kt.2006

Hi

I'm hoping that someone can help with a bit of advice on properties. I have read a bit about negative gearing on investment properties and some of it has sunk in (not a lot!) but it seems to be mostly aimed at reducing high wage earners' tax bills.

We will definitely not fall in the high wage earner category but we have enough capital from our house sale in the UK to buy a house outright here (we are 45 so it has taken a long time to get there). I have been warned that buying a house outright might not be so good from a tax point of view and would like to know why.

We also quite liked the idea of buying a small house to live in for a while and then to rent it out. We would then buy a bigger house to live in (with a mortgage) or is this not the best way to do things for tax reasons. Do you have to pay capital gains tax on your second property if you sell, as in the UK?

Sorry I have asked so many questions but I know some of you have seem to have investment properties. I am hoping ABC Diamond will respond as he always explains things so clearly that there should be a sub-section 'Ask ABC Diamond'

Thanks

Kathy

Vicky88

The only reason I can see that it would be bad to buy a property outright would be if you intended to rent the property down the track. Not having a mortgage would mean the property would be positively geared and you would be paying tax on the rental income.

If you intend to buy a small place, live in it now, and rent it out in the not too distant future, you should put down the minimum possible as a deposit. Put the rest into a mortgage offset account so in effect whilst you are resident in that property you would not be paying any mortgage interest, your entire payment would be going off the principal.

Then when you moved to your new residence you would take the money from the mortage offset account and fund your new residence. Property #1 would then be negatively geared, and you would have yourself a tax deduction.

ABCDiamond

Now I can't concentrate.......

Yep.

eg:
Year 1 Buy house (No1) $300k, No mortgage
Year 3 Buy House (No 2) $400k, $400k mortgage
rent out house 1, but pay lots of tax on income, as NO MORTGAGE INTEREST is allowed, as the initial purchase had no mortgage.
Do it that way and you end up paying about $6,000 pa in tax.
Do it the right way, and you could end up getting $3,000pa back in tax refunds = $9,000pa better off

Setting up loans etc for this type of thing, is VERY dangerous from the future tax angle. You Must get it right at the very beginning.

Many investors will pay Interest Only loans, so they can pay off Personal Residence Mortgages first, as they are not tax deductible.

geordie downunder

As you say it is to reduce tax and all hope is on capital gain,which is taxed.Take half the gain and add it on to your income ,say you earn $50,000 a year and have a gain of $100,000 then half of that is added to your income and is taxed at your marginal rate(rough explanation). This tax thing seems to infect everybody that comes here as they think a deduction is investing ,it is not.Look at it this way you own 5 properties and make a loss on each one of $5000 a year so your loss is $25000,the tax man gives you back $7500.You have a net income of $50,000 per year,take off the negative bit ($25000) and your money in the pocket is $25000 add on the $7500 and you have $32500 for the year.You own 5 houses (same scenario) and each one makes you $1000 per year,so you earn $5000 and the tax man takes $1500 leaving you $3500 to add to your $50000 giving you $53500 for the year(positive gearing).Which would you rather have $53500 a year or $32500 a year.Like any country the more tax you pay the more you have in your pocket,I would be the happiest man in Oz if I paid a million a week in tax.Cash flow is always king,try to increase it rather than decrease it.To gear a property you live in then borrow on it,say the property is worth $300,000 the bank will advance you $240000 on it.Buy 8000 shares in ANZ bank (approx $26 each so $208000),the income from them will be approx $9600 (broker forecasts for 2006),the interest is $13520 ($208000 x 6.5%)Forecasts for 2008 are an income of $11360 (8000 shares at $1.42 divi per share).this is an example and you need to think for yourself.it should not be taken as advice on things to do.The estate agents selling property and holding seminars will always tell you property is the best investment,they want the commission,a stockbroker will always tell you shares are the best investment,he wants the commission,a financial planner will always tell you managed funds are the best investment,he wants the commission from the fund and the trailing commission as long as you stay in it,it is vitally important that you think for yourself and do your own research.I stress this is not advice but discussion,good luck.

ABCDiamond

Most serious Investors gain the tax benefit via depreciation of the property.

Therefore, you can actually have a property being cash flow positive, yet bring depreciation into it, and still get tax rebates, via negative gearing.

That way you can get to own Investment properties, without spending any of your own money, and,
Get a small income from them,
and
Get a tax rebate on them,
then at time of selling, assuming capital gain, you end up with more money, for nothing.

renth

The ATO have been clamping down on the depreciation with strict new guidelines so that unscrupulous landlords can't keep depreciating items that should have gone to the tip 5 years ago.

geordie downunder

Forgot to your property costs add stamp duty ($20000.?long time since I bought a property),land tax ,repairs,insurances,agents fees(I think mine is 7%),rates and probably more,the bills come in I pay them.Brokerage on $208000 around $600 and nothing further to pay.dividends carry a 30% tax credit if they are fully franked.Property also has a depreciation schedule to offset all the extra payments above the interest (eg carpets ,window treatments,cookers etc) Landlords insurance is around $150-200 per year for malicious damage by tenants etc.Fully franked means the company has paid tax on profits at 30% so using ANZ at $1.42 per share then the real divi is $2.02 per share but tax has been paid on it,when you do your tax your gross income would be $16228 ($11360/70 x 100) on 8000 shares,tax office will then rebate any tax overpaid if you are in a bracket less than 30% and deduct further tax if you are in 47% bracket.You can use the dividends to buy further shares in the bank free of all charges,Ec if the DRP price is $26 then your 6 monthly divi is divided by that and you get extra shares to increase wealrh/income over the years,should double your shareholding approx every 15 years.

