Lenders Mortgage Insurance (LMI) is often an unavoidable cost for investors with a smaller deposit, but its impact on your tax deductions is a crucial consideration. Under Australian tax law, LMI premiums are considered borrowing expenses and can be claimed over a period of five years, provided the property is used to produce assessable income.
When you pay LMI, it essentially protects the lender, not you, in case you default on your loan. However, because it's a cost associated with obtaining finance for an income-producing asset, you can claim it as a deduction over five years. This is specifically under the borrowing expenses provisions, which include costs incurred to secure a loan for investment purposes.
A common misconception is that LMI can be claimed in full in the year it is paid. However, the ATO requires that borrowing expenses, including LMI, be spread over a five-year period or the term of the loan, whichever is shorter. This means if your loan term is three years, you would claim the LMI over three years instead of five.
To see how this plays out, consider a scenario where you purchase a $700,000 investment property in Melbourne with a 10% deposit. Your LMI premium might be around $15,000. For tax purposes, you can claim $3,000 each year as a deduction over five years. At a 37% marginal tax rate, this results in a tax saving of $1,110 per year.
In our experience reviewing thousands of properties across Australia, many investors overlook LMI as a deductible expense. They often focus on immediate costs like interest and ignore the long-term benefits of spreading borrowing expenses. Additionally, some investors fail to adjust their claims when refinancing or selling the property, potentially missing out on deductions.
The answer can differ depending on your situation. For instance, if your property is not income-producing, LMI is not deductible. Also, if you refinance your loan, the unclaimed portion of LMI related to the original loan generally becomes immediately deductible. Similarly, if you sell the property before the end of the five-year period, you may claim the remaining LMI deduction in that year.
Given that LMI deductions depend on individual circumstances, consulting with a Chartered Quantity Surveyor and an accountant is crucial. They ensure that all borrowing expenses are correctly claimed and aligned with your overall tax strategy.