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December 9, 2013 - 7:02 am

I agree Freckle, except perhaps for the fact that the offset account should be applied to private debt if it exists. There won't be any tax effect in this case. I doubt that you'd keep the private debt for thirty years if you could help it, but that's not really the issue. 

  My pet hate is when banks and advisers love to tell us how much interest we'll save if we pay just a little bit extra each month or pay 10k up front (which does the same as the 10k in the offset acct) without taking inflation into account as you've mentioned. The 10k or early repayments are in today's dollars, but they are saving dollars up to 30 years into the future. Let's try 2.5% average inflation for 30 years: that makes a dollar then worth about 47c now. 4% inflation => 31c now etc.

 It would be nice to see the true savings always quoted in today's dollars, not just the nominal saving in future dollars.

That's my 2c.

Cheers, S/C

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December 9, 2013 - 6:14 am

Hi Harry, I assume your accountant meant that it pushes you down to the next bracket below if you claim depreciation. That may be the case if it pushes you down to the zero tax bracket ($18,200 pa), but even if it pushes you down to the bracket above that (20.5%) then it's still worth claiming depreciation. It all helps with your bottom line, ie net cost to hold the property after tax. It's surprising how many property investors don't claim depreciation when they can. 

I'm sure it would be worthwhile getting a QS report on your property if it's only 4 years old. It will cost you ~$500 or so, but that's tax deductible (all in one year). It makes your tax return easier; you just refer to that report each year (the report should detail several years into the future).

Cheers, S/C

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September 30, 2009 - 9:26 am

Wow Sandy, That's a pretty sizable IP. I said you would save a lot more in tax than it would cost you for the changeover but I didn't really think that through. The value of your IP made me think that perhaps you should really calculate the numbers.

You haven't given us the size of your IP loan and your PPoR loan, but let me work through a hypothetical example and you can do the same with your real numbers.

Say you owe 200k on your IP, 500k on your PPoR. You want to sell your IP and buy a new IP. You'd probably not pay so much for the new IP, but let's for the sake of argument assume it's the same value.
Selling costs on your IP = ~ 16500 I'm guessing a bit, but that's the rate I paid in 1985 the last time I sold a house!
Buying costs on new IP worth 650k = ~ 24k stamp duty in NSW, 34k in Vic. Lets use 24k
Legals/ loan costs ~ 5k
Lost Rent ~ 5,500
Total changeover cost ~ 50k min.

You have ~ 400k left after sale and changeover costs deducted and the IP loan paid out.
You'll need to keep 130k for the 20% of your new IP worth 650k.
That leaves 270k to pay off the PPoR loan.
PPoR loan now = 230k
IP loan will be 520k
Now your total borrowings have increased by 50k, and only 270k has shifted from non tax deductible to deductible.
Assume you'll be paying 7% interest in a little while and assume you're in the 39.5% tax bracket, then the shift of 270k to deductible will save you 7% x 0.395 x 270k = 7,466.50 pa. The extra 50k you've had to pay or borrow will have an opportunity cost of 7% of 50k (because you could pay it off your home loan if you had it spare), ie $3,500 pa.

The bottom line: You're only saving about 4k per year after all this mucking around and it's going to take a long time to pay off that 50k extra.

This conclusion is heavily dependent on the numbers of course; you need to do this exercise with your real numbers.

There're other considerations too, like your positively geared IP may be joint tenants with your wife, and getting a better tax treatment with her share.

Perhaps you need to just keep your IP and throw your heart & soul into killing the PPoR debt as fast as possible, leaving the IP debt as IO.

Interesting exercise, sorry I didn't think about it earlier. Sounds good in theory until you do the numbers!

PS, I'm trying to wean myself off this forum, so I won't be back for a while.

Good luck with it, S/C

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September 29, 2009 - 8:04 pm

Hi Sandy, this is a very common problem. You can't increase the mortgage on your IP to increase the tax deduction. It's all about the purpose of your loan. You're effectively taking out the extra loan to finance your ppor and this doesn't wash with the ATO. Probably your best solution is to sell your IP. It won't have a huge CGT as it was your PPOR until last year. There will be selling and buying costs, but the best path is to sell your IP, pay out your PPOR mortgage with the proceeds, start an investment LOC with your spare equity and use that for the 5% legals & 20% deposit on a new IP with its own new property loan for the other 80%. In the long term, this will save you a lot more in tax than you'll be losing in the changeover.

IPs get sold all the time with tenants still in them, so don't let that stop you from trying.

Cheers.

