When to negative gear?

[muppie]

What would you consider "high income" and start to worry about negative gearing? This is in relation to Australian income tax of course.

[Aceyducey]

Muppie,

Most people look at high income as being well into the top tax bracket, but that's just my 7,000,000c worth.

Cheers,

Aceyducey

[see_change]

To me , negative gearing isn't something to do because you make lots of money and want to make less..

It's something to do when the negative gearede properties that are going to have better capital growth , than any of the cash flow pos properties you can find.

See Change

[Mry]

What would you consider "high income" and start to worry about negative gearing? This is in relation to Australian income tax of course.

Depends. You should be looking at it if your taxable income exceeds $70,000 which is where your tax rate becomes 48.5%.

But remember that negative gearing is a means to an end. The ultimate purpose for investors (rentals and shares alike) is to acquire/grow/build income producing assets and/or assets that grow in value. Negative gearing is a tool to reach that objective, not an objective itself.

When I meet people who say "I want to negative gear to save on tax", I turn it around on them and say to them (within the confines of FSR stuff) that they should be thinking about what they want to invest in, their investment plans for the future and then we can find tax effective ways of doing it. Certainly there are some investments where the tax savings make it more attractive but the investment itself has to stand on its own two feet and then you look at how negative gearing might interact.

[tubs]

When people tell me that they want to negative gear, I tell them to give me $1 and I will give them 50c, if they think that its such a good deal. They're still losing money. It is a means to an end as you say, but I like positive gearing as it doesnt harm your serviceability.

[madmurf]

When people tell me that they want to negative gear, I tell them to give me $1 and I will give them 50c, if they think that its such a good deal. They're still losing money. It is a means to an end as you say, but I like positive gearing as it doesnt harm your serviceability.

Tubs
If only life was that simple.
I negative gear but for a long term reason. My IPs generate a high CG which easly offsets my small paper loss. I dont pay tax on that CG till I sell the IP.
Now if I sell the IPs when Im retired and have a minimal income then tax will be stuff all.
On my way to retirment I have the taxman and the renter paying for my asset. Thats my plan. Now thats simple.

Madmurf

[Pete]

Muppie,

"and start to worry about negative gearing?"

It is not something to worry about.

It can be a very helpful to you - regardless of income levels.

Learn about it and make it your friend / helper!

best wishes,

[duncan_m]

but I like positive gearing as it doesnt harm your serviceability.

Certain gurus would want you to believe this..

BUT, given that:


Only 80% of rent is taken into Account
A higher interest rate is used in the serviceability calculation
You are usually assessed at Principal and Interest..(even for an IO loan)


What might appear, on paper, to be a positive cashflow property is often viewed by the bank completely differently. Spreading your lending around can help.. but at the end of the day.. YOUR ability to borrow money CAN be severly constrained by "positive cashflow properties" ( PCP's :) )

Whilst its not necessarily true, it is often seen that PCP's have less growth potential because they are located in quiet backwaters and country towns, they MIGHT experience significant growth in "interesting times"..

Now.. to my point.. Its extremely important for me that what little OPM the banks will grudgingly lend me is put to use in securiing assets with SIGNIFICANT potential capital gain. If I was to blow all of my available OPM on shanties in Oonawoopwoop I'd have a lot of property, but not much upside. Alas, the properties that DO have significant potential upside do generally end up being negative geared, so I wear that. They eventually enter positive territory.. it doesn't happen overnight, but it does happen.

[Aceyducey]

When people tell me that they want to negative gear, I tell them to give me $1 and I will give them 50c, if they think that its such a good deal. They're still losing money. It is a means to an end as you say, but I like positive gearing as it doesnt harm your serviceability.
tubs,

Give them a receipt as well to claim back another 25c :)

Then they'll feel successful!

Cheers,

Aceyducey

[Glebe]

I think alot of people think about negative gearing incorrectly.

