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Real Estate Tax Leverage

Discussion in 'Accounting, Tax & Legal' started by Michael_Johnson, 16th Feb, 2009.

  1. Michael_Johnson

    Michael_Johnson Member

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    Hello,

    I was wondering if someone could share an effective tax strategy that allows me to put more money back into my pocket regarding rental properties.

    My partner and i are looking to invest within the next 3 - 6 months, and require a tax strategy. I have heard you can set up offset accounts and claim the interest on the loan and place it within the offset account.

    I was also told that you keep the loan at its highest so you can claim the most interest back. Im not sure if this is a good strategy, and am unsure about where i can further research these options (failing my accountant).

    Thank you for any input given.
     
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    There's lots of good books around about real estate investment, and most of them should have a section on taxation of rental property income and how to structure things to maximise the benefits.

    In general, I prefer IO loans with an attached offset account - don't use redraw facilities (unless you only ever use the redrawn money for investment purposes).

    Use all income to pay down non-deductible debt first (credit cards, car loans, and then your PPOR, in that order). Because you don't get a tax deduction for non-investment loan interest, that debt is costing you more that you would save by paying it off an investment loan ... so get rid of the non-deductible debt first!

    The key thing to consider is that you should be investing primarily for positive returns - not for tax minimisation - the tax benefits are a benefit, not the end goal. Too many people make poor investment decisions because they are only considering how much tax they can save, but possibly end up worse-off in the longer term if their investment doesn't perform well.

    There's other things you can take into account too - newer houses generally have lower holding costs (less maintenance) and higher depreciation (tax benefit!), but there's more scope for buying well and adding value with older properties - so it does depend on your strategy. Even with an older property, there may well be fixtures which can be depreciated (kitchen, HWS, roofing, etc), so it may pay to get a depreciation report done for your property.
     
  3. Michael_Johnson

    Michael_Johnson Member

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    Thanks Sim.

    My partner and i are looking at IO loans, offset account and were going to consider redraw once we increased the equity through renovations.

    Our investment strategy is to do demographic searches and try to see where the flow of people is going (Low supply high demand), add value through renovations once we find the property (using our checklist we got from an investment course), if it cannot have value added, we look to see if it is going to be a capital gains property or just cashflow.

    The other part of our strategy was to do what you said (paying down the cards and PPOR). I dont own cards, i personally hate the things. My partner uses them, within reason however.

    I couldnt agree more with the concept of positive cashflow property. Its what i have been aiming for for a while now. Whether it was through real estate or buying businesses, i have always been hungry for positive cashflow. Didnt see much point in negative gearing and such. My brother does that, and i dont really understand why. He just said his property was there for tax purposes. ??

    We want to have cash cows - lots of them. As soon as we make our work life a choice the both of us will be very happy.
     
  4. Billv

    Billv Getting there

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    MJ
    Be careful because as soon as interest rates rise your positive cash flow property will become -ve so you will have to feed that cow throught the long wintery days.....
     
  5. Michael_Johnson

    Michael_Johnson Member

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    BV: We will try not to bite off more than we can moo :)

    Im assuming its difficult to fix an investment loan at the current rate. I dont know, ive yet to apply for one.

    We want to try and achieve a property per year. I know some people go harder than that, but we are a bit more realisitic in terms of what we can afford and such.

    With the loans, we will just have to chew into them until they become positive or better still, buy them when they are positive. Starting with small real estate deals - units or apartments as an example. The demand for rentals at the moment is quite high, and we were also considering using a contact to purchase mortgagee sales.

    Im still trying to find the right balance in knowledge. Out of all the investment vehicles, i feel property is the right one. Just have to find out how to make it work.
     
  6. Billv

    Billv Getting there

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    MJ

    I've also been thinking of fixing some of my loans but the fixed rates are not very competitive.

    I'm interested in 10 years or more and hoping for something under 6 %
    but it's not looking good atm
     
  7. dudek

    dudek Well-Known Member

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    BV, RBA indicated last time at the meeting that they will slow % reduction so we can be confident to see few reductions this year Saying this I think % will hold at low levels for some time. The sooner you fix the less time you will benefit. I know is hard to time these things but fixing while we still have some juice left can be a bit premature.
     
  8. Billv

    Billv Getting there

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    good point dudek
    cheers
     
  9. Michael_Johnson

    Michael_Johnson Member

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    I suppose its about seeing how low it can go, and then basing your call as close as possible to the lowest point. Kinda like i buying a share for a trade - buy at its lowest, and ride the wave up - however, you dont want your loan to go up too much.

