Loan Interest: Gili family missed out $400k Due to Trust

Scenario Overview: Shawn and Jenny Gili, who recently engaged Investax for their tax affairs, have submitted their tax information for the annual tax returns. They acquired an investment property through a discretionary trust. Both Shawn and Jenny are the directors of the trustee company. Both of them are also beneficiaries of the Trust. They withdrew $400K from the equity of their principal place of residence (PPOR) and transferred it to the trust for the investment property’s deposit, stamp duty, legal fees, and building inspections.

There is no commercial loan agreement between the trustee and the borrowers. They have submitted their annual tax paperwork and intend to claim interest deductions for the $400K loan in their personal tax returns against the trust distributions they receive from their discretionary trust.

The question is whether Shawn and Jenny can claim an interest deduction for their $400K home equity loan in their personal tax return against the profit distribution from their discretionary trust.

Answer: Deduction Eligibility for Trust Beneficiaries

Key Points:

• Common knowledge: When it comes to claiming tax deductions for an investment loan on a property, the Australian Taxation Office (ATO) provides specific guidelines. Generally, if you use a property to earn income, you can claim certain expenses as tax deductions. These expenses include interest on loans taken out for the purchase of the property and pre-purchase expenses such as legal fees, stamp duty, and buyer’s agent fees.

• Reference to ATO Rulings: According to TD 2018/9, mere receipt of trust distributions doesn’t qualify an individual for interest deductions. A beneficiary of a discretionary trust who borrows money, and on-lends all or part of that money to the trustee of the discretionary trust interest-free, is usually not entitled to a deduction for any interest expenditure incurred by the beneficiary in relation to the borrowed money on-lent to the trustee.

• Interest-Free Loan: The absence of a loan agreement between the trustee and the original borrower, specifically one intending to charge interest, indicates that the funds provided to the trust are not considered a loan. Consequently, the trust does not have any obligation to pay interest. In the trust’s records, this contribution will be treated more like a gift to the trust, rather than a loan.

Conclusion: As Shawn and Jenny do not have any fixed entitlement from their discretionary trust, the interest on their loan is not an allowable deduction against their trust distribution. If Shawn and Jenny had planned from the beginning and consulted with a specialist property tax accountant before purchasing the investment property, they could have implemented a tax strategy allowing them a tax deduction for their investment loan.

If you’re navigating similar circumstances with a trust and are uncertain about your tax position, consider reaching out to Investax Group. Our team can provide tailored advice to ensure you’re making the most of your tax situation in compliance with ATO guidelines.

Reference – TD 2018/9 | Legal database (ato.gov.au) 

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