Australian property tax and expatriate tax expert STEVE DOUGLAS gives smart tips for tackling investment property loans.

Q I’m thinking of reducing my loan on an Australian investment property to save on interest. Is this a good idea?

A Reducing your property loan isn’t a bad idea, but it can lead to drawbacks later.

·         In Australia, investment property loans are fully tax-deductible, while loans for land or private property you currently reside in – or intend to in the future – are not. So it would be wiser to reduce the loan relating to the property you intend to live in. Any dollar you pay off an investment property loan is one you may have to borrow back, to pay for your family home.

·         Once you “trap” equity in a particular property you cannot get it back again.

·         A reduction in interest cost results in a dip in tax deductions, which can greatly impact investment performance as well as the tax cost of your property. As someone living abroad, your starting tax rate is 29 percent of your rental profit – since this is high you are able to legally reduce your overall tax rate, by maintaining a sensible debt level.

·         Future tax protection from the accumulation of annual tax losses will be reduced, leading to greater capital gains tax costs or higher taxes on your return to Australia.

          A wise alternative is to consider an Offset Account. Rather than paying off the loan, stream the amount into a separate savings account linked to your loan. Interest is then only charged on the net balance. For example, if your loan is A$300,000 and you’ve deposited A$40,000 in your offset account, you’d only pay interest on A$260,000. Another advantage is if you want your money back at any point, the loan remains intact. So, if you remove funds from the offset account it will increase the net balance, resulting in a higher interest cost – fully-deductible against the rental property the loan was originally used for.

          Offset bank accounts are available at all Australian banks and are a simple and effective way to manage your money during a time of investment uncertainty. You’ll pay reduced interest and have control over your money. If you find an investment opportunity set to outperform your interest savings you can withdraw your funds. If not, leave the money there and enjoy the savings! 
          Use the Property Tax Estimator tool at www.smats.net to quickly assess the merits of reducing your loans by comparing different borrowing levels. You’ll be surprised to learn reducing your loan can in fact be a disadvantage.