People too often think about the tax deduction. It's not about the tax deduction!

It's about determining that an investment is a worthwhile decision despite the fact that over the short or medium term it will be costing you money to maintain it. Of course, the cost of maintaining it is subsidised by the government in the form of a tax deduction, and the size of the tax deduction is determined by the marginal rate you're at, but ultimately you have to be confident the (long term) capital gain is worth the (short/medium term) losses in maintaining it.

[duncan_m]

What might appear, on paper, to be a positive cashflow property is often viewed by the bank completely differently. Spreading your lending around can help.. but at the end of the day.. YOUR ability to borrow money CAN be severly constrained by "positive cashflow properties" ( PCP's :) )


I thought I ought to quantify this statement.

Consider this..

Two portfolios.. one consisting of properties returning 10% and growing at a fairly low 2.5%pa.. And the other portfolio yielding just 5% but growing at 10%pa.. 2 end of the spectrum perhaps..

For the first portfolio (low growth, high yield), the borrowings can go to a respectable $1.6M before the 'classic' serviceability tests fail..

For the second portfolio (low yield, high growth), the borrowings max out at a paltry $500K.

But, the Equity at the end of 10 years is:

Low Growth/High Yield: $448,135.
High Growth/Low Yield: $796,871.

In reality, we all now that you spread loans around banks, convince banks to take tax savings into account, etc..

If you managed to get the first portfolio (LG/HY) to a whopping $2.5M of debt, the net result after 10 years would be a Net Worth of $700,211..

And if you managed to push the second portfolio (HY/LG) to $1M of debt the net result after 10 years would be a Net Worth of $1.5M

The RISK profile is also significantly different.. one (you choose) is VERY low risk.. if rates moved up 2-3%.. no great stress.. the other.. if the rates moved up 2-3% DISASTROUS..

Exposing yourself to significant debt (with the increased exposure to rates) for less than stellar gains is not smart.

My working speadsheet attached.. as usual, its probably full of bugs and in fact I have it all wrong? :)

[tubs]

Hi Duncan

I understand what you are saying by your calculations, but my definition of positive gearing is a situation where you dont have a loss on the property. Generally a yield of around 5-6% and good depreciation is enough to do this. There have been many places around Oz that give you this type of yield, and many of them have been out growing the other places with typically 4% returns. I'm certainly not referring to places such as an old block of flats next to the meat works 20k away from the nearest one horse town. These I consider to be positive cash flow, as opposed to positively geared. Places such as Cairns (which has attracted pages and pages of comments on here) and now Rockhampton (also pages and pages of comments) are positive geared, and a typical house here has gone up almost $100k in less than 2 years.

But my real concern is that many people like negative gearing for the tax benefits without thinking that they have to LOSE money before getting the benefit. You dont invest in property to save money on taxes, and it appears that everyone agrees on that. And, I agree that negative geared property does have an important place in many people's strategies, and when my serviceability and income improves, it will probably play a more important part in mine.

Cheers

Tubs

[Aceyducey]

I understand what you are saying by your calculations, but my definition of positive gearing is a situation where you dont have a loss on the property. Generally a yield of around 5-6% and good depreciation is enough to do this.
Tubs,

That's like a public company breaking even one year and saying that it's done a good job for it's shareholders because it didn't lose money!

What you defined above is generally called neutral gearing. You're not making or losing money.

POSITIVE gearing requires a POSITIVE cashflow.

Cheers,

Aceyducey

[NigelW]

I thought I ought to quantify this statement.

Consider this..

Two portfolios.. one consisting of properties returning 10% and growing at a fairly low 2.5%pa.. And the other portfolio yielding just 5% but growing at 10%pa.. 2 end of the spectrum perhaps..

For the first portfolio (low growth, high yield), the borrowings can go to a respectable $1.6M before the 'classic' serviceability tests fail..

For the second portfolio (low yield, high growth), the borrowings max out at a paltry $500K.

