Warning: Redrawing Investment Loans

Thinking about redrawing from your Investment Loan? While convenient, this action can permanently destroy your ability to claim interest deductions, according to the ATO. This urgent guide explains why redrawing violates the core tax principles and provides safer alternatives (like an Offset Account) to safeguard your tax benefits. Don't let a small mistake lead to massive financial losses in your investment portfolio.

Is it a good idea to redraw from investment loans ?

I. Core Concept Explained: Redrawing and the ATO

To understand the risk, Australian investors must first grasp the core definitions used by the Australian Taxation Office (ATO).

1. What Exactly is Redrawing?

Redraw is a feature allowing you to pull back extra principal repayments you have made on your home or investment loan. When you redraw, your total loan balance is increased by the amount you take out.

1. The ATO's Golden Rule: The Purpose Test

The ATO's golden rule for claiming interest deductions is crucial:

Interest deductibility is always determined by the purpose for which the borrowed money is used, not the asset that secures the loan.

• If the funds are used for an Investment Purpose (e.g., a rental property), the interest is tax deductible.

• If the funds are used for a Private/Personal Purpose (e.g., a holiday, new car), the interest is non-deductible.

II. The Severe Tax Risk: The Mixing of Funds

This section details the critical failure that occurs when you redraw an investment loan.

2.1. The Mixing of Funds Problem

The issue arises when you redraw money from an existing Investment Loan (which is fully deductible) and use those funds for a Private/Personal Purpose.

• The Consequence: The original, clearly defined investment loan becomes 'mixed' or 'tainted' by a personal purpose.

• ATO Requirement: You are now required to apportion your interest payments into two parts: a deductible portion (for investment) and a non-deductible portion (for private use).

2.2. Permanent Loss of Deductibility

Once the redrawn funds are used for a private purpose, the interest corresponding to that portion of the loan permanently loses its tax deductibility status. Importantly, repaying the redrawn funds later does not reverse this loss of deductibility in the ATO's eyes.

2.3. The Complexity of Apportionment (Calculating the Split)

The calculation needed to comply with the ATO is highly complex and error-prone, requiring continuous tracking:

Non-Deductible Interest = Total Interest Paid x (Amount Redrawn for Private Use / Total Loan Balance)

Because the Total Loan Balance (the denominator) is constantly changing, manually tracking this calculation year after year is extremely difficult, significantly increasing the risk of incorrect tax returns.

2.4. Consequences of an ATO Audit

If the ATO audits your affairs and rejects your apportionment calculation, the financial penalties are steep:

• Back Taxes: You must repay all tax previously saved through incorrect interest deductions.

• General Interest Charge (GIC): A high, daily compounding penalty interest rate applied to the back taxes.

• Penalties: Fines for false or misleading statements, which can range up to 75% of the tax shortfall.

III. Safer Alternatives for Investment Loans

To maintain liquidity without compromising tax compliance, investors should opt for these safer banking features:

3.1. Offset Account

Benefits	Tax Safety
Interest Reduction: Cash in the offset account is netted against the loan balance daily to reduce interest paid.	Extremely Safe. Money is drawn from your cash balance, not the loan principal. It does not alter the loan's original investment purpose.

3.2. Loan Split (or Splitting the Loan)

• Mechanism: Separating the original loan into two or more distinct loan accounts.

• Tax Safety: If you need funds for personal use, you arrange a new loan split for that specific, non-deductible purpose. This keeps the original investment loan clean and fully deductible.

IV. Conclusion and Actionable Advice

The convenience of Redrawing from your Investment Loan is simply not worth the permanent tax risk. Mixing private and investment funds is the costliest mistake you can make with the ATO, leading to permanent loss of deductibility and severe penalties.

Gordon Q.C Du advises: To safeguard your assets, you must cease using the Redraw facility immediately for all personal expenses. Instead, opt for a secure Offset Account or arrange a Loan Split. If you have ever redrawn funds privately, contact your Tax Accountant today to review your loan structure and mitigate costly ATO penalties. Act now to protect your investment strategy!