Debt Recycling
Debt recycling is the act of turning non-deductible debt, such as your home loan, into deductible debt. On a $1m home loan, this could cut tax by about $25k a year.
When you borrow funds to generate an assessable income with, such as buying a rental property or shares, the interest charged on the loan is tax deductible. The ATO considers that all named parties on the loan have equal portions of deductibility.
Example: $100k debt recycling
| Step | Current | Lump sum | Redraw |
|---|---|---|---|
| Cash | 100 | 0 | 0 |
| Investment | 0 | 0 | 100 |
| Loan Balance | 150 | 50 | 150 |
| Interest Rate | 6% | 6% | 6% |
| Interest Payable | 9 | 3 | 9 |
| Deductibility | 0% | 0% | 67% |
| Tax Rate | 47% | 47% | 47% |
| Tax Reduction | 0 | 0 | 2.8 |
Each time you draw funds from a loan account you look at what you did with those funds to determine the purpose. When you repay the deductible percentage does not change. When you redraw the deductible value increases.
Example: Loan purpose impact on deductibility
| Step | Purpose | Repayments | Borrowings | Loan Balance | Deductible % | Deductible $ |
|---|---|---|---|---|---|---|
| 1. Draw Down | Home | - | 100 | 100 | 0% | 0 |
| 2. Lump Sum | - | 10 | - | 90 | 0% | 0 |
| 3. Redraw | Invest | - | 10 | 100 | 10% | 10 |
| 4. Repayments | - | 20 | - | 80 | 10% | 8 |
| 5. Lump Sum | - | 20 | - | 60 | 10% | 6 |
| 6. Redraw | Invest | - | 20 | 80 | 33% | 26 |
| 7. Holiday | Personal | - | 10 | 90 | 29% | 26 |
| 8. Release Equity | Invest | - | 50 | 140 | 54% | 76 |
Strategies
- Split loan accounts so when you redraw it is always from a loan which is 0% deductible.
- Investing in income producing growth assets (property or shares) can result in negative gearing for the borrowers.
- Lending to a family trust or company can allow you to stream excess returns to low income family members. Only beneficial if the investment inside the trust can return more than the commercial rate you have to charge.
- When interest rates are low purchase secured bonds or notes from your business or trust at commercial rates for 20 years. When interest rates rise this may result in negative gearing.
- If on a principle & interest home loan, loan your family trust using a P&I loan with the same term so the principle reduces together. You can release equity later and purchase other assets.
- If you have two loans - a non-deductible home loan and a deductible investment loan - the investment loan will generally be at a higher interest rate. While you should normally pay down the higher rate loan first, debt recycling produces the best outcome: 1) Repay the home loan, 2) Redraw from the home loan, 3) Use the redraw to repay the investment loan. This converts non-deductible debt to deductible debt while eliminating the higher interest rate.
Key Requirements
- Cash movement must be traceable and recorded. Don't mix your personal and investment funds.
- Investment must be on commercial terms. Don't loan your cousin the money at 0%.
- Investment must produce assessable income. Don't invest in a collectable.
- All parties on loan must benefit from income. Don't invest only in your name.
Simulator
10-Year Debt Recycling Benefit
| Year | Deductible Amount | Deductible Interest | Tax Benefit | Cumulative Benefit |
|---|---|---|---|---|
| 1 | $100,000 | $5,000 | $2,350 | $2,350 |
| 2 | $100,000 | $5,000 | $2,350 | $4,935 |
| 3 | $100,000 | $5,000 | $2,350 | $7,779 |
| 4 | $100,000 | $5,000 | $2,350 | $10,906 |
| 5 | $100,000 | $5,000 | $2,350 | $14,347 |
| 6 | $100,000 | $5,000 | $2,350 | $18,132 |
| 7 | $100,000 | $5,000 | $2,350 | $22,295 |
| 8 | $100,000 | $5,000 | $2,350 | $26,874 |
| 9 | $100,000 | $5,000 | $2,350 | $31,912 |
| 10 | $100,000 | $5,000 | $2,350 | $37,453 |
Risks
- Market falls can exceed tax benefits.
- Higher variable rates increase cashflow stress.
- Record‑keeping failures may deny deductions.
How to do it with Self Managed
Assign the deductible proportion when you redraw from a loan account or issue a credit. Self Managed calculates the deductible percentage and applies the deduction to your taxable income from that date for all interest incurred on the account.
Self Managed tracks loan balances between entities and charges yearly interest. The commercial rate is set as RBA + 2.5%, or the DIV7a rate for companies.
FAQ
That depends on the interest rate charged by the bank for being interest only, the type of investment you make, and your cashflow. P&I usually has a lower interest rate, and you can refinance and redraw to unlock more equity regularly.
No, ATO v Hart (2004) confirmed that capitalising interest, which increases the deductible loan portion, is seen as having a dominant purpose of obtaining a tax benefit and therefore Part IVA (general anti-avoidance rule) applied.
No, the loan is only deductible if it produces income for the person claiming the deduction.
Yes, it needs to be a commercial investment. So if you loan the money to a family member, company or trust you need to have a loan agreement just like you would if you loaned it to a stranger.
No, the principle on the loan must be paid down and then redrawn or a new loan taken out. An offset account is more like a savings account where the interest rate is the same as the loan rate.
No, it's best not to as this can taint the loan purpose and make the loan non-deductible.
Yes, as long as its done in a timely manner and you can show that the cash moved from asset to asset. Usually it is best to pay down the loan and redraw so the purpose refreshes and remains clear. At the very least you need to ensure that the current balance of the deductible loan is invested again as soon as possible; do not let it mix with your private funds.