But, the Equity at the end of 10 years is:

Low Growth/High Yield: $448,135.
High Growth/Low Yield: $796,871.

In reality, we all now that you spread loans around banks, convince banks to take tax savings into account, etc..

If you managed to get the first portfolio (LG/HY) to a whopping $2.5M of debt, the net result after 10 years would be a Net Worth of $700,211..

And if you managed to push the second portfolio (HY/LG) to $1M of debt the net result after 10 years would be a Net Worth of $1.5M

The RISK profile is also significantly different.. one (you choose) is VERY low risk.. if rates moved up 2-3%.. no great stress.. the other.. if the rates moved up 2-3% DISASTROUS..

Exposing yourself to significant debt (with the increased exposure to rates) for less than stellar gains is not smart.

My working speadsheet attached.. as usual, its probably full of bugs and in fact I have it all wrong? :)

Great post Dunc!

Playing around with this sort of analysis convinced me that capital growth is what makes you rich. Cashflow is the oil that lubricates the growth engine.

The only potential benefit I can see from taking a totally CF+ approach is that you may be able to replace your job income sooner...but then if you're comfortable drawing equity/using appropriate structures you can do that anyway with a growth biased portfolio in probably a similar timeframe.

My research indicates the net return on any one CF+ property is usually pretty slim - maybe $2k-4k per year. That's easily chewed up by a couple of weeks' vacancy and some maintenance.

My 2.2c
N.

[Mry]

I was going to post earlier as well about the benefits of negative gearing, but I didn't get around to it.

I actually lost a potential client because I don't really believe in positive gearing and they were gung-ho for it. I believe in positive gearing when the house is paid off, but I don't believe in acquiring low value, high rent properties solely for cash flow.

From a tax perspective, positively geared homes are taxed in full on their profits. Negatively geared properties give back money on your tax return, and the capital growth on the property is untaxed until sale, and even when the property is sold, the tax on the profit is halved. The tax system itself favours negatively geared properties.

[Les]

Sorry, Madmurf,
but you might be in for a shock when you retire
Now if I sell the IPs when Im retired and have a minimal income then tax will be stuff all.
As I understand it, (assuming you've held the "sold" property for greater than 12 months), your Capital gain is halved, then ADDED to your income for the year, and taxed as though you earned that money in that year.

Yes, being retired DOES help, but every $ over $70,000 is taxed at 48.5% (plus all of the "little tax" leading up to that $70k figure). And, if you've held this property for 30 years, (e.g. bought for $30k in 1975, then sold for $500k in 2005), your gain is likely to be approx. $420k. Divide that by 2, (because you held it for > 12 months) and you still have a gain of $210k.

I reckon you'll be up for a big chunk of Tax, even if you earned NO dollars that year....... Tax will probably be in the order of $85k (guessing a bit here). Yes, retirement helps - the first $70k is taxed as though you EARNED $70k - and then, every dollar above $70k will cost 48.5%


So, it's not all beer and skittles - and there WILL be a tidy profit for you.... Tax, though, is unlikely to be "stuff all" - BUT, it will likely be FAR better than accumulating cash in a Bank account for 30 years.

Regards,

[Merovingian]

Great post Dunc!

Playing around with this sort of analysis convinced me that capital growth is what makes you rich. Cashflow is the oil that lubricates the growth engine.

The only potential benefit I can see from taking a totally CF+ approach is that you may be able to replace your job income sooner...but then if you're comfortable drawing equity/using appropriate structures you can do that anyway with a growth biased portfolio in probably a similar timeframe.

My research indicates the net return on any one CF+ property is usually pretty slim - maybe $2k-4k per year. That's easily chewed up by a couple of weeks' vacancy and some maintenance.

My 2.2c
N.

I agree with this too, Nigel.

I've read a few books from both camps, (pro-cash flow and pro-growth), and have done my best to look at both arguments objectively, (well, as objectively as one can try).