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September 29, 2009 - 7:49 pm

Déjà vu Kenny! Thanks again for your help on this topic with me. I've since refinanced my mixed purpose debt. 
Cheers, S/C
Richard you really should know better, we've had a few discussions about mixed debt before.

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September 29, 2009 - 7:21 pm

Hi Dru, interest in your term deposit is taxable income, so to compare with the same tax bracket of 39.5%, you'd need to be getting better than 5.5% which will give you 3.3275% after tax. If you started your term deposit a while ago, you may well be getting better than that. You'd pay a penalty if you withdraw it early. The difference of a percent or two on 5k isn't that significant in the short term though.

I'm currently paying 5.11% with a pro package with Westpac as a comparison. There's no difference in interest rate between IO & P&I; just the repayments are different.

There should be little penalty in refinancing if you have a variable loan. There's no mortgage stamp duty any more (at least in Qld) but you may have a few other fees. The most significant is usually the establishment fee, but I don't pay those with my pro package. I'm sure the mortgage brokers here could help you with that. Your current lender will probably discount your rate if you start mentioning the "R" word.

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September 29, 2009 - 10:49 am

Hartfam, it's a tax credit of 6k, ie 6k less tax. The actual deduction is nearly twice that, as you're in the 46.5% bracket. This deduction will rise if interest rates rise, but it will fall as depreciation dwindles. Property is certainly a great benefit in the long term. Tax is just part of the picture, and as I've mentioned, getting big tax deductions now means you may pay the piper a lot more in a decade when your gearing goes positive.

 You're in a much better situation than most investors, as you have enough income to support quite a few negatively geared properties, but your limiting factor is equity. You have a 520k home with 300k loan. If you wish to keep all loans at 80% LVR, then your 300k loan must be securitised by 375k worth of property. That leaves 145k spare, and you'll be able to get an LOC of 116k(80% of that spare equity). That 116k LOC will allow you to buy one property worth about four times that, ie 464k with another loan of 348k . I use 4:1 because you'll need about 25% deposit (5% to cover legals & stamp duty on top of the 20% for the bank).

These numbers will be a lot bigger if you can push the ratio a bit more aggressively to 90% with associated LMI expenses, but your wage should allow you to push the boundaries a bit more.
S/C

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September 29, 2009 - 6:03 am

Hi Hartfam, just one thing about shares/manged funds, you'd be hard pressed to invest in shares that pay less than the current interest rate anyway. Banks etc currently have a yield of about 5-6% fully franked, which is 7.14 – 8.57% after franking credits are added in. Your loan interest may well be less than that if you use a home equity loan, so it won't do much to reduce your tax. All you could do is pre-pay interest for one year if your income is going to drop drastically next f/y. It's still chicken feed compared to your wage though.
 As for property, for some perspective, say you buy a new IP for 420k, you'll be getting tax credits of about 6k on a 250k wage, ie that's how much your tax will be reduced for one property. That will fade quite considerably after a few years, and may even be zero after a decade at which time you'd rather have the props in your name as the lower incomer earner.
There isn't much difference long term between having the properties in your name or your partner's when you bring it all back to net present value. You {save tax now, but pay more later} or {carry forward losses now and pay less tax later}. Most of us put it in the higher income earner's name to make it more affordable at the start, but that shouldn't be an issue with you;) You should have it in a trust as Terry says, which will have much the same tax situation as having it in your name (with net losses having to be carried forward in the early years), with the added benefit of asset protection.

Salary sacrifice to the limit into super, but that's now chicken feed as well thanks to the latest changes.
Best wishes, nice problem to have, S/C

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September 29, 2009 - 4:48 am

No WJ, it's not really "tax free". Your just offsetting tax deductible debt. It's only when you're offsetting private debt that you can truly call it "tax free". For example, if Dru is in the 39.5% tax bracket, his effective saving with the offset account balance is 5.5% X 0.605 = 3.3275%. If the offset account is against private debt, then he'll be saving 5.5% with the balance.

Andrew the formula is simply: Daily Interest calculated for today is precisely: {(Yesterday's closing loan principal – yesterday's closing offset account balance) x (loan interest rate)/100 } / 365. Each of these daily contributions are added together at the end of the monthly cycle for your monthly interest, ie they don't compound daily, just monthly.

