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Thinking through some ideas

Discussion in 'General Investing Discussion' started by smeggett, 2nd Jul, 2007.

  1. smeggett

    smeggett Member

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    Hi there all,

    I have been pondering a few ideas for kick-starting some property investment, and wouldn't mind some general feedback as to whether the ideas are sound or otherwise...

    So here goes with some background first:
    I have dabbled in shares (pretty much now those companies which dig stuff out of the ground, since this is what I understand and is the industry I work in) over the past few years and currently have a portfolio worth ~$110k. Have recently taken out a margin load to boost the portfolio with some higher cost blue chip shares, without going overboard - looking at a loan of $60k to keep the LVR conservative as this is my first foray.

    I purchased a PPOR about 18 months back (cost: $200k, loan outstanding ~$132k) which at current market prices would be worth in the high $200's.

    I would like to convert the PPOR to an IP by rolling over the loan to an interest only type affair (should be able to achieve $250 to $270 pw rent which would make the property positively geared), and purchase a new PPOR (which would be in the vicinity of $300k).

    I have the capacity to comfortably pay a loan back at $1k per fortnight (and currently do), and would like to investigate options for purchasing the new PPOR with a company or trust and then renting it from the same - this way, if I decide to move towns, etc. I can rent the place through the company (assuming it can be positively geared) and pay only the company tax rate. If I had my time again I would have done this with the current property!

    Would there be any benefit in following this path, or would things be simpler and better by keeping the properties in my name? Also, are there any potential routes for minimising tax payments (beyond the usual rental cost deductions)?

    My current marginal tax rate is at 40%.

    Look forward to any thoughts people may have and if you have further questions please ask.

    Cheers,

    smeggett
     
  2. Bantam Roosta

    Bantam Roosta Well-Known Member

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    Hi smeggett, and welcome. Well done on your achievements so far. You look like you have really got yourself going.

    Simpler yes, better not necessarily. Basically what you have outlined is a sound strategy and as you say, quite conservative. Basically any costs involved in the running of your IP is deductible so just make sure you claim everything you are entitled to. A basic list of claimable items can be viewed here.

    If you want tax minimisation, negative gearing is the way to go. But if you can only afford $1k a fortnight than there won't be much left after purchasing your PPOR. Another potential option is to stay where you are if possible and buy a new IP or 2.

    As far as trusts go, can't help sorry. Hope this info helps a bit.

    BR
     
  3. Nigel Ward

    Nigel Ward Team InvestEd

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    Hi Smegs and welcome. Some thoughts in CAPS below

     
  4. smeggett

    smeggett Member

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    Thanks for the responses BR and Nigel Ward - it's certainly provoked a few further thoughts about how to go about things.

    I was sure I wanted to (and still am leaning this way) covert the PPOR to an IP, purely due to the fact I can positively gear the property (which of course prevents the opportunity to minimise tax, however I have a long held philosophy that I would rather pay tax on money I am making than not pay tax on money I am losing).

    I do like the idea of gearing up the current property to purchase further investment property - the property market here has risen ~30% each year for the last two years (I'm glad I bought when I did!) and isn't showing any signs of slowing - that said, if it all stopped tomorrow, I can't see prices retreating since in a town of 23,000 odd people the property market is tight (which has its own inflationary effect on prices), but there are more people moving to the town than the available property can service - and with the mining work likely to go ahead in the region (Roxby amongst others) I can't see this letting up at all. Rumor has it there are only 30 to 40 properties on the market in towm at the minute.

    Is it possible to leverage off my existing PPOR to purchase an IP and claim the costs as a tax deduction? (Same idea as Nigel Ward's, but without converting PPOR to an IP).

    I am in what you might call the feasability stage of planning - sorting through thoughts and ideas, trying to flush out all the potential options to determine the most suitable way to progress forward. So all thoughts are welcome for consideration.

    But as you can see the dilemna is whether to start out positively geared, or use margin and negatively gear property. On the plus side the shares are currently providing some positive returns which could be used to offset any potential suprises.

    Cheers,

    smeggett
     
  5. Nigel Ward

    Nigel Ward Team InvestEd

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    Yes you can. Key principle to bear in mind is that it doesn't matter what security you provide to the bank whether it's a mortgage over your home, your IPs, your shares or even your car.

    What matters for interest deductibility is the purpose to which you put the bank's money...namely it must be used to acquire income producing assets such as investment properties and shares. There are thousands of pages of cases and subtle nuances on this principle...but rigorously stick to keeping your investment loan proceeds quarantined from your loans for personal purposes (such as your home loan) and only use the investment loan proceeds for investment purposes and you'll be fine.

    Another key principle is to maximise your investment (i.e. deductible) debt whilst minimising your non-deductible debt i.e. your home loan. You could for example borrow against the spare equity in your home to invest in shares or managed funds and throw the dividends or distributions against your home loan to pay it down faster and perhaps sell the shares/funds, pay CGT at the 50% discount, pay out your home loan and then redraw as much as possible to apply for investment purposes.

    All sorts of possibilities and of course you must only borrow to the extent you can meet your interest obligations...

    The living on equity article series will give you some perspective on the whole +ve vs -ve gearing issue. Theres an extensive example comparing the results for buying cashflow positive property with buying quality growth properties...

