"Is negative gearing out of fashion? Long post, fo"
Reply: 3.1.1.1.1.1.2.1.1.1.1.1.2.1.1
From: Kristine .
Dear All
Here is a demonstration printout for you to ponder and think upon the wonders of leverage, and how through negative gearing, that is, efficient use of our compulsory, pre-paid tax, we can buy and hold significant property for our long term benefit.
Please understand, that in preparing these analysis, I have had to make a number of assumptions as well as applying known contractual details.
Please print these pages so that my explanation can be correlated to the spreadsheet format. You are welcome to email me with any questions, and I will answer directly plus a summary of questions in the forum.
(i) Property Value. This is the actual Contract or Purchase Price of the property. ($585,000)
(ii) Purchase Costs. I simplify this to actual Victorian Stamp Duty entered here ($30,760)
(iii) Please note Loan Costs further down the list, but important to mention at this point. I allow 1% of purchase price to cover conveyancing fees, broker or bank charges, searches, miscellaneous stamp duties etc ($6,210)
(iv) Outlays: Allow $1,000 deposit not recovered at settlement ie the actual personal investment paid as a preliminary deposit remains with the investment. ($1,000)
(v) Loan: the total estimated Loan Cost here is the Property Value + Stamp Duties – Deposit Paid + Loan Costs ($620,970)
(vi) Obviously, by borrowing more than the contract price, equity in the property will be negative at commencement of the first year of the investment (-$35,970)
(vii) Capital Growth: In the absence of a crystal ball, this is a tough one! To present a most conservative picture, I use an allowance of 8% capital growth. This is not intended as an indication or opinion, simply a figure for the purpose of the exercise.
(viii) Inflation Rate: This is important in this instance, as the rent is indexed and the program must be told the indexation rate. Thus, inflation is 3% and any other indexation within this spreadsheet will be at this rate.
(ix) Gross Rent: I am using an example of a leased property where the terms and conditions of the lease are known,. In this instance the rent is neither gross nor net. The tenant pays all outgoings concerned with the safe, efficient and effective operation of the building eg all body corporate fees and charges, all insurance, maintenance, operating expense, necessary capital works etc for the life of the lease (which, with options, could run through to 30 September, 2025), and the incoming owners pay municipal and statutory charges such as municipal and water corporation rates (no garbage fees or water consumption as these are the responsibility of the tenant) and state land tax if appropriate to the individual owners.
Please note that the first indexation of rent occurs at the commencement of the third year and then annually. (First rent $38,025 per annum)
(x) Interest: As repayment of principal borrowing is not relevant to a taxation model, I have entered loan details at averaged 8%per annum, interest only. ($49,678 per annum)
(xi) Property Expenses: As explained under rent, outgoings for which owners are responsible are minimal. Property expenses are indexed, thus the annual increase of 3% (and remember, the 3% is there because the lease is indexed etc) (allow $2,000 first year)
(xii) Pre-Tax cash flow. Up to this point the age or type of property does not impact on the analysis, and cash income is significantly less than cash expense. However, the property I am presenting carries particular depreciation benefits, which are not cash based and are actually the amortization of the asset at varying rates and over varying times as specified under Tax law. Here is where the whole process gets very interesting! (-$13,653 first year)
(xiii) Depreciation of the Building: This example carries an unusual depreciation benefit, that of 25 years at 4%, and even though the building was constructed in 1990, the depreciation benefits to the new purchaser commence from the date of subdivision last year. So, the full amount to be written off is approximately $118,875, at the rate of $4,755 equally per year
(xiv) Depreciation of the fittings: There are quite a number of different items here, from the small item kitchen pool, to a pro-rate share of the lifts, fire service and swimming pool. I have shown an aggregate sum, and small amounts of depreciation can continue to be claimed up and until the 34th year. Please note that because items must be fully depreciated by the end of their allowable period, the amounts of depreciation claimed may contain final balances, and totals may fluctuate because of this. ($5,828 first year)
(xv) Loan and other Costs: Can be written off over five years ($1,242 per annum)
(xvi) Total Deductions: Here is the nitty gritty! By adding cash and non-cash deductions together, we see that the surplus expense comes to $25,478 in the first year
(xvii) As Australian tax brackets change in defined steps, for every dollar earned above $60,001, we are taxed $485/$1000. Thus, for the purchaser earning $85,478, by claiming $25,478 they have effectively reduced their taxable income to $60,000, and are therefore owed a refund of overpaid tax of $12,357. I previously mentioned s.221.d and the ability to reduce tax payments on a weekly instead of annual basis, thereby directly contributing to the cash flow of the investment.
(xviii) The after-tax cash flow, a shortfall of $1,296, is calculated at $25 per week, which would need to be contributed from other sources.
***
For a purchaser earning a Gross Income of $30,000, their ability to claim tax is limited to a refund of $5,830, as their tax structure was $10,000 @ $315/$1000 = $3,150, plus $14,000 @ $185/$1000=$2,590, plus $1,478 @ below the tax free threshold (and no, I don’t know where the PIA found the other $90).
This purchaser would then have to make up a shortfall of $7,823 per annum, or $150 per week, at least in the first year.
****
In reading the summary, be aware that the spreadsheet follows the assumptions exactly, and has calculated that the deposit plus contributions has earned the equity as displayed.
Should the property be sold – the program calculated ‘selling costs’ plus the capital gains tax applicable to that individual owner if they sold the property in a year when their personal taxable income level was as described in the Assumptions. Should the property be sold in a year of for example unemployment or retirement, the CGT burden would be considerably less.
All in all, its not a bad return for a $1,000 deposit, is it?
Happy analysing
Kristine
NB After a number of unsuccessful tries to load the complete file which includes scans of the PIA spreadsheet, I will copy type it tomorrow and post it separately. Actually, it may be that the complete file exceeds webboard limits; maybe someone could advise on that subject?