A friend owns a PPOR (no mortgage) and an IP (mortgage). He wants to move into the IP because it is larger than his current PPOR and rent out his current PPOR. He would like to know how to structure his debt / mortgage so that he can make it tax effective. Any views would be appreciated. Thanks in advance.
Help - how to gear when switching PPOR and IP?
- Thread starter babushka
- Start date
duncan_m said:
He has never been married and is still single (45 years old, his mother told us!). Yes, he works and has money stacks away in an offset account against his IP mortgage, plus a share portfolio.
I was trying to remember if this question was asked before and how people dealt with it, but could not remember.
He doesnt really have many options then unless he establishes a Trust and sells the current PPOR to a Trust, incuring the Stamp Duty in the process.. but the loss he'll generate will be quarantined in the trust until it makes a profit of some sort on other assets or the thing, eventually, starts flowing cash.. I think this would be the only way to reduce the debt on the current IP (in anticipation of it becoming a PPOR)..
Hi Duncan
Thanks for your thought. We thought similarly - he could set up a family trust (but not sure if it would be beneficial in the long run given he is single and not likely to get married in the near future, according to his mother!), sell the current PPOR into the trust (stamp duty payable, of course). He will have to borrow the money to buy units in the trust to enable the trust to buy property - this is his gearing for tax. Then with the money from the sale of the current PPOR to the trust, he could pay down his IP mortgage, move into it to make it his new PPOR. So, the biggest expense would be the stamp duty on the transfer. Not sure I have missed something else here?
Thanks for your thought. We thought similarly - he could set up a family trust (but not sure if it would be beneficial in the long run given he is single and not likely to get married in the near future, according to his mother!), sell the current PPOR into the trust (stamp duty payable, of course). He will have to borrow the money to buy units in the trust to enable the trust to buy property - this is his gearing for tax. Then with the money from the sale of the current PPOR to the trust, he could pay down his IP mortgage, move into it to make it his new PPOR. So, the biggest expense would be the stamp duty on the transfer. Not sure I have missed something else here?
Hi Babushka
We recently did exactly that, selling PPOR to a trust, with it becoming an IP.
If he needs something 'tax effective' it might be worth mentioning HDT (Hybrid Discretionary Trust) which allows the ability to claim negative gearing benefits.
The downside of transferring the previous PPOR to IP is the cost of the Stamp Duty which is unavoidable, and the costs and effort of setting up the structure.
Your friend would be best to run his calculations based each scenario with fair market value of each property, the costs of setting up and maintaining the Trust, and negative gearing or other benefits, paying the stamps etc.
If this is the first of many IP's, the trust idea may well be a goer. If this is a once off deal, it might be simpler and more cost efficient to simply forego some tax effectiveness, maybe release some of the equity in the original PPOR to invest elsewhere and generate income to help pay off the new PPOR and its bigger mortgage. Depends on the figures I 'spose.
Its not hard to do, but not enjoyable (or cheap) either, so let the calculations do the talking
Cheers
Carl
We recently did exactly that, selling PPOR to a trust, with it becoming an IP.
If he needs something 'tax effective' it might be worth mentioning HDT (Hybrid Discretionary Trust) which allows the ability to claim negative gearing benefits.
The downside of transferring the previous PPOR to IP is the cost of the Stamp Duty which is unavoidable, and the costs and effort of setting up the structure.
Your friend would be best to run his calculations based each scenario with fair market value of each property, the costs of setting up and maintaining the Trust, and negative gearing or other benefits, paying the stamps etc.
If this is the first of many IP's, the trust idea may well be a goer. If this is a once off deal, it might be simpler and more cost efficient to simply forego some tax effectiveness, maybe release some of the equity in the original PPOR to invest elsewhere and generate income to help pay off the new PPOR and its bigger mortgage. Depends on the figures I 'spose.
Its not hard to do, but not enjoyable (or cheap) either, so let the calculations do the talking
Cheers
Carl
Thanks, Carl, for sharing your views.
