A common, yet risky, investment strategy used by share investors has been to borrow money, usually via a margin loan, to buy shares.
Borrowing is a good strategy in a rising market, but it can multiply any losses in a falling market. The last thing you want is a loan to repay but no shares to show for it. Don't consider borrowing if you are new to investing.
Just like the tax rules for investment properties, if you borrow money to buy a share portfolio, you can claim a tax deduction for the loan interest, provided it is reasonable to expect that assessable income (dividends or capital gains) will be derived from the share investment. If the loan has a private component, you will only be able to claim interest incurred on the part of the loan used to acquire the shares.
The benefit of such a strategy is that the interest expense should offset any dividend income received, resulting in franking credits that can be offset against other taxable income.
Hopefully the shares increase in value under this strategy and any capital gains are only realised in a later year when the taxpayer is on a lower tax rate, for example, in retirement.
If you expect to earn a lower income next tax year (for example, due to redundancy or maternity leave) an excellent strategy to consider is prepaying interest 12 months in advance before year end on your margin loan to maximise your tax deduction based on the higher marginal tax rate.
Borrowing expenses (such as establishment fees, legal expenses and stamp duty on loans) may be claimed for tax purposes. If borrowing expenses are more than $100, then they must be apportioned over five years or over the term of the loan, whichever is less. Borrowing expenses under $100 are fully deductible in the year incurred.
For a borrowing strategy to work you need to get a return greater than the cost of the interest rate that you are paying (which is generally at a premium for margin loans), otherwise you are falling further behind despite receiving the tax benefi ts. Remember the ABC motto: Absolute Bloody Cash!
Some investors use a capital protected borrowings strategy, where shares are bought using a borrowing arrangement where the borrower is wholly or partly protected against a fall in the market value of the investments.
Any interest paid for capital protection under a capital protected borrowing arrangement for shares is not deductible but instead is treated as if it were a payment for a put option.
While there was a change in the laws in September 2007 that made it possible to borrow within self managed super funds, special rules apply. Seek professional advice on how to structure such a borrowing to avoid any contravention of the complex superannuation rules.