Debt Recycling: How Can Homeowners Restructure Debt for Investment?
Property & Tax Update
Many homeowners have a significant mortgage on their principal place of residence. As this is generally private debt, the interest on the home loan is usually not tax deductible.
For homeowners who are also investing in property or other income-producing investments, debt recycling may be a strategy worth considering.
What Is Debt Recycling?
Debt recycling is a strategy of progressively reducing non-deductible private home debt and replacing it with new borrowing used for an income-producing investment.
The important point is that the new borrowing must actually be used for an income-producing purpose. Simply changing the name of an existing home loan to an "investment loan" does not make the interest deductible.
A Simple Example
Assume an investor has:
- Home loan: $500,000
- The home is their principal place of residence.
- The existing $500,000 debt is private and the interest is not deductible.
The investor has $100,000 of available cash.
1. Repay $100,000 of the home loan
The home loan reduces from $500,000 to $400,000.
2. Establish a separate $100,000 investment loan split
The $100,000 is then drawn for the purpose of purchasing an investment property.
The resulting structure is:
| Debt | Amount | Purpose |
|---|---|---|
| Home loan | $400,000 | Principal residence — private |
| Investment loan | $100,000 | Investment property — income-producing |
Subject to the applicable tax requirements, the interest on the $100,000 investment borrowing may be deductible because the borrowed funds are being used for an income-producing purpose.
The investor has therefore progressively changed the composition of their debt from non-deductible private debt to potentially deductible investment debt.
Keep the Money Trail Clear
One of the most important practical considerations is tracing the borrowed funds.
When the new investment facility is drawn, the funds should, wherever practicable, be kept separate from the client's own money and clearly traced through to the investment expenditure.
For example:
Investment loan drawn → dedicated account → investment property purchase
It is preferable to avoid depositing the borrowed funds into an everyday account containing salary, savings and other personal funds and then making multiple unrelated payments from that account.
Clear loan splits, separate accounts and supporting bank records can make it much easier to demonstrate how the borrowed funds were used.
If a loan is used for both private and income-producing purposes, the interest may need to be apportioned and appropriate records should be maintained.
Debt Recycling Is Not the Same as Simply Borrowing More
Debt recycling is not simply increasing the mortgage on the family home.
The objective is to replace existing non-deductible debt with new borrowing that is genuinely used for an income-producing purpose, while maintaining an appropriate overall level of debt.
The strategy should also be considered together with investment risk, interest costs, cash flow and the investor's ability to service the debt.
Before Implementing a Debt Recycling Strategy
Investors should consider:
- whether they have sufficient cash flow to service the investment debt;
- the risks associated with the investment;
- whether the proposed investment is genuinely income-producing;
- whether separate loan splits can be established;
- whether the movement of borrowed funds can be clearly documented; and
- the tax consequences of the proposed arrangement.
Debt recycling can be a useful financial strategy in appropriate circumstances, but the tax treatment depends on the purpose and actual use of each borrowing.
Ace Solutions Accounting & Taxation
Disclaimer: This article provides general information only and does not constitute accounting, taxation, financial or investment advice. The tax treatment of borrowing depends on the individual circumstances and the use of the borrowed funds. Professional advice should be obtained before implementing a debt recycling strategy.