In fact, hubby and I discussed the various strategies between ourselves, and what you suggested was right - do the calculations for the various scenarios before deciding.
Our friend lives in Melbourne (we are in Sydney) and last night he phoned so hubby told him about the HDT structure or take out an LOC on the current PPOR to use as deposits to buy other IPs, pay out his mortgage on the current IP before moving into it, etc
In fact, hubby and I discussed the various strategies between ourselves, and what you suggested was right - do the calculations for the various scenarios before deciding.
Our friend lives in Melbourne (we are in Sydney) and last night he phoned so hubby told him about the HDT structure or take out an LOC on the current PPOR to use as deposits to buy other IPs, pay out his mortgage on the current IP before moving into it, etc
I thought your PPOR is automatically determined by where is your current main residence. The fact that can only have one main resident at a time means if you live in the IP, your PPOR automatically becomes your IP? That’s what I thought anyway.
If I was right, you can draw out the equity from your current PPOR to pay off the mortgage in your IP?
correct me if I am wrong.
If I was right, you can draw out the equity from your current PPOR to pay off the mortgage in your IP?
correct me if I am wrong.
Nanuq said:
You are right but to do this would be a disaster. Drawing money against one property to use for another property taints it taxwise.
So if you draw from your current PPOR and pay down your IP and then move into your IP you will be no better of with regards to deductible interest.
Remember it is the purpose of the funds drawn, not the security of the loan that determines deductibility.
The only way to change the debts around so that the IP has 100% debt and the PPOR has the smallest debt is by changing ownership and establishing new borrowings. A trust or selling to a spouse are two of the ways to do this.
Simon said:
How about drawing the fund from the PPOR equity for investment purposes, and use the fund to purchase another IP or a share portfolio. By doing so you will have 2 properties with mortgages attached to them and some cash on hand to invest elsewhere. Would this be a better idea if you do not mind more debt? The cost of setting up a trust is just too much especially when the transaction is between yourself and your trust.
Simon - You are spot on in terms of the potential disastrous tax consequences. We have read many articles on this - the ATO looks at the intentions.
Our friend actually has enough money in the offset account to pay down the mortgage on the IP so he could pay out the IP mortgage and move into it as the new PPOR. On the current PPOR he has no mortgage, to convert it into an IP with a gearing he could sell it into a trust. But like Nanuq said, the cost of setting up a trust is high. And, he is single and his job is not high risk so the benefits may not be great. Also, he is a bit old fashioned in terms of having too much debt - so buying another IP may not be on the card for him (although we are trying to change his views on this).
Hubby thought of another idea - our friend could drawdown the equity on his current PPOR and put the money into his offset account, thus creating a mortgage back on his current PPOR. Later, he could pay down the mortgage on his IP and move into it as his new PPOR, and rent out his PPOR (now with a mortage from the drawdown of the equity earlier). However, I am not sure if this would work in terms of tax purpose.
Our friend actually has enough money in the offset account to pay down the mortgage on the IP so he could pay out the IP mortgage and move into it as the new PPOR. On the current PPOR he has no mortgage, to convert it into an IP with a gearing he could sell it into a trust. But like Nanuq said, the cost of setting up a trust is high. And, he is single and his job is not high risk so the benefits may not be great. Also, he is a bit old fashioned in terms of having too much debt - so buying another IP may not be on the card for him (although we are trying to change his views on this).
Hubby thought of another idea - our friend could drawdown the equity on his current PPOR and put the money into his offset account, thus creating a mortgage back on his current PPOR. Later, he could pay down the mortgage on his IP and move into it as his new PPOR, and rent out his PPOR (now with a mortage from the drawdown of the equity earlier). However, I am not sure if this would work in terms of tax purpose.
If it were me I would sell the current PPOR, pay off the IP mortgage with the sale funds, move into the IP mortgage free. Then establish a new IP with new borrowings that are fully deductible.
