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When managing your mortgage or investment loan, the structure of your loan matters just as much as the interest rate. A common pitfall I see among clients is the use of a Line of Credit (LOC) as their main loan account — often with the best of intentions, but with serious tax consequences down the track.

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Let’s break down why this can be a problem, particularly from a tax perspective.

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LOCs and Loan Purpose Tracking

A Line of Credit is a flexible facility that allows you to deposit and withdraw funds at any time, much like a bank account. This seems convenient — and it is — but it comes at a cost when it comes to tax deductibility.

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Here’s the issue:
Each time you repay part of the loan, it’s considered a permanent reduction of that loan. Each time you redraw or withdraw funds, it’s considered a new borrowing. That distinction is critical.

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For example, if you initially borrow $100,000 to buy a home and then repay $1,000, your loan balance becomes $99,000. That $99,000 is still tied to the original purpose — buying the house.

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However, if you later withdraw $100 to pay for groceries, your loan is now mixed purpose:

• $99,000 relates to the home purchase (possibly deductible if the home becomes a rental), and
• $100 relates to private use (never deductible).

As time goes on, if you're regularly depositing income and withdrawing for private expenses, your loan purpose becomes increasingly muddled. Eventually, even if the balance is $80,000, none of it may be tax-deductible if you decide to rent out the property later on. The original use of the borrowed funds has effectively been erased.

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The Long-Term Tax Implications

Why does this matter? Because the tax deductibility of interest depends on the purpose of the borrowing. If you can no longer demonstrate that the funds were used to acquire income-producing assets, the ATO may deny your interest deduction.

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Many debt reduction strategies in the past promoted using a LOC as a transaction account — with income going in and living expenses coming out. While this may help reduce your loan faster, it complicates your ability to claim tax deductions in the future.

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A Better Alternative: 100% Offset Accounts

If your goal is to reduce interest while preserving the tax integrity of your loan, a 100% offset account is a far superior choice.

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An offset account allows you to:

• Deposit your salary or business income to reduce interest costs
• Withdraw money freely without affecting the purpose of the original loan
• Maintain a clear link between the loan and the asset it funded (e.g. your home or an investment property)

From a tax and compliance perspective, this is the best of both worlds: flexibility with no messy records or recharacterisation of borrowings.

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When is a LOC Useful?

LOCs do have their place — particularly for accessing equity for investment purposes, such as buying shares or another property. In these cases, they can provide a convenient way to draw funds for a clearly defined investment activity. The key is to keep the purpose clear and separate from personal or everyday use.

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Final Thoughts

If you’re a homeowner or investor, the way your loans are structured can significantly affect your tax position. Avoid using a Line of Credit as your everyday account. It may seem like a good way to reduce debt quickly, but it can create long-term complications, especially if you want to convert your home into a rental later on.

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At Plan Tax, we help small business owners and individual taxpayers make smart financial decisions that align with both their goals and the ATO’s requirements. If you're unsure about your current loan structure or planning to invest, let us help you get it right from the start.

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Contact Plan Tax today to schedule a consultation and get personalised advice that supports your financial future.