By all means, put everything you've got in your offset account. It's not necessary to separate rent from income, that's what your yearly summary from the agent is for, or just keep a database/ spreadsheet of your own for each month's rent & expenses. It doens't matter a razoo where that income/rent sits so keep it in your account that pays you the most or saves you the most.
cheers, S/C

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September 28, 2009 - 10:43 pm

Hi Shivasko, thanks for the good rap. As the sticky thread says, always seek your own professional advice if you're unsure, and take what we say as a guide only.
What I can say however, is that my ppor is joint tenants with my wife, and I have a few IPs in my name. I have loans in my name only, using our ppor as security, for which my wife had to go guarantor. I also have loans in both our names with my IPs as security. The bank just needs security, but legislation says that if someone else shares that security, and they aren't on the loan, then they must get all that written advice stuff. Just speaking (writing) from experience.
Cheers,

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September 28, 2009 - 8:26 am

Hi Shivasko, You certainly can use all the available equity as Richard says. You could increase your existing loan, but it may be better to simply start another loan account with the same bank. It can be in both your names to simplify the application, and then you can invest it in an asset solely in your name and then claim all the interest as a deduction in your name (it's the purpose of the loan and ownership of the asset that counts, not the names on the loan). If you just took out the loan in your name, your Mum would have to go guarantor on it, and she'd have to go through all the rigmarole of getting written independent legal and financial advice satisfactory to the new legislation. I do a similar thing with my wife, ie put her name on all the loan docs to simplify the process.
  That private loan agreement is a good idea. Your Mum must understand that she's effectively acting as a guarantor whether her name is on the new loan or not.

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September 28, 2009 - 8:08 am

AW 180k is their combined income. You're a bit out of date by the way, the current tax table is 39.5% from 80k to 180k.
Cheers.

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September 28, 2009 - 8:05 am

Hi ClarieBear, Welcome to the forum. You certainly have a fair bit of equity built up with your two props, certainly enough to fund the 25% required for another IP or two (or more). LOCs don't really have features, they just have an interest rate as low as you can get it! Debt servicing ratio may be your limiting factor.
You could switch your IP to IO, but you won't save a huge amount (by paying principal off your home loan instead) while it's fixed at 7.64. Assuming you're both in the 39.5% tax bracket, then your effective interest rate is 0.605 x 7.64 % after tax, ie 4.6222%, only slightly less than you'd be paying with your variable at the moment, which I assume would be in the low 5's. That's the same after tax because it's private debt of course.
 This may change in the near future when your variable rate increases a bit more.
Certainly when your fixed loan expires, you'd be better off concentrating any extra payments on your private debt, not on your investment debt, ie definitely switch your IP debt to IO then if not now. Switching it now may improve your debt servicing ratio though, ie it may improve your borrowing capacity.
cheers, S/C.

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September 28, 2009 - 2:17 am

Hi Mrs P, here's some real numbers based on a house that cost ~200k to build including fittings, landscaping etc, just to give you some idea.
The QS set the cost to build the house at 187200 which will be depreciated at 2.5% prime cost (ie it stays the same each year until it's used up). This will give me a deduction of 4680 pa for 40 years.
The fittings are all diminishing value, with more at the start, but it tapers off fairly rapidly after about 8 years.
Here's the first few years: 2658, 4764, 3296, 2293, 1634….
The first year was a bit lower because it wasn't for the full year.
Now you asked what it's worth to you. Your wage does play a big part in this. At 90k wage, you'll be in the 39.5% tax bracket and with a 40k wage, you'll be in the 31.5% bracket. A decade ago, anything above 50k would cop 48.5% tax, so they've certainly reduced the effectiveness of negative gearing quite a lot since then.
  With 90k you're only 10k above the next tax bracket below (31.5%), so it you may be negatively geared enough to push some of your depreciation down to the bracket below. This depends on interest rates, rent etc.
Anyway, every $1 you'll be deducting while your taxable income is above 80k will give you 39.5c back in your tax refund, and similarly 31.5c back for the 40k wage. 
 Just for interest the house in this example is $13/week positive (in the second year) after tax at my current interest rate.

  The sting in the tail will be that when you sell, your cost base will be reduced by $1 for every $1 you have deducted for depreciation. You'll only have to pay tax on 50% of that though with the CGT discount, and it may be in year 2029 dollars if you've kept it 20 years.