I would also ringfence the PPOR sale money (left over after paying the IP mortgage off) for personal use and take a 100% mortgage on the new IP by using the new IP and PPOR as security to get the 100% mortgage.
The remaining sale funds are then free to be used for anything else, an extension on the new PPOR/former IP for example.
The main thing to consider in this approach is that on sale of the new PPOR, there will be CG to consider for the period it was an IP. But that's nothing to worry about until sale.
I would also ringfence the PPOR sale money (left over after paying the IP mortgage off) for personal use and take a 100% mortgage on the new IP by using the new IP and PPOR as security to get the 100% mortgage.
The remaining sale funds are then free to be used for anything else, an extension on the new PPOR/former IP for example.
The main thing to consider in this approach is that on sale of the new PPOR, there will be CG to consider for the period it was an IP. But that's nothing to worry about until sale.
But wait, there's more.....
G'day Nanuq,
I don't believe this is correct:-
I'm NOT a full bottle on all of the ramifications, but, can I say, it's worth getting "impeccable" advice on just what is or isn't possible. I believe it is far more flexible than what you suggest. e.g. I think it is possible to nominate a PPOR after the fact, rather than just "the day you shift..." (do get advice on this though). A lot of the situation depends on your circumstances. Your Accountant is a good start...
Regards,
G'day Nanuq,
I don't believe this is correct:-
As I understand it, you can move from a nominated PPOR into rental accommodation, yet still retain the PPOR status of the original home. Makes sense, eh? I guess it depends on just who wants to move to where.Nanuq said:
I'm NOT a full bottle on all of the ramifications, but, can I say, it's worth getting "impeccable" advice on just what is or isn't possible. I believe it is far more flexible than what you suggest. e.g. I think it is possible to nominate a PPOR after the fact, rather than just "the day you shift..." (do get advice on this though). A lot of the situation depends on your circumstances. Your Accountant is a good start...
Regards,
TTRTR said:
Hi TTRTR
What you suggested makes very good sense also - besides the trust suggestion. It is "cleaner" to do, but our friend does not want to sell his current PPOR. People tend to get "attached" to their home and do not want to let go. They rather keep it as an IP! Also, if he sells the current PPOR there will be the changeover cost like agent's commission. This may be equate to the same as the cost of setting up a trust - I stand to be corrected here.
He has more than enough money in the offset account to pay out his IP mortgage, if he wanted to go ahead to move into his IP as his new PPOR. Just imagine what we can do with the equity in 2 properties with no mortgage! - more IPs, but he cannot see it like that.
babushka said:
Not sure why you mentioned trusts. I'm not an advocate of complicated arrangements. IMO they just add another layer or problems to deal with.
I think your friend should seriously consider whether keeping the PPOR as an IP is the right thing to do. The current gain is fully tax free so a sale results in as much money in their pocket as possible after sale costs. If they rent it out & prices stagnate or only rise slowly, the tax free gain will be diluted and they'll be going backwards. The UK method for calculating taxable gain for CGT purposes is to adjust the gain by the number of years held each as a PPOR and as an IP. So the years of ownership as a 10/0 (PPOR/IP) = no CGT. A 10/1 = very small CGT A 10/5 still majority not taxable. 10/10 now 50/50 taxable. 10/20 now 66% taxable (as in 66% is taxed at 25% in the UK after taper relief).
If the Aus method is the same and prices stagnate, the taxable amount will grow each year & the tax free amount will fall. But that probably isn't enough to worry your friend.
But IMO they should also consider whether the PPOR is really a good IP. IMO many OO's live in places tenants don't want & many tenants live in places OO's don't want.
Anyway IMO the clean break set out in this method is best and gives the highest possible tax dedctible loans, but there is always the human factor that complicates things.
Why not consider having the old PPOR mortgage free as an IP, having the old IP mortgage free as a PPOR and buying a 3rd or 4th IP & therefore having a bigger income, but also bigger deductions? That would allow them a full portofolio without having to send a large chunk of the rent to the taxman every year.