ABCDiamond

You're right, instead of depreciating at 10% per year over 10 years, they would now allow 20% per year over 5 years. And some things at 33% over 3 years.

It all adds up OK at the end.

renth

I bet the broken dishwasher in the garage is still "depreciating"

ABCDiamond

The big difference between shares and property is: Which one will go up in value, and which one could go down.

It's easier to pick a property than it is to pick shares, ask the investors who bought HIH June 1995 $1.50 each, June 1997 $3 each, June 1999 $1.50 each , 2001 BUST, all gone.

I've messed about in shares too, and it is nerve racking, watching them go up and down. And never knowing for certain if you could lose the lot.

A company I was once with had online buying from the office desk, and the guy that did it was a nervous wreck. I like relaxed investment

ABCDiamond

If it breaks, you don't bother with further depreciation, you write of the entire remaining balance in that tax year, and get the refund faster.

renth

When I worked in a dot.com our share options were worth over a million, sadly the bust meant we never got a chance to vest them - easy come easy go...

My workmate used to exclaim (in a Scottish accent) "My trophy wife just got bigger tits!" each time they shot up

kt.2006

Thanks for all the information. I think from what everyone says my idea of living in a small house (with no mortgage) and then renting it out, having moved to another house (with mortgage) is definitely not the best way to do it.

Do you think it is easier in the UK or Australia to rent out property / buy a house to renovate and sell on?

Thanks

Kiwipaul

Your talking about 2 very different investments here.

1) Rental properties where the tennant pays most of the mortgage and you are in it for the capital gain over time. If you do your homework this is a pretty safe bet.

2) Property speculator where you buy a dump and renovate and then sell without renting it out. Highly risky IMHO and only for those who know what they are doing.

My experince of renting in the UK from 15 years ago was it was council house or chase the very very few rental properties available.

Here in Oz and NZ your spoilt for choice with rental properties but the good ones don't stay vacant for long so you just have to look at lots and be quick when you find the one for you. In Brisbane you would have no trouble looking around 20 different properties in one suburb in a day so long as you can visit 10 different estate agents to obtain the keys.

geordie downunder

No serious investor would use a depreciation schedule,your highest is the first year (on a new property) say your surveyor comes up with a scedule of $140,000 for the building @ 2.5% for 40 yrs,$20,000 for the items under $300 (may have gone up,I do not know,stopped buying property in 1990 ish) and $10,000 for 10 yr items,carpets curtains etc,use prime method at 10%.First year you have a tax loss of $20,000 + $3500 (building) +$1000 (prime @10%)total $24500,this gives a rebate of $7350,it may turn it positive it may not.Second year your schedule is $4500 for building and 10yr items giving a rebate of $1350 which is not going to turn it positive when rental returns are around 2-3 % and money costs around 7%.After 10 yrs your only deduction is $3500 for building,should you wish to spend $20000 for new carpets curtains etc then using 10% prime your rebate is $600 ( ($20000 x 10%) x 30% ),spending $20000 to get $600 back off the tax man for the next 10 yrs is hardly serious investing.Keating got his wish to destroy negative gearing,in the old days when tax rates were 60% and no CGT tax was payable it was great.When tax rates came down to 50% (inc medicare ) and CGT was index linked it was good,still possible for capital gain to be tax free and 5 yr average could be used (forgot how that worked now,age is a high price to pay for maturity).Now tax rates are 30% and capital gain is taxed at 25% max(approx) negative gearing is long past the use by date.that being the reason I stopped buying property and started seriously buying shares.100% of the working population are forced to put money into shares through the 9% super,10-15% of the working pop are forced to rent (or live with parents or be homeless)the other reason.Should you choose property as your only investment vehicle then I hope it works for you,but do think about it.Looking at it now say you have $1mill worth of property (3 houses) renting out at $12000 per year each,total income $36000,no debt.holding costs are rates, insurance ,etc.Your net income is $15000-$30,000 depending on repairs, tax position etc,if you are retired you are struggling at the lower end of that.You have the same amount in shares return is 4.5% franked giving a net return of $45000 and a gross income of $64000 due to franking credits,a rebate from the tax man of around $3000 so a total income for retirement of$48000.Holding costs are $0 so all yours to spend,people seem to forget that the idea of investing for the average man is to have a good income at the end of it,not go for tax rebates during working life ,the rebates are the icing on the cake,they are not the cake.Also shares can be sold in small lots and the million can be left for further capital growth,property must be sold as a large lot and CGT paid,an example sell $25000 worth of shares collect $20000 after tax income of $68000.Sell a house say you have $150000 after CGT,put the money in the bank get approx $8000 in income and pay tax on it.Extra money can be drawn out but capital reduction means income reduction.Dividred income is the only income I can see that is tax free and can produce a rebate,all other income is taxed and cannot produce rebates.Good luck.