Did you know you can pay one years’ interest in advance (IIA) for an investment property and sometimes this can save you a huge amount of tax?
The typical situation when interest in advance will be beneficial is when you have a high taxable income say this financial year, but expect to have low taxable income next financial year.
Remember your tax rate is set each financial year by calculating your net taxable income. While most costs and income have to be paid on a particular date, some costs, such as interest can be paid at different dates, which can change your taxable income from one year to the next.
So if your income is likely to be very different between financial years, it may be very beneficial to move some of the expenses such as interest.
Some lenders will allow you to pay one whole year’s interest in one month, so in May or June, if you have already paid about 11 months of interest, you can request to pay the next 12 months interest, plus the usual month in one payment. This means you can pay two years’ of interest on one financial year, but none in the next.
If your taxable income is much higher one financial year, it may be very beneficial to also pull forward as many of your expenses as you can to that year.
This may be a year when you plan on taking time off for a long holiday or having children, or you may have had large bonuses this year and don’t expect much next year.
Interest In Advance Example:
Let say you are a busy woman on a high income above $180,000 and paying tax at 47 per cent, but you are pregnant and planning to take next year off paid work to raise your child. This would likely mean your income would drop below $18,200 so there is no tax payable that year.
If you have investment property, you may then be missing out on tax benefits in this lower income year. In such an instance, if we arranged for a full year’s interest to be paid in the year you earned more, it would usually reduce your tax by up to 47 per cent.
There would then be far less expenses in the year your taxable income is low, so relatively less tax payable that year.
For every $100,000 of investment property debt, at about 5 per cent interest rate, there is $5,000 of interest per annum, so if this is paid one year early, it would create an additional tax deduction of $5,000, which at 47 per cent tax rate would provide an extra $2,350 tax back.
If you have say $1,000,000 of investment debt, this strategy may save you up to $23,500 of tax!
You can chose to either pay the interest in advance with cash or you can usually arrange a loan increase to fund it temporarily, so you are not out of pocket initially but will have far more cash in the bank after your tax is finalised.
Important Note and Warning: This information is general in nature and should not be considered personal tax advice. We highly recommend you discuss these concepts with your accountant, property investment adviser and investment finance mortgage broker jointly to ensure any considered concepts are suitable for your personal financial situation, as one effect of the concept may negatively impact another part of your plan.