Tax-effective investing generally requires an element of borrowing funds – which is commonly known as investment gearing, and can be a powerful strategy for wealth creation when done correctly. Under the right conditions, it can not only magnify returns but also offer attractive tax benefits. In this piece, we explore how borrowing to invest can have tax-effective elements, compare the various types of investment loans currently available, and how investors may consider incorporating tax-effective strategies into their portfolios.
What is Investment Gearing?
Investment gearing involves using borrowed money to invest in income-producing or growth assets, such as equities, property, or managed funds. When borrowing to invest, the objective is to invest in assets that generate returns in excess of the investment costs associated with the borrowing.
Tax-effective investments include elements that are tax deductible, which reduce the investors taxable income. These deductible borrowing expenses are generally interest payments, and any applicable fees.
Borrowing funds to build wealth is not a new concept, most homeowners had to borrow funds to allow them to acquire their home, and in a rising property market, the homeowner is able to magnify their gains thanks to the leverage created by the loan. Most jurisdictions, including Australia, don’t allow tax deductions on the costs associated with loans on your principal place of residence, but for investment purposes, it is generally possible to claim a deduction for the costs associated with an investment loan.
Types of Investment Loans
The most common types of investment loans in Australia are property investment loans, and equities margin loans, both of which provide leverage and offer tax-effective elements, such as deductible interest costs, and fees.
All investment loans feature a Loan-to-Value (LVR) ratio, which is the maximum amount investors can borrow as a percentage of the amount of collateral, or security, they’re able to pledge to the lender.
Investment Loan Risks
One of the greatest risks associated with borrowing funds for investment purposes, is the risk that the underlying asset falls in value over the investment term.
In the case of a property investment loan, this becomes an issue if the investor needs to sell the property for any reason, in which case, the investor would be liable for any fall in the property’s value.
With an equities margin loan, if the value of the shares in the margin account falls to a level that breaches the maximum LVR, the investor is required to deposit funds, or sell shares, to bring their loan back to an acceptable LVR – this is known as a margin call.
Anadara’s limited recourse loans do not expose investors to downside risk – the risk is limited to any interest + fees paid only (which are tax-deductible). The limited recourse nature of the loan prevents the lender from pursuing the investor for any fall in the underlying assets value.
ATO Product Ruling 2024/6
Anadara, with its tax advisors who worked collaboratively with the Australian Tax Office, obtained a product ruling for Anadara’s tax-effective investments, and were issued with Product Ruling 2024/6, which confirms the deductibility of interest and fees, and also the benefit of CGT discounting on any gains on investments that are held for over 12 months providing the investment is structured in a manner consistent with the Master Information Memorandum.
Benefits of Borrowing to Invest
The tax-effectiveness of a geared investment largely stems from one key benefit: Investment Cost Deductibility
If the borrowed funds are used to invest in assets that generate assessable income, the costs of the investment, such as interest and any fees, are typically tax-deductible. This has the ability to reduce an investor’s taxable income, especially beneficial for high-income earners. Consider the below hypothetical example:
- An investor borrows $100,000 at an interest rate of 5% p.a.
- Annual interest cost: $5,000
- If the investment generates $8,000 in income, the net profit is $3,000
- The $5,000 interest may be used to reduce the investor’s taxable income, potentially leading to a tax refund depending on their marginal tax rate.
In this example, excluding the benefit of any tax deductions, the investor paid $5,000 to generate a net return of $3,000 – or 60% on the investment cost, this is where the power of leverage becomes clear.
100% LVR Investment Loans
Anadara’s limited recourse loans allow investors to borrow the entire investment amount, potentially making the product attractive to investors that want leveraged exposure to markets without tying up large sums of capital. Anadara requires investors to pay the interest and any fees upfront, which is tax deductible, and the maximum amount at risk.
Investors use tax-effective investments not only to grow wealth but to manage their overall tax position. We typically see an increased level of interest in tax-effective investments towards the end of each financial year, at the point investors tax liability for the year starts to become clearer.
Anadara’s tax-effective investments are available to all Australian investors, and we encourage anyone interested in investing in one of our tax-effective products to discuss the suitability of our products with their Financial Advisor, or Accountant. It’s important that investors always read any offer documents in full before choosing to invest, and these documents include any relevant PDS or IM, and Target Market Determination.
Summary
Borrowing to invest can be a highly effective way to build wealth and manage tax liabilities—but it’s not a strategy that is suitable for everyone. The use of 100% leveraged loans adds another layer of complexity and risk, making professional advice essential. When aligned with financial goals and risk tolerance, tax-effective investments can play a crucial role in a well-rounded investment strategy.
If you’d like to discuss tax-effective investing with us,, please book a time for someone from our team to speak to you.
As with any financial product, understanding the features, benefits, and risks is key to making an informed decision. We highly recommend that investors speak to their professional adviser before choosing to invest in any of our products.
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