I am also convinced that growth is "the engine", and cash flow is "the lubricant". In my mind, both are absolutely essential to success, and they both complement each other.

Now to switch my ranting button to the "off" position. Click! :D

[duncan_m]

Great post Dunc!
Playing around with this sort of analysis convinced me that capital growth is what makes you rich. Cashflow is the oil that lubricates the growth engine.


Thanks Nigel, love your analogy!

[Mry]

And, if you've held this property for 30 years, (e.g. bought for $30k in 1975, then sold for $500k in 2005), your gain is likely to be approx. $420k. Divide that by 2, (because you held it for > 12 months) and you still have a gain of $210k.

You'd better choose a different date of purchase, because that one won't work.

Retirees also have the option in some circumstances of making large superannuation contributions to lower their tax bill just before they "officially" retire.

[geoffw]

And, if you've held this property for 30 years, (e.g. bought for $30k in 1975, then sold for $500k in 2005), your gain is likely to be approx. $420k. Divide that by 2, (because you held it for > 12 months) and you still have a gain of $210k. Actually, a property held for that length of time I believe will have a different set of rules applied. I believe it was the Fitzgerald eqnuiry in about 1993 which suggested the 50% rule- capital gains before that time were indexed for inflation- so that you opnly paid CGT if the asset appreciated above the inflation rate over that period. My understanding is that the indexation rule still applies to assets acquired before the rule change.

[Jamie]

Actually, a property held for that length of time I believe will have a different set of rules applied. I believe it was the Fitzgerald eqnuiry in about 1993 which suggested the 50% rule- capital gains before that time were indexed for inflation- so that you opnly paid CGT if the asset appreciated above the inflation rate over that period. My understanding is that the indexation rule still applies to assets acquired before the rule change.

There is no capital gains tax payable on the sale of any property purchased prior to 20th September 1985.

[Mry]

There is no capital gains tax payable on the sale of any property purchased prior to 20th September 1985.

Bingo!

Indexation is frozen from 21 September 1999 btw.

[madmurf]

Sorry, Madmurf,
but you might be in for a shock when you retire

As I understand it, (assuming you've held the "sold" property for greater than 12 months), your Capital gain is halved, then ADDED to your income for the year, and taxed as though you earned that money in that year.

Yes, being retired DOES help, but every $ over $70,000 is taxed at 48.5% (plus all of the "little tax" leading up to that $70k figure). And, if you've held this property for 30 years, (e.g. bought for $30k in 1975, then sold for $500k in 2005), your gain is likely to be approx. $420k. Divide that by 2, (because you held it for > 12 months) and you still have a gain of $210k.

I reckon you'll be up for a big chunk of Tax, even if you earned NO dollars that year....... Tax will probably be in the order of $85k (guessing a bit here). Yes, retirement helps - the first $70k is taxed as though you EARNED $70k - and then, every dollar above $70k will cost 48.5%


So, it's not all beer and skittles - and there WILL be a tidy profit for you.... Tax, though, is unlikely to be "stuff all" - BUT, it will likely be FAR better than accumulating cash in a Bank account for 30 years.

Regards,

Hi Les

"As I understand it, (assuming you've held the "sold" property for greater than 12 months), your Capital gain is halved, then ADDED to your income for the year, and taxed as though you earned that money in that year."

Im going to retire on an income of 10K for THAT YEAR because I will make sure that I am making a paper loss and as such have only to support those investments for a year.
Now you can do your sums on what CG I will have to pay. :D

Madmurf

[geoffw]

There is no capital gains tax payable on the sale of any property purchased prior to 20th September 1985.OK, thanks.

I don't own anything purchased prior to that date (except a pair of slippers and a few books)- so on a "need to know" basis...

[Les]

G'day Mry,

Well caught!!!
Originally Posted by Les
And, if you've held this property for 30 years, (e.g. bought for $30k in 1975, then sold for $500k in 2005), your gain is likely to be approx. $420k. Divide that by 2, (because you held it for > 12 months) and you still have a gain of $210k.