    5% is still a pretty good deal. Dont know if its greed or not, but i would be pretty happy with either 5% or even 4%+. In either case, its still better than the 7% or 8% that people fixed their rates at.
     
  10. dudek

    dudek Well-Known Member

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    Yes, I am one of “these people”. I locked 50% of my mortgage at 8.5% But I did it to half of it so either up or down movement of interest will benefit me. I am missing on full benefits of the lower rates but then again I still get 50% of it. I planned it with my budget so I don’t cry poor as all was a calculated risk.
    Fixing rate at 100% of you loan can also mean you are locking your assets and getting out of contract can be sometimes painful. You always have to read “fine print” as I believe many contracts will prevent you from paying additional lump sums. I think 10K per year max. So in case you need to improve your cash flow you could pay off remaining 50% without selling property. Perhaps getting new loan and topping the 50% without breaking the contract? Combination are endless but all scenarios must be taken into consideration.

    As of the rate, official RBA stand in inflation is 2-3% per year. If you can get close to 4% you are the winner!!!! However, I would encourage everyone anticipating locking rates to do some risk study and perhaps live at least 25% on variable rate. During the high inflation periods you will perform quite well even if part of the loan is exposed to higher rates.
     
  11. Michael_Johnson

    Michael_Johnson Member

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    "paying additional lump sums"

    I didnt realised you could be penalised for paying more of the money back! Would of thought the banks would be happy to get there money back. Of course, loans are investments to them.

    Is there a different type of loan for every investment goal i wonder? Like is there a time to use split loans vs variable vs fixed? Or is it merely a matter of choice and what you would actually prefer in a loan?

    Cheers.
     
  12. dudek

    dudek Well-Known Member

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    I am sure bank will be happy to get away from low interest rate arrangement when market rates are higher. :D
    If you pay more that you should on already low interest loan their profits are shrinking even more. I was also referring more to the fact that every time you terminate the contract and/or apply for new, some fees may apply regardless. Each time you terminate the contract they are loosing potential client and all profits associated regardless how big or small profits are. You may meet half way if you are still staying with them but when you gone they will chase you for the last penny. As of the different types of loans there is no silver bullet. As mentioned before fixing 100% of your money can come very uncomfortable at times and it does not work for me. You have to do your own homework and model it around your life style. You have to shop around for best loan model to work for you and no one can know better than yourself. I am using St. George portfolio loan. I decided to do so after one of my friends paid over 4000K for “financial consultant” to reconcile finances for them. Consultant charged fees and I must say they are no better off. Credit card with one bank, loan accounts with other etc… Refinancing should work on the paper but in reality they can’t keep track of their finances as it is scatted across of many places. I walked to the branch and did the same for fraction of money and I am happy with having all in one place. When I sit with my bank manger I say: “ c’mon, with portfolio of this size you can do me better deal” :D
     
  13. Michael_Johnson

    Michael_Johnson Member

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    True that. They tend to like you more when you have a good repayment history with a sizeable debt ratio. :D

    I realise its all about my own financial goals and such. I have read that many books on investing, even bought the nice 1500 dollar courses and such. They all sound so similar, yet so different in what they are saying.

    The way i see it, if i can pay less interest and end up with more in my pocket, thats a good thing. If i have to pay more just to have the property in the first place and its going to go into negative, i dont really want to bother with that. Im very much about positive cashflow, even if it is just 50$ a week.

    Edit - according to the ATO, i can claim back all the interest. Thats really comforting to know.

    When it comes to the tax side of things, there are still some things i need to clarify. Like for instance, you can only claim so much of the interest, i was told it was something in the 40% vacinity. The people i would go to talk to about this, cost a fair bit of money. Not to mention the day i had an appointment with them, i lost my job. Still bad form for not contacting them.

    Needless to say, if i can get a good rate, fix it in, know what my repayments are every month, and gear the property in a fashion that allows me to have income in my pocket, i dont really mind. I have often put too much thought into things, but in some cases, have put just enough. I just need to have enough money in the offset account, to offset the interest (Funny that), so that the property returns maximum value. (Yay for savings). :)
     
    Last edited by a moderator: 18th Feb, 2009
  14. dudek

    dudek Well-Known Member

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    Yes it is nice to make profit instead of loosing money but…. Sometimes you have to loose battle to win the war. Higher yields are usually linked to lower capital grow. While getting $50 p/w extra in your pocket is nice but will not make you any richer. Higher capital grow can potentially offset your negative gearing losses over the time. Again it is matter of balancing your cash flow.

