Best Solution

I am very new to property, and frankly very nervous. I wll try to briefly describe our situation but apologise if this post ends up at a 100 pages.

Currently we own a property in Currambine, for those that don't know Perth this is a suburb just to the North west of Joondalup. The property is a 3 by 1 with extensive landscaped improvements, currently valued ultra conservatively at $180k. Currently we owe $90K on the mortgage on this house.

My partners parents are ageing, and she wants to move closer to them they currently reside in Rockingham, which is around 90 km away.

Our incomes are such that the banks will lend us to about $280 k if we want to be in hock for that much. I don't see monies as being a problem, as much as making the right moves.

We are considering several options, one of which involves retaining this house and renting it out. I am aware of the negatives given the amount we owe from a tax point of view, however, some decisions are not solely based on tax.

There are reports coming through of rising vacancy's in all capital cities, how much credence do we put in that?

In the described situation, what would some of you, more experienced property owners do?

Are there other options that would be more benficial and if so why?
 
Hi dynamictiger,

Keeping the property to rent and buying another home is a poor option since the larger home loan is not tax deductible. I feel like a parrot repeating this basic point. If you are planning to buy another home, the home should have the smallest mortgage and most equity in it. Then you release the equity to fund the necessary deposit for an IP. Therefore, you will need to sell this property. Before you do, can the value of it be improved by a smart renovation or subdivision? You might as well milk it for all it's worth while you have it?

When you begin your search for a good IP, consider future growth, rental yield, rental demand and within a price range which leaves a buffer just in case interest rates go up or you have an extended vacancy.

Mike
 
Hi Mike

Of course you are correct in the PPOR mortgage being the smallest being the best thing. There are some issues that sometimes "muddy the waters " though and they include:

1. The Net Present Value of todays dollars that are lost when you sell and seubsequently replace an asset. While the stamp duty AT purchase would have been small it would now be much larger.

2. The tax position of the borrowers. If they have a smallish income with marginal rates around the 20 % mark then the benefit of IP debt vs PPOR debt is less of an issue than for those with biggish incomes where the tax man provides a larger rebate.

If the above is the case Id be looking real hard at selling the PPOR asset to a family trust at the VG valuation, and regearing it in the process.

An actual sale has taken place so the usage of the funds is indeed not personal. The funds thus freed up can be used to lower the new PPOR mortgage.

Yes, one pays stamp duty and transfer costs, but you are paying these at a reduced rate and yes the trust will quarantine tax losses until it starts to make a dollar.

What do the tax people think ?

Just the rantings of a madman :O)

ta

Rolf
 
Mike,

I am currently in the process of paying as much off an IP as possible because I have the intention of moving into it in the near future.

This becomes a dilemma because although we will move into it and as our principle place of residence it will have the lowest mortgage (which I know is a good thing), we only intend to stay in the house for a maximum of 5 years.

We don't want to sell the house because it is a great renter and to re-buy in the same area would cost a fortune. In this situation is it sometimes better to hold onto it. I suppose I am also considering the sell/buy costs that would also be incurred in the scenario you have mentioned above ?

I am also thinking that at least when we move out we can contribute the rent from the IP to the new home even though we would be paying tax on it.

It would be great to know your thoughts....

Thanks
PIppety
 
Hi PI

Real easy solution.

Use an offset acct to park your advance payments.

That way you pay interest only on the difference between what is in the loan and what is in the offset acct.

Soooooo, during your PPOR occupation you can pay low interest on a low balance. When you move on you transfer the offset acct to the new PPOR loan, and retain all or most of the principal borrowings in the old PPOR now new IP.

Have your cake and eat it it too.

ta

Rolf

Sorry for jumping the gun mike, my 2nd pet topic :eek:
 
Hi Pippety,

I'm with Rolf on this one. You have good reasons to keep the property so I won't try and talk you out of it but I don't like you paying it off quickly because in five years when you move again you will have a large PPOR mortgage and a small IP mortgage which is a no-no.

The reason you want to pay it off quickly is to save on interest and have some positive cashflow from the rent to pay the mortgage payments on the new PPOR. The mortgage payments on the new PPOR will be mainly interest in the first few years.

So the structure you adopt should save you as much interest and tax as possible. If you follow your idea to pay down the IP you will save interest on the IP but pay tax on the rent later and pay a lot of interest on the new place. If your idea is to pay the new place off quickly, as well, then you will not be able to build up a large portfolio of properties which is what IP investing is all about. Constantly paying properties off is a slow way to wealth creation. This is the way Jan Somers did it before she realized there was a better way which she describes in her books.

So, coming back to Rolf's idea, set up an Offset Account linked to this IP and make sure it is portable in the sense that you can link it to the new PPOR loan when you move in 5 years. By doing this most of your capital stays in the Offset Account but the interest it earns pays some of the interest owed on the IP loan so you are not paying so much interest on the IP.

