07 Oct Avoid the Most Common Financial Mistake Made with a Line of Credit
There is a critical mistake made by many people who have lines of credit and who have investment properties.
This mistake is common and you’ve got to be aware of it, because it’s costly to fix up.
Now, I assume you know what a line of credit is
A line of credit is like a big credit card.
The banks give you approval for a limit on how much you can spend, and you can spend it anywhere you want.
You can even use it to pay the interest on the line of credit itself.
Let’s imagine someone gets a line of credit of $100,000, and they’ve used that $100,000 as the 20% deposit to purchase a property.
So it’s a now business expense.
The interest on that loan is a tax deduction, because the money went towards the investment property.
Here’s where they make a mistake…
They put their wages into that line of credit, because their bank or their broker says, “It’s a great idea, because it will save you interest.”
Isn’t that what most people are told?
Many people are also told to get a “credit card” and put all of their expenses on it, then pay it off once a month.
So you’ve got your wages sitting in your line of credit, earning you interest and then you put all your expenses on your credit card.
This gives you 55 days interest free, and on the 54th day or 55th day, you transfer the money from your line of credit and pay down your credit card.
The problem with that is you just changed the purpose of your loan.
The original purpose of the loan was a tax deduction.
Okay. Let’s say over 12 months you put your wages into your line of credit. And let’s say your wages came to $50,000.
Let’s look at the big picture here…
You’ve reduced your line of credit down to $50,000, and let’s assume over 12 months your credit card payments totalled $50,000.
Once you pay this off, your line of credit is now back up to $100,000.
But you saved the interest on that $50,000 whilst your money is sitting in the line of credit which is now back up to $100,000.
Now, can you see that this money here is private?
Can you see that you’ve just changed the purpose of your loan?
The tax department looks at where your money went to and the purpose of that loan.
Even though your $100,000 liability is still there and you’re claiming 100% of the interest; here you can only claim 50% of it.
And to make things worse, your accountant will probably spend $2,000 in trying to work out all the little bits and pieces going back and forth in the last 12 months.
Does that make sense?
You need to be very careful with this.
So what should you do?
Have two lines of credit.
For example, if you have a business or an investment line of credit, and that’s $100,000, you don’t touch that. You leave it alone.
You might also have a private line of credit for your private mortgage, and it might also for $100,000.
This is where you put your wages into and you pay your credit cards from.
Ed is a founding partner of Chan and Naylor accountants and a leading property tax specialist. He has co-authored 3 best selling books. As a seasoned property investor he shares his unique understanding of the relationship between property investment and tax. Visit www.Chan-Naylor.com.au