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Does more rent mean less income?

Discussion in 'Accounting, Tax & Legal' started by WannaInvest, 6th Feb, 2011.

  1. WannaInvest

    WannaInvest Member

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    Hi
    I am looking at my first investment property that has rental yield close to the interest liability (7%+). Due to good rental yield I wouldn't be able to negatively gear the investment/income. If the property does not appreciate in value, would this proerty not add any value to my kitty? As i understand only interest component is tax deductible--paying off the capital would mean diverting that money from my principal residence mortgage repayment. Effectively I would just be paying the interest--like running on the tread mill--not going anywhere. Is my understanding correct or am I missing something here?
    Will taking an investment loan to repay the investment property and capitalising interest add any value?
    Look forward to views of more enlightened members...
    WannaInvest
     
  2. Billv

    Billv Getting there

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    WannaInvest

    Welcome to the forum.
    Even if the property doesn't increase in value overnight, it will eventually due to inflation. Its just a matter of time.

    What makes you think it won't increase?
    Where is the property and is it a unit?
     
  3. WannaInvest

    WannaInvest Member

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    Many thanks for your reply Bill.
    This property is indeed a unit and in Wiley Park NSW. I was being conservative in assuming zero capital growth.
    However, the operative part of my question was twofold, and more conceptual than specific in nature: a) in principle, can earning more rent mean less profit (due to no-negative gearing); and b) can line of credit kind of approach with interest capitalisation help in such situations?
    Look forward to hearing furhter on this matter...
     
  4. Evan

    Evan Member

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    assuming the same capital growth then more rent = more income.

    Negative gearing is simply reducing your tax payable by offsetting losses. If you negative gear and claim a $1,000 you will recieve a deduction of (1000x Marginal Tax Rate). In the top tax bracket this is still going to be <$500 meaning you are still out of pocket $500+. Negative gearing is only effective if capital growth exceeds the losses. If your property is not profitable when positively geared, it won't be profitable negatively geared.
     
  5. WannaInvest

    WannaInvest Member

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    Thanks Evan. Makes perfect sense...sometimes you need an expert to make you understand the obvious!!
    Any word on the line of credit approach?
     
  6. Evan

    Evan Member

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    From what I understand you are interested in the difference between paying the interest regularly or letting it capitalise?

    The only real difference I can see of the top of my head is that in that if you let the interest capitalise then over time the investment loan will increase and essentially the interest on the interest is going to be deductible. I would assume that avoiding tax must not be the sole reason for capitalising interest for it to fly with the ATO.

    Don't forget to consider once again, the deduction isn't going to cover the whole of the amount so it wouldn't be beneficial unless you had the money you didn't pay as interest working somewhere else.

    A quick google search came up with a booklet on Tax Claimable Loans. I haven't read it but it looks like it would be of help to yourself:
    http://www.bantacs.com.au/booklets/Claimable_Loans_Booklet.pdf
     
  7. WannaInvest

    WannaInvest Member

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    Thanks again Evan. much appreciate your response, am downloading the document will have a look at it shortly.
    Will try to explain the idea behind LOC as I understand from an expert's advice on TV some time back: take an investment loan to pay off the interest on the investment property and use the rent from it to pay your principal residence mortgage by depositing it in your offset account. Claim tax rebate on the LOC outlay and top the account up annually when you get tax refund. The expert on TV did warn though to seek advice regarding this as under some cicumstances this sort of structure is frowned upon by ATO. Hope i have understood the plan correctly (and explained it here adequately) and that it is legal.
    My assumption here is that there is no law or rule that prohibits one to use rental income to pay towards your own mortgage before using it to pay off the loan for the rental property it is coming from.
    Hope this makes some sense...
    Thanks again for your comments.
     
  8. Evan

    Evan Member

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    Using rental income to pay off your primary home is a pretty common strategy and there are no rules preventing you from doing so. An interest-only loan for your investment would be the best way to minimise the amount you pay towards the investment (allowing more cashflow for your own home). The concept of the strategy is to reduce non-tax deductible debt (your home) before debt with any tax advantages (the investment). Using the offset account would allow you to withdraw the funds from the offset in future so that makes sense.

    I've not heard of using an investment loan to pay the interest before though, I would think some lenders would be a bit cautious of lending so you can pay interest on existing debt but otherwise the strategy makes sense.
     
  9. WannaInvest

    WannaInvest Member

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    Thanks very much for your views. The pdf you sent the link to was quite helpful too.
    Drawing a separate loan to pay off interest on your investment property is a strategy many people seem to use, though not widely popular. One needs to be a bit cautious--the primary purpose of using this strategy should not be tax saving. Paying off your mortgage early is a valid motive, which this strategy may contribute to. You must confirm this with your accountant first. This is what i concluded from my last couple of days research.

    Btw what is general view about investing in units in Wiley Park?
     
  10. Rod_WA

    Rod_WA Well-Known Member

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    Search for 'debt recycling' (both here in Invested and in Google).

    As Evan says, negative gearing is a means to an end, and inherently involves negative cashflow (a loss) each year. The end game is capital growth and positive cashflow, where rental income and other benefits (eg tax refund due to interest and other deductible cash outflows) exceeds outflows.

    The key to this and any geared investment is to understand the cashflow and ensure that you can meet cash outflows when they are due (interest, land tax, strata fees, council and water rates, maintenance, property management fees, letting fees, etc). Keep in mind that the tax refund comes but once a year.

    You must also allow for future interest rate rises and periods of no tenancy.

    A 7% rental return is 'very attractive' (almost positively geared from day one)... so what is too good to be true here? How sustainable is the rental return? Is it consistent with other properties in the area? Typical median rental yield for Sydney is 5%. http://www.rpdata.com/press_releases/aussie_dwelling_values_tread_water_in_december.html
    (Put it this way, why not buy 100 of these and retire in two years?)
     
    Last edited by a moderator: 10th Feb, 2011
  11. Hillview

    Hillview Member

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    Negative gearing

    Just because it makes good rent may not also mean it is not making you a tax loss. In the early days of the purchase, as long as you buy a unit that is new enough to use the building allowance deductions, then you will still have tax losses as you have the 2% building allowances, depreciation, and interest claims, as well as the property expenses.
     
  12. WannaInvest

    WannaInvest Member

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    thanks Rod and Hillview...
    i am getting a better understanding of the issues now...thanks for your responses!