When you move out in 5 years you will shift the offset account with all your capital to the new loan and start to save on interest on that loan. That means you still have a sizable loan on the IP and the interest is tax deductible. The rent will not be used to make payments on the new PPOR. It will be used to make payments on the IP. If all goes well, the rent will cover the repayments and you will be neautrally geared. If not use some of the capital in the offset account to make a lump sum payment to reduce the principal so it is neutrally geared or take a loss on the IP and deduct that loss from your job income which is known as negative gearing.

If you decide to leave the IP as a NG property it is better that the ownership of the poroperty is in the name of the highest taxpayer. Having said that, there are good arguments to say that is not a good idea because when the IP eventually becomes positively geared the excess rent will make the taxable income higher instead of lower which means you pay more tax.

Regards, Mike
 
Hi Rolf,

I am in a similar situation to dynamictiger in that I have a PPOR with a relative small principal still owing. I'm renting at the moment, however, when I choose to buy another PPOR I will have a large mortgage on that unless it is funded by the sale of my current PPOR. This seems totally unnecessary if I want to keep my current PPOR as a rental.

I assume what I am proposing is currently not possible but here it is anyway.

Using dynamictiger's figures:

Value of current PPOR is $180K
Equity is $90K, Debt is $90K

Value of new PPOR is $180K
Equity is $0, Debt is $180K

Umbrella loan is $360K
Loan is split two ways.

IP (current PPOR) component is full $180K
Equity is $0, Debt is $180K

New PPOR component is $180K
Equity is $90K, Debt is $90K

All we have done is shift the equity component to the new PPOR. Now the debt on the IP is back up to $180K so the extra interest is now tax deductible.

The purpose of the borrowings on the IP is clear. It is used to gain taxable income so the interest on the full amount is tax deductible.

What isn't clear is the purpose of the umbrella loan? Is it really tax avoidance or plain economic sense? My argument is why should people be inconvenienced and have to fork out selling costs to sell a PPOR just so they can transfer all that equity to a new PPOR and then have to buy another IP and fork out more buying costs and stamp duty. I'm sure more people would consider property investing if they didn't have to jump through hoops to get their first IP.

All they would need to do is buy one property and keep the current property as the IP. They just keep transferring the equity to the new PPOR. Is there a moral reason why this shouldn't be allowed?

Regards, Mike

PS Rolf, your idea in Post #3 is feasible but is another hoop which should not be necessay to achieve something as basic as moving equity around. The govt would encourage more property investing if transferring equity was made easier.
 
Hi Mike

Its a good position to be in I feel.

What you are doing is fine from a financing point but you, like me mix up logic with making decisions on what is and isnt a sustainable tax position.

Logically, Morally and ethically you are right. I suspect from a taxation point you are also right UNTIL you receive the audit notice. Try for a private ruling and confirm, you may be surprised.

Beyond flogging the asset entirely or into a trust I cant help Im afraid.

There are many many anomalies in tax treatment and a primary one in IPs is that of deposit bonds.

I see a bond as a borrowing cost. The ATO does not. It sees the bond as forming part of the cost base of the asset. I suspect that part of the basal argument there is that you dont own the asset until it settles. If that is the case and I dont own the asset does the ATO calculate my Capital Gains tax from the date and value that I signed the contract, or the date and value on which I settled on the asset. I knwo it to be the former.

This one is really a case of begin with all possibilities in mind.

ta

rolf
 
Thanks Mike and Rolf,

I am lucky that we recently refinanced to have the loan part fixed and part variable with an offset.

My main concern was that when we move into the house we are not sure if our incomes will be as high as what they are now and hence the reason to pay the loan off as quickly as possible.

What would you suggest is the best course of action when the offset amount is the same as the loan ?

For example, lets say the loans on the IP are split :

1. Fixed rate IPL $100K
2. Variable rate IPL $100K

What if the offset amount grows to $100K ? Where would you direct the additional funds given that the FRIPL cannot receive additional payments ?

You have now reminded me that I would still be better off keeping it in the offset and worst case scenario transferring the funds at the time we move. This would be much better than reducing the debt now with the funds that could be in the offset.

Thanks again for re-directing my focus ! I am sure I will want to thank you again in about 5 years time too !!!!!

PIppety
 
Hi Pippety,

You have an interesting situation there with the split loan. Remember I said to take all the funds with you in the offset account unless you want to use some of those funds to reduce the principal amount owing on the IP. You may need the help of an accountant when the time comes to calculate the best strategy.

Let's assume, for a moment, the accountant advises to reduce the principal on the IP, which loan should be reduced? You say that you can't reduce the fixed interest loan. Why not? It is still a Principal and Interest loan, is it not? If it is, the principal should be able to be reduced.

Assuming I'm right, which loan should be reduced? If the prevailing interest rate was greater than the fixed rate then the variable loan should be reduced. However, if the prevailing interest rate is less than the fixed rate then the fixed loan should be reduced.

Regards, Mike
 
Mike,

I can reduce the fixed loan but not any additional payments. I think the restriction is that you can pay $15K additional over the fixed term (3yrs in this case) but it needs to be in lump sums of $5K !

A bit silly but I suppose they are the rules. Perhaps I just need to cross that bridge when I come to it and hassle the bank !

Thanks again for all your advice.

PIppety
 
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