    Cheers
    N.
     
  6. bundy1964

    bundy1964 Well-Known Member

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    Praise (insert diety here) that you can capitalise interest as well. I think I am sitting on the tax free threashold atm and headed towards a negative number soon :D
     
  7. smeggett

    smeggett Member

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    Ah, true - question: Is it possible (I guess this will depend on the lender) to capitalise only a portion of the interest on a leveraged investment?

    Say, I purchase a property yielding 5% rental return, so use the rent to pay a portion of the interest costs, and then capitalise the remainder of the interest costs? (I think it getting time to set up a spreadsheet!)

    Thanks for the suggestions thus far - this has certainly provided me with some clarity and direction, not to mention an impetus to actually DO something, rather than ponder 'what-ifs'.

    Cheers,

    smeggett
     
  8. smeggett

    smeggett Member

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    Well, been doing some more searching and reading through the site and have stumbled upon what I believe to be a good idea for my situation.

    The general theory can be found in this thread: http://www.invested.com.au/6/financing-new-ppor-4705/

    The basic theory here involves setting up a (HDT) trust (for the negative gearing benefits) which will borrow to purchase my PPOR at the current market price ($280k). This property will become an IP, rented at $270 pw.

    The funds generated from the sale of the PPOR will be used to pay down the outstanding mortgage (~$130k) with the remainder to be used as a deposit on a new PPOR ($350k). This will leave an outstanding amount to be mortgaged of ~$200k on the PPOR.

    By my quick and dirty calculations, this should cost me ~$2500 per calendar month to service (assuming rental income coming in and IO loan and interest deductions).

    I would love to hear of any thoughts people may have on this structure? I realise that stamp duty is payable on the transfer and have factored this into the calculations.

    What is the rule on CGT if the property is sold to the trust, given it has been a PPOR for nearly 24 months?

    If this seems like a positive way to progress it will be a trip to the accountants to explore the options.

    Cheers,

    smeggett
     
  9. MF35

    MF35 Member

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    Hi Smeggett,

    I'm not an expert but my thoughts that may be things for you to consider are included amongst your comments below.

    You said,

    "The basic theory here involves setting up a (HDT) trust (for the negative gearing benefits) which will borrow to purchase my PPOR at the current market price ($280k). This property will become an IP, rented at $270 pw.

    The funds generated from the sale of the PPOR will be used to pay down the outstanding mortgage (~$130k) with the remainder to be used as a deposit on a new PPOR ($350k). This will leave an outstanding amount to be mortgaged of ~$200k on the PPOR."

    I understand this to mean you'd be using the profit from the sale of your current PPOR (to your Trust) to pay down the loan on your current PPOR (which is to become the Investement Property) when you've moved out. Then to purchase a new PPOR (in your own name or the Trust?) and use what is left (150k) to reduce the loan on the new PPOR to 200k.

    You may be better off to leave the loan outstanding on the property that will become an IP (tax deductible interest) and use the profit from the sale to pay down / reduce the amount you need to borrow on your new PPOR. This would leave you with 130k deductible debt and 70k non deductible debt on your PPOR. You can still borrow against the equity in either of these properties to invest elsewhere and use any additional income to pay down the PPOR loan.


    By my quick and dirty calculations, this should cost me ~$2500 per calendar month to service (assuming rental income coming in and IO loan and interest deductions).

    I'm assuming this repayment figure is quoted for the 200k you would have outstanding. My calculations tell me the monthly repayments on 200k even at 8% would be about $1540 P&I and $1333 IO.

    I would love to hear of any thoughts people may have on this structure? I realise that stamp duty is payable on the transfer and have factored this into the calculations.

    I can't see where you've factored Stamp Duty in but assume your saying generally that you think it's still worth doing even though you know you'll have to pay stamp duty.

    What is the rule on CGT if the property is sold to the trust, given it has been a PPOR for nearly 24 months?

    A PPOR or your "main residence" is generally exempt from CGT on sale. Including a previous residence that you still declare as your 'main residence' after you've moved out, for up to 6 years in some circumstances I think.

    "If this seems like a positive way to progress it will be a trip to the accountants to explore the options."

    If you're thinking about living in a property owned by a Trust controlled by you I would seek professional advice to make sure that in your circumstances it wont be declared 'tax avoidance' (have a read of the ATO website). While some think this is able to be done, if it is able to be done, it will only be in very limited circumstances of which the intent of your actions is significant and shoudn't be done without professional advice.

    My comments for what they're worth.

    MF35
     
  10. smeggett

    smeggett Member

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    Was planning on purchasing the new PPOR in my own name. This way the IP's and their funding arrangements can be kept separate from the PPOR.

    Now theres and angle I hadn't considered, but certainly sounds appealing. The bit missing seems to be the where the trust will obtain funds from to pay for the (to become) IP?

    These repayments were based on the IP having an IO loan and the PPOR with a P&I loan, based on 7.5% interest. Did stuff up one number with the stamp duty which makes the service costs of the plan $2700 pcm.

    Thanks for that - I certainly intend to seek professional advice before progressing and I appreciate any thoughts, comments or suggestions others can offer.

    smeggett