinvesting.com but I don’t think I have outlined this strategy in detail with an example.

The strategy works by Spouse A selling a property, or part of a property they own to Spouse B. Spouse B borrows to acquire the property or part property and claims the interest on the loan, while the funds released from the sale are used to pay off the non-deductible main residence.

The stamp duty laws need to be carefully considered as an exemption is generally only available where the property is the main residence at the time of the transfer and the property is going from one name into 2 names either as joint tenants or tenants in common in equal shares. In some states the exemption is not available if the share of the property is purchased, as is the case in Queensland or Victoria. To be able to claim interest on the loan there must be ‘consideration’ given as you cannot borrow to make a gift and expect to claim the interest. On this see:

Tax Tip 15: Transfers for No Consideration and Deductibility of Interest https://propertychat.com.au/community/threads/tax-tip-15-transfers-for-no-consideration-and-deductibility-of-interest.2686/

Example

Homer and Marge have owned their home for about 20 years now. It is just in Marge’s name as she bought it before their marriage and the loan has long been paid off. The property is located in NSW and is worth approximately $1mil.

They want to buy a new home (House 2) to live in, but they don’t want to sell the existing home (House 1) just yet, because of the subdivision potential it has.

However if they don’t sell it they will need to pay a lot of interest on the loan used to acquire House 2. They estimate they will need to spend about $1.5mil but only have $700,000 as a deposit. That means they would need to borrow about $800,000 and pay about $40,000 in interest (at 5% pa) per year which would not be deductible.

Instead they decide to utilise the ‘Spousal Transfer Strategy, after seeking appropriate legal advice, where Marge would sell 50% of House 1 to Homer for $500,000. If they do this while still living in the property there may be no stamp duty at all. There would also be no CGT because the property has always been the main residence.

Marge and Homer go to the ABC Bank and borrow $500,000 so that Homer can pay Marge for her 50% share. Both names will need to be on the loan as they will be joint owners and joint mortgagors.

Marge will receive $500,000 from Homer from the sale. This $500,000 will sit in the offset account of the loan from ABC Bank until they need to use the money for the new purchase of House 2. No interest will be incurred while this happens as the offset account balance equals the loan balance.

After the transfer they would remain living in House 1 for a few months and then move out and into a new property, House 2, which will be purchased.

When they find House 2 they will arrange their finances so that $300,000 is borrowed, say from DEF Bank, and $1.2mil of cash is used for the remainder of the purchase monies (the $700,000 cash they have plus the $500,000 from Marge’s 50% sale to Homer).

After House 1 is available for rent Homer is able to claim the interest on the $500,000 loan.

Comparison – Strategy v No Strategy for Homer and Marge

Without using this strategy

Homer and Marg would have a loan of $800,000 on House 2 as they only have a $700,000 deposit on a $1.5mil purchase.

At 5% per year interest rate this would be approximately $40,000 in interest with none of it being deductible.

Using the Strategy

They will still have a debt of $800,000 in total, but as $500,000 of this relates to the purchase of House 1, the interest on this loan will be deductible to Homer.

At 5%pa interest rate this amount $25,000 p.a. in deductible interest.

They will also have $300,000 in non-deductible debt because this was used to acquire the new property which will be their main residence and therefore non-deductible.

Total $25,000 plus $15,000 = $40,000 in interest

But because Homer is on the top marginal tax rate his tax will reduce by 47% of $25,000 which is $11,750

So they will be better off, as a family, by $11,750 per year by doing this strategy. This extra money saved can be used to pay down the main residence and debt recycle into investments – saving even more interest and making ever more income.

Over the course of a life time these savings could add up to be hundreds of thousands of dollars.

Cost of implementing is very cheap because the only costs would be

  1. a)    Legal advice;
  2. b)    Taxation advice (on deductibility of interest and Part IVA)
  3. c)    Conveyancing;
  4. d)    Loan exit and entry fees.

All up it should come in at less than $3,000.

Note – Please do Not try this without legal advice as I have seen at least one person do the conveyance for no consideration which meant that none of the interest is deductible at all. They were left in a worse position than before doing it.

Do Not try this without tax advice as the loans need to be made to pay out the other party, and payment should be made. Also the Commissioner of the ATO can also deny the deductions, under Part IVA, if the sole and dominant purpose in doing this is to increase tax deductions.

Written by Terry Waugh, solicitor at www.structuringlawyers.com.au