I have a hypothetical question (i.e. I am not seeking personal tax advice) about using a home equity loan for investing and would greatly appreciate your replies to this. I have simplified my numbers and have not considered repayments (which complicate things) in the following explanation and question:
My understanding is that a home equity loan can be used as an investment loan when the money is applied to income producing purposes (shares, saleable assets etc). As such, the loan interest for the portion of the borrowed funds applied to income producing purposes is tax deductible. In other words, if a person took out a $500,000 home equity loan (line of credit) and used $250,000 to purchase a home and the remaining $250,000 for income producing purposes, then half of the loan interest (say rates at 10% for the purposes of this example) would be tax deductible. So, the person could claim $25,000 as a tax deduction - just like the tax deduction for interest on an investment loan of $250,000. Assuming the person has a really big salary (once again, for simplicity) and pays 50% tax on a reasonable whack of it, then this would represent a saving of $12,500. In other words, the $250,000 used for income generating purposes was effectively borrowed at an interest rate of half of the loan interest rate (5%). My understanding is that this is correct. Any comments on this? It is covered in tax ruling TR200/2. Now taking this to another level:
If the $250,000 was drawn and placed in a term deposit (i.e. income producing purpose) earning 12% interest (the key thing is that it is higher than the interest rate on the loan) then this interest earned would be subject to the persons 50% tax rate and thus end up being 6% after tax. As such, the person has made a profit of 1% on the $250,000 ($2500) just for taking a bigger loan than they needed and using half of it for income generating purposes. Obviously this only works if the person can access a term deposit that pays a higher rate of interest then the home equity loan, and managed to secure such a loan in the first place. My questions are: is my understanding correct? Can it be done this way? Wouldn’t this be particularly attractive if this person had a low fixed-rate home equity loan and could access safe income-producing high-rate term deposits?
Perhaps this is too good to be true or I have made an obvious error in my understanding; hence this post. My thanks to those who take the time to reply.
Happy New Year.