What makes your debt tax deductible?by Wealth Architects / 05.07.2018
There are two kinds of debt in this world: the kind that is tax deductible and the kind that isn’t.
Knowing the difference, and planning your purchases accordingly, can significantly improve your cashflow, opportunities and overall financial position.
So what makes debt tax deductible or not?
Non-tax deductible debt
Let’s start by clarifying that we’re talking about whether the interest on a debt is tax deductible.
So a non-tax deductible debt, also known as ‘bad debt’, is any money you borrow for a purchase that doesn’t deliver a return.
Examples can include your credit card, car loan, personal loan or the mortgage on your family home. You need to pay these debts from your after-tax earnings.
Tax deductible debt
You can usually consider a debt tax deductible if it was incurred to generate taxable income.
In other words, if you borrow money in order to make more money, your debt may be tax deductible.
Examples of tax deductible debt can include borrowing to invest in shares or property.
Potential benefits of tax deductible debt
If a debt is tax deductible, the interest is considered an ‘expense’ incurred in order to earn a taxable income.
Expenses are allowable tax deductions. Therefore the interest can be set against your taxable income, thereby reducing your total taxable income.
Let’s consider the following scenario: say you incur a debt to purchase an investment property. The interest payments, management and maintenance costs, capital works spending and depreciation on the property may all be claimed as tax deductions.
Depending on your individual circumstances, this may entitle you to various tax deductions and concessions, it may improve your cashflow and allow you to focus on paying down your ‘bad debts’.
This may all seem fairly straightforward, but life – and finances – are often anything but straightforward.
Say you incur a debt to buy property. Down the track you might want to redraw, consolidate your debts or upgrade the family home to make the original an investment property.
All of these actions will affect whether the interest on your loan is tax deductible. And the tax office will be watching carefully, so it’s important to do your homework and get expert advice before claiming a deduction.
Protect the tax deductibility of your debt
There are numerous steps you can take to protect the tax deductible status of your debt.
These can include keeping personal and income generating loans strictly separate or setting up an offset account.
The best course of action will very much depend on your personal circumstances, financial goals and obligations.
If you’d like to find out more about whether your debt is tax deductible or not, get in touch today.
We’d be more than happy to talk you through the ins and outs!