Inflation: The invisible Tax

I am sure many of you have heard or read about this before, but until recently I never understood the true meaning of what exactly does it mean by inflation being an invisible tax and why governments love it.

Best to explain with an example.

Suppose you decide to buy a piece of land for investment purposes. The land costs you $100k and you hold it for 10 years. During the 10 years the land only manages to increase in value in line with inflation which averaged around 3.5%pa for the past 10 years.

Sale price after 10 years: $141,060 approx
Sale commission 2%: $2820 approx
Gross profit: $38,240
Taxable profit after CGT Discount (50%): $19,120
Tax on taxable income (30% rate): $5,736
Net profit: $32,504
Your investment return: 2.85%

Your real return: -0.65%

Even though on paper you think you have made a profit but in reality you have reduced your purchasing power by 0.65% pa for 10 years due to the inflation tax you have to pay on your investments which in reality were just keeping up with inflation.

Moral of the story is always look for investments with real returns (aka inflation adjusted returns). The longer you hold the asset (buy and hold) the lesser the impact of inflation tax will be on your investment returns.

Cheers,
Oracle.
 
Interesting topic Oracle.
I've always seen buying vacant land a bit like buying gold, i'm not overly interested unless there's some cash flow coming from it.
Does the average block of land only go up the same as the rate of inflation? Pretty poor choice of land if you ask me.

Ausprop, we're thinking along the same lines. Happy for time to do its thing to the debt so long as there's some rent coming in.
 
I am sure many of you have heard or read about this before, but until recently I never understood the true meaning of what exactly does it mean by inflation being an invisible tax and why governments love it.

Best to explain with an example.

Suppose you decide to buy a piece of land for investment purposes. The land costs you $100k and you hold it for 10 years. During the 10 years the land only manages to increase in value in line with inflation which averaged around 3.5%pa for the past 10 years.

Sale price after 10 years: $141,060 approx
Sale commission 2%: $2820 approx
Gross profit: $38,240
Taxable profit after CGT Discount (50%): $19,120
Tax on taxable income (30% rate): $5,736
Net profit: $32,504
Your investment return: 2.85%

Your real return: -0.65%

Even though on paper you think you have made a profit but in reality you have reduced your purchasing power by 0.65% pa for 10 years due to the inflation tax you have to pay on your investments which in reality were just keeping up with inflation.

Moral of the story is always look for investments with real returns (aka inflation adjusted returns). The longer you hold the asset (buy and hold) the lesser the impact of inflation tax will be on your investment returns.

Cheers,
Oracle.

Can you do the sums for an Investment Property at a 80 or 90% LVR?

Some are 100% LVR when you look at deposit and other costs coming from another IPs equity
 
Can you do the sums for an Investment Property at a 80 or 90% LVR?

Some are 100% LVR when you look at deposit and other costs coming from another IPs equity

Lets make a few assumptions

- We buy IP for $100,000 instead of land
- LVR 80% = Borrow $80,000 and put $20,000 deposit
- Rent = Interest payments + other expenses (to keep things simple)

After 10 years we still expect the property to only increase in value by inflation 3.5% so all the above figures about sale price and net profit remains the same.

Net profit: $32,504
Your compounded nominal investment return on $20,000: 10.13% pa
Your compounded real investment return on $20,000: 6.63% pa

Not bad at all...leverage will magnify your returns both ways we all know that.

I would expect the rent from the IP to have increased a fair bit during the 10years so it should give extra cash after all expenses which should increase your returns even more.

Cheers,
Oracle.
 
Not quite Oracle - too low. You are just looking at the profit and not adding the initial asset value. So the original $20k needs to be added to the profit figure.

In reality, $20k has become $52,504 after 10 years - not $32,504. Plus the extra cashflow in rent growth.

I'm too lazy to work out what that does to returns - I'll leave that up to you. Needless to say, leverage is a wonderful thing!
 
yup, either add back the initial deposit, or do new sums borrowing 100%....

$0 to $32k in ten years is a pretty good rate of return.....
 
Not quite Oracle - too low. You are just looking at the profit and not adding the initial asset value. So the original $20k needs to be added to the profit figure.

In reality, $20k has become $52,504 after 10 years - not $32,504.

Net profit: $32,504

I used the word Net profit which is correct. Total would be cost + net profit.

I believe my figures are correct. For $20,000 to become $52,504 (net profit of $32,504) you need to make 10.13% pa for 10 years.

Plus the extra cashflow in rent growth.

I did acknowledge this point in my post

- Rent = Interest payments + other expenses (to keep things simple)
....

I would expect the rent from the IP to have increased a fair bit during the 10years so it should give extra cash after all expenses which should increase your returns even more.

I'm too lazy to work out what that does to returns - I'll leave that up to you.

I hope you don't use this attitude when it comes to your own investments.

Needless to say, leverage is a wonderful thing!

As long as you are on the right side of the trade :)

Cheers,
Oracle.
 
Sorry Oracle, but you started with $80k debt and a total asset value of $100k, which means $20k equity.

You ended up with $80k debt and a total asset value of $132,504, which means $52k equity.

Your $20k equity has therefore become $52k. You have earnt a CAGR of 10.13%.

Feel free to throw around more insults if you like. I'm only trying to help... :(
 
And the invisible tax also gets eaten up by the totally visible tax deductions along the way, especially the non cash ones.;)

Yes, as nice as it sounds the reality is all depreciable items which form part of the non cash deductions would eventually be required to be replaced with money which will be worth a lot less due to inflation.

As they say there is no free lunch.

Cheers,
Oracle.
 
all those returns are just icing - the real guts of the cheesecake is what inflation is doing to your debt, which needs to be added to your profit.

as they say there is no such things as a free lunch, it's just a question of who pays. in this case it is suckers with cash on deposit at the bank that are funding leveraged investors
 
Sorry Oracle, but you started with $80k debt and a total asset value of $100k, which means $20k equity.

You ended up with $80k debt and a total asset value of $132,504, which means $52k equity.

Your $20k equity has therefore become $52k. You have earnt a CAGR of 10.13%.

Feel free to throw around more insults if you like. I'm only trying to help... :(
I have faith in you HE. I'd be happy to be in your financial position. Maybe one day.... :)
 
Back
Top