    I am not an accountant so I can't advise you on tax matters. I can only go as far as advising you to get a good accountant whom you can "click" with.
    Also, many people are confusing accountant with financial adviser. Accountant is just getting your papers processed. He does not need to tell you what to do how to do. Information must come from you so he can process it. Yes, he/she can give your tips but will not make financial decisions for you. Ultimately is up to us to get educated enough to make good decisions.
     
  15. AsxBroker

    AsxBroker Well-Known Member

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    Hi DudeK,

    Sounds like your busting your lending manager for a better deal...

    Good work!

     
  16. Jacque

    Jacque Team InvestEd

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    You might want to seek some advice from your property-savvy accountant (I hope you have one!) and also broker about the type of loans you're planning to take out. If you're aiming to achieve positive cashflow properties from Day 1 then borrowing IO is going to make a big difference here, as well as maximising your cashflow. Paying IP's off (P and I) is usually only recommended if you've paid off all or most of your PPOR (if you have one). Remember that the IP loan interest is tax deductible after all, which may make the difference between a neg and positive geared property as well.

    Curious about your "using a contact to purchase mortgagee sales"? Don't automatically make the assumption that MIP sales/auctions constitute a bargain. I've been to many an auction where this was just the opposite, and buyers overpaid what they would have had the property been a normal PT sale.
     
  17. Michael_Johnson

    Michael_Johnson Member

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    I know there is a lot of ground work to be done and still a lot of other things that need to fall into place (Stability in work, quality relations with brokers etc). In terms of accountant, i have one. I also have another, through a friend, that managers her fathers accounts. In terms of a finance broker, am still looking for one. I was going to use one that was linked to the real estate course i did, but for one reason or another that hasnt happened yet.

    With the PPOR we were going to buy out my partners mum and use that as the equity. She is currently 62 and has a property with a mortgage of 245000 approximately. After paying down our small debts, were going to help her out and give her a break. She had a messy divorce and a long story short, got screwed. When it comes to properties, i have about 3 checklists that i got from momentum wealth that will aid my partner and myself in finding an appropriate IP.

    Like i said, i know there is a hell of a lot of research that needs to be done and the list of contacts we need is large. But im willing to work at it, im willing to take a bit of a risk. Of course, it will be an educated risk and not a blind freddy leap. When it comes to the figures, im confident that we can work it in the way we would like.
     
  18. Jacque

    Jacque Team InvestEd

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    Hi Michael

    I'm sure there's ppl on here who can recommend a good accountant and broker for you. If you don't mind dealing with an interstate broker let me know and I'll pass you on the details of my personal broker who is, in my humble opinion anyway :D, simply the best at what he does.
     
  19. Michael_Johnson

    Michael_Johnson Member

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    Im still trying to figure out what i want.

    Thanks for helping out though, i will get in contact if i need that service. You've all been very helpful. Thanks.
     
  20. Michael_Johnson

    Michael_Johnson Member

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    Hello,

    I just returned from a 3 week trip in Canada. Had a good amount of time to think about what we were going to do.

    As it stands, we are buying the property off of my partners mum. We will go 3 ways in it, change the title down the track and make a substantial capital gain on the property.

    This will then move us into our second phase, which is simply to purchase 1 property per year, over the next 20. Our strategy is long term, which also has in it a savings strategy.

    My wage will be going straight onto the house, and we will be living off of my partners wage. Which is really good, mainly due to the fact that i dont have to think so hard about what to do with my money.

    All i know is that it will take approximately 60 months to pay off the house with 4000 dollars as the main payment per month. Every other bonus that i receive will go straight onto the house again.

    My partner will be saving 1/4 of her wage, paying down my monthly expenses as well as her own, and it seems at this point that things are looking very positive.

    We have 5 debts in total that need to be rid of, the main concern has been the property, mainly due to the fact that it hasnt been paid in a few months. So naturally, that is the first to go. All other debts will pay themselves off over time.

    At this point in time, i am happy with the strategy. Its simple, cost effective, and is all relative to work performance. So thats really all i have to worry about, just plain and simple work performance.

    In regards to the broker, i would like to get one. I dont mind dealing interstate, provided that they are good at what they do. We will more than likely look to invest in maybe 2 years, its just a matter of getting the leverage in the house up and running before we do that.

    So yes, nice to be back home, Australia is an awesome country.