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September 28, 2009 - 12:43 am

Thanks Terry, I've since done a bit of reading about the Steele case. Sorry I should have done a bit more research, but that keyword "Steele" was the important bit of info I needed.
   Just one thing: How do you claim for the interest when doing your tax online. It won't let you lodge unless you put a figure in the "date first rented" field. I lodged my daughter's tax (who's 50:50 with me on that property) by putting in $1 into the rent received field, and increasing the interest by $1 to make up. I had to put something in the date first rented field, so I chose the contract date.
  Their software doesn't seem to cater for the Steele case.
Cheers, s/c

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September 26, 2009 - 9:11 am

PS B, here's a good book by Stuart Wemyss that I've just read. It gives a good comparison of the various strategies of pos or neg gearing and development, plus defining goals, retirement strategy etc. 
http://www.prosolution.com.au/books/ppuzzle.htm
 The only thing I'm a bit dubious about in his book is the expectation of always getting 7 to 10% capital growth. I've averaged about 7 to 8 % over the last decade, but that can't go on forever; it's mathematically impossible. If it were possible then a house that goes up 7% for 100 years while inflation averages 3% over the same period would cost 45 times what it does today. If I could get 10% growth over that period, then it would cost 717 times what it does today (all in today's dollars that is).
S/C

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September 26, 2009 - 8:44 am

B, it's great that you've now created a determined goal; I think that's the first big step. I finally saw the light 11 years ago. I started with 4 negatively geared IPs that are now just about neutral after tax. My rent has gone from about 155pw to 280pw on two houses, and from 200/w to 300/w on two units. Most of the depreciation has gone now, just the building at 2.5% for another 29 years is available. I've also got a CP (commercial property) that pays about 40k pa net before tax. I've just bought another IP 50:50 with one of my children, which is just cf neutral after tax with a fair bit of depreciation (being brand new), but only at the current interest rate I'm paying of 5.11%.

   As you can see it's barely enough to retire on, and it will all evapourate if the interest rate goes up by about 3%. What I'm trying to show is that it can be a long slow process, but it eventually shows results. You just have to start early enough in life. 

   I do have a fair bit of equity now however, so if push came to shove, I could retire a fair bit of debt by selling one or two IPs. I'm loath to do that because of the CGT and selling costs would take a big chunk of my working capital.

   The thing is that it all sits pretty much in the background except for the occasional feverish activity doing my own repairs between tenants, or doing my own landscaping (26 tonnes of stuff we moved!!!) on the last one, and I'm free to do my day job which I've enjoyed doing. It's a real bummer if you don't enjoy your work. If that's the case then maybe you need to get much more proactive in your property endeavours, eg start developing or renovating.

Best wishes, S/C.

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September 26, 2009 - 6:26 am

Hi Bergy, ppor = principal place of residence as you've guessed. You have good equity in that. An additional cash flow +ve property won't really affect your negatively geared property. 
   Your negatively geared property may drop you down to a lower tax bracket, so when you're working out your net cash flow from your next property you have to use your reduced income after the neg gearing effect. It's not logical to consider the effect the other way around, because the neg gearing IP came first.
   If your next IP is only cash flow +ve after tax, ie relying on depreciations & other non cash deductions to make it positive, then the negatively geared property may make this just a bit harder if it's pushed you down a tax bracket.
  It's going to be a lot more difficult if you're neg geared now with a wage, and you want to stop working; your neg geared IP will be even more negative of course, and maybe your cf+ve one will become negative as well.
 If you're talking about a positively geared property which makes you pay more tax, not less, (ie it's cf+ve before tax) then the less wage the better for that IP. You'll need quite a few of those before you can give up your wage, or just wait 20 years or so with a lot of initially neg geared ones that eventually become +ve.  Either way it'll take a fair bit of time to really support you in retirement if you're just a passive buy & hold investor like me.
cheers, S/C

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September 25, 2009 - 5:58 am

Hi Prestons, there's no need for personal emails; just reply on the forum is fine.
I don't know about wraps (and I'm just not interested) but for buy & hold, IO is best if you have any non-deductible debt. There's such little difference between IO & P&I for a short time frame then it doesn't really matter if you're doing flips I would think. Eg for a 350k loan P&I over 30 years, your principal reduces by only about 5k after 12 months.
     IO keeps your borrowing capacity to the max with buy & hold, and you can achieve exactly the same effect as P&I if you put extra payments into an offset account. The main difference is that it requires discipline to not raid the offset account for financial disasters like fast cars!
  Never use your own money unless you have to for investment (tax deductible) purchases; save it for private expenditure (like your ppor that you're going to stay in for at least 20 years). If you don't have discipline, then P&I on investment debt is better than squandering the extra payments on junk. You get the drift I'm sure.

Cheers, S/C

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September 25, 2009 - 1:20 am

Looks like your question has been ignored P. (like my answer;)
 I suggest you go for a good trawl through the forums. You'll find a lot of threads discussing IO vs P&I.
BTW it's principal, not principle. It's a very common misspelling in these forums though. Have a look in dictionary.com.