You'd better choose a different date of purchase, because that one won't work.

And I should've known, as I own one bought pre 1985 !!!!! :o

Regards,

[Les]

G'day madmurf,

Im going to retire on an income of 10K for THAT YEAR because I will make sure that I am making a paper loss and as such have only to support those investments for a year.

Not sure I follow you, mm. Are you saying you'll end up with a loss big enough to offset $200k (approx) so that TAXABLE INCOME after CGT is 10k????? If not, can you explain what you mean, please?

BTW, please ignore my earlier gaffe (using 1975 as purchase date).

For the exercise, assume it was a Sydney property bought in 1996 for $380k, and you're about to sell for $850k - so, near enough, still a $420k CG to account for.... How would you go?

Regards,

[madmurf]

Hi Les

I think we may be side tracking this thread.
My understanding is CGT is payable based on the income for that year.
NOTE income not number of assets.
At the moment I fall in the higest tax bracket so if I sold my IPs today based on my income I would be paying top tax less 50% as I have owned them over 12 months.
Now when I retire the year before I sell my IPs I will make sure my income for that year is bloody low, less than 10K.
My CGT I pay will be based on a income of that Tax Year not the years before.
I believe this is correct.

Cheers ;)

[duncan_m]

Hi Les
My CGT I pay will be based on a income of that Tax Year not the years before.
I believe this is correct.


There's a subtelty I think you've overlooked.

In the year you sell the assessible capital gains is ADDED onto your income and your tax is calculated on the lot..

So if you earnt $10,000 in a PAYG Job and then had $200,000 of assessible capital gains then your income for that year is $210,000... BANG! Straight into the highest tax bracket for the lot.. even though you only earnt a paupers wage at work.

[madmurf]

There's a subtelty I think you've overlooked.

In the year you sell the assessible capital gains is ADDED onto your income and your tax is calculated on the lot..

So if you earnt $10,000 in a PAYG Job and then had $200,000 of assessible capital gains then your income for that year is $210,000... BANG! Straight into the highest tax bracket for the lot.. even though you only earnt a paupers wage at work.

Ducan

That is true but at least it will be 50% less than PAYG Tax.

Cheers :o

[Mry]

In the year you sell the assessible capital gains is ADDED onto your income and your tax is calculated on the lot..

So if you earnt $10,000 in a PAYG Job and then had $200,000 of assessible capital gains then your income for that year is $210,000... BANG! Straight into the highest tax bracket for the lot.. even though you only earnt a paupers wage at work.

Then because your PAYG income is less than 10% of your capital gain, you can make a very large supperannuation contribution (deductible), so instead of paying tax at 48.5%, you pay 15% in the fund. I don't have the rates with me but for people over 50 you can contribute over $90,000 though only the first $5,000 and 75% of the excess of that is deductible. Then you retire the next week and cash in your super.

You can also talk to your employer about sacrificing a majority of your salary for super as well.

There are lots of nice tricks you can do with super close to retirement.

[coastymike]

Even better if you are being engaged through your own company or trust then the self employed super limits do not apply (i.e. the $5K plus 75% of the excess) and the whole amount up to $95,980 for 2004/05 would be deductible.

[Ausprop]

tubs,

Give them a receipt as well to claim back another 25c :)

Then they'll feel successful!

Cheers,

Aceyducey

but down the track you will have to give them back the original $1 plus another $1 of growth

[HotRod]

Does the 50% deduction for CG still apply if you making a super contribution from CG?

If so, the real rate would be 7.5% versus 24.25% normally.

Or is it not applicable and would be 15% versus 24.25% normally?

Also, back to the title of the thread, it's horses for courses. But I agree with the of of the posts (too lazy to quote) regarding getting the CF+ to fund the CF- props. The best of both worlds.

Later.................