Deducting bond interest when using an access bond facility

Jul 10, 2022 | Articles, Tax

You can use a loan re-advance against your house to purchase a rental property, and get the interest allowed as a tax deduction – it just needs to be structured properly

STEVEN JONES

ONE OF the questions most frequently asked is whether interest on a bond raised to purchase a rental property is deductible against the rent for tax purposes.

The short answer is ‘yes’, in that Section 11(bB) of the Income Tax Act provides that in cases where an asset is purchased from which taxable income is to be derived, and a loan is raised to finance the purchase of such asset, any interest incurred during the year of assessment may be deducted against the income derived from the use of such asset.

However, there is always a variation on this theme, particularly when it comes to rental properties and so-called ‘access bonds’, as the following questions from a reader indicate:

A person has bought a place to live in, but after many years the property is to be rented out for income; an access bond is almost settled with a few years remaining to repay and previously been drawn from for other purposes.

The person now wants to draw access on the bond to settle part of another bond (higher interest rate).  Can the person deduct the interest on the access amount withdrawn from the income generated?

The other property has a flat to rent and is bought to generate income from the flat.  The house on the property will now be the prime dwelling whilst the first property is rented out.  May any interest on the bond or anything else be deducted from the income received for flat rent?

The key aspect to remember is that the general principle for interest to qualify for deduction is that it must be incurred on a loan that is raised to purchase the asset in question, from which taxable income is derived.  Simply put, if you have purchased Property A as a rental income property, the loan raised must be with the express purpose of purchasing (or improving) Property A.

Clearly, if a would-be rental property investor has cash available, it doesn’t make sense from a tax point of view to pay cash for the rental property if such investor has a bond outstanding on their private dwelling, since while interest on a loan to purchase an income-producing asset is tax-deductible, interest on the loan used to finance the private dwelling is not.

However, registering a bond is expensive, and in the current climate many people would probably not be able to raise bonds with the kinds of interest rate concessions that were on offer before the current economic woes took hold.  It therefore makes sense to draw down against an access facility, particularly if such facility is readily accessible and a decent rate concession had been negotiated on the original loan.

The problem is that if the access facility is on a bond registered over your private dwelling, it would appear (on the face of it) that you have raised this additional loan for private purposes, and therefore the interest would not be deductible.  You can however structure an advance against your access bond in such a way as to get the interest allowable, by following these steps:

  • When purchasing a rental property for which finance is provided using an access bond, make it part of the agreement that the purchase price is to be settled by means of a drawdown against an existing access facility.
  • When applying to the bank for approval to draw down against the access facility, ensure that it is clearly stated that the purpose of such drawdown is for the purchase of the rental property.
  • When the funds are required to make physical payment for the purchase of the rental property, request that your bank transfers the funds directly from your access bond facility into the transferring attorney’s trust account. This also applies if you are initiating the transfer yourself electronically.
  • The costs of purchasing the property (legal fees, transfer duty, etc.) form part of the total cost of acquiring the asset, and therefore interest on any loan raised to cover such costs will also be deductible. Such costs are also added to the ‘base cost’ when it comes to calculating the taxable capital gain when such asset is disposed of.
  • Draw up a spreadsheet that calculates the interest portion of the outstanding amount of the loan, ensuring that you use the same basis of calculation (interest rate, capitalisation of interest, etc.) as your bank does. Make sure that the initial capital amount corresponds to the amounts physically paid for the purchase of the property, and don’t forget to take into account any interest rate fluctuations.
  • Wherever possible, obtain all loan conditions as well as any changes to such conditions (e.g. interest rate adjustments) from your bank in writing.

The purpose of the above is to be able to prove your claim for an interest de-duction to SARS, should this be required.

Remember to keep such calculations and supporting documentation for at least five years, as legally required by SARS.  It’s in fact probably a good idea to keep such records indefinitely, since you will need them when it comes to calculating Capital Gains Tax on the property at a future date (whether this is due to death, donation, or disposal).

When making repayments into the bond account, and part of the total outstanding balance relates to your private dwelling, it is more tax-efficient for you to pay off the ‘private’ part of the loan capital first, since the interest on this portion is not tax-deductible.

For example, if you owed R300 000 on your house bond and then took an advance of R900 000 to purchase the rental property, make sure that any capital repayments are specifically allocated to the private portion first.

Obviously, once the private portion of the loan is settled, any further repayments need to be offset against the loan amount relating to the rental property, which will result in a reduction in the interest charged (and thus claimed).  However, don’t let tax deductions deter you from repaying the loan—as I have said numerous times in the past, it never pays to spend R1 in order to save 45 cents in tax!

 

Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.