Here’s an overview of what the debt recycling strategy involves and how it may support long‑term investment objectives.
For further reading the below two AFR articles may also be of interest…
- Why high earners will leverage shares instead of houses in new tax era
- How the rich use this tax strategy to get richer
Debt recycling is a financial strategy that gradually converts non‑deductible home loan debt into tax‑deductible investment debt.
It allows homeowners to use the equity in their home to invest, while aiming to improve their overall financial position over time.
How the Strategy Typically Works
- You make extra repayments on your home loan to reduce the non‑deductible debt.
- You then take/ reborrow these same funds back out (via ‘redraw’), to invest in income‑producing assets, thus creating investment debt, which subject to appropriate tax advice, may be tax deductible.
Clients are drawn to the strategy because they see it as a way to grow investments in a tax-efficient manner over time.
The alternative is building more equity in your home (and not investing), but then there is no deductible interest, nor is there any income or wealth being accumulated via investments.
Here is a worked example courtesy of the AFR article referenced above.
Imagine a taxpayer on the top marginal rate of 47% including the Medicare levy borrowing $300,000 via the debt-recycling strategy to invest in shares.
Assume the interest cost is 6%, and assume the shares generate 4% income, plus 3% capital growth.
The pre-tax investment loss is $6,000 (e.g. $18,000 interest vs. $12,000 dividends), and the tax refund via negative gearing is $2,820 ($6,000 x 47%).
The after-tax holding cost is therefore reduced to $3,180 (e.g. $6,000 – $2,820).
However the value of the shares rises by $9,000 (e.g. $300,000 x 3%).
Therefore the clients’ wealth in the first year increases by $5,820 (e.g. $9,000 – $3,180).
Note that if a client were to simply take money from their offset account to purchase investments (without paying down/ redrawing and repurposing any debt) then they just end up paying more non-tax deductible interest on their original home loan.
Also note that if the client didn’t pursue the debt recycling/ investment strategy at all, the $300,000 just remains in their loan or offset account, meaning they don’t generate the hypothetical $5,820 wealth boost from our example. Albeit they have not taken on any risk…
All investments involve risk, and if the portfolio declines in value (rather than generating the 4% capital growth) then the client would become worse off financially. Their wealth position would go down. Shares can be more volatile than property hence the importance of seeking sound financial advice before pursuing.
Ultimately debt recycling is a wealth-building strategy for people who’ve focused on paying down their home loan but are then open to trying to grow wealth beyond their home. Rather than getting to retirement age and not having much to show for it other than a paid off house.
Here are some important points to be aware of…
- Historically clients have used this strategy to buy real estate investments (as well as shares), however interest paid towards established residential property investments will no longer be deductible after the budget/ policy changes, hence a renewed interest in shares and managed funds.
- The impact of franking credits creates more potential upside, via larger tax refunds
- Clients require proper tax advice from their accountant before implementing, qualified financial advisers should be consulted too
- The above example shows pre-tax treatment on capital gains. If the client liquidated the share portfolio, which grew in value, then capital gains tax ‘CGT’ may be payable, reducing the after-tax benefit
If you’d like to understand how debt recycling may apply to your personal situation feel free to reach out and we can explore the various options.
We regularly work alongside clients’ accountants and other advisers to ensure everyone is aligned and to ensure the lending is structured in the best possible way.
Thanks as always for reading.
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This article provides general information only and has been prepared without taking into account your objectives, financial situation or needs. We recommend that you consider whether it is appropriate for your circumstances and your full financial situation will need to be reviewed prior to acceptance of any offer or product. Nothing on the Long Property website constitutes legal, tax or financial advice and you should always seek professional advice in relation to your individual circumstances.
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