Living On Equity issue- tax vs interest

[see_change]

Living off Equity is something that divides opinions and there have been several comprehensive debates over the last couple of years.

The concern of those who are anti it, is the ever increasing amount of Debt.

I asked Steve Navra at a Sydney presentation, what would happen if you got to the end of you cash bond and prices had gone down and you couldn't get another cash bond. His answer was " disaster".

While there are many safeguards in Steve's system to counter the likelihood of this happening , I'm not interested in a system where one possibility is disaster.

See Change

 

[Rixter]

What would happen if all your IPs were blown over or hit by earth quakes? Now that sounds like disaster to me . Lucky I'm not interested in a system where one possibility is disaster , but I am always interested in a good fishing contest!

 

[see_change]

I'll be suprised if the same storm takes out Townsville and Hobart

See Change

 

[Rixter]

Nevertheless it's still, and I quote - "a possibility". but at least the fishings fine

 

[see_change]

What would happen if all your IPs were blown over or hit by earth quakes? Now that sounds like disaster to me . Lucky I'm not interested in a system where one possibility is disaster , but I am always interested in a good fishing contest!

Rixter , I have no doubt that you position is as bullet proof as anyone else on the forum.

I was just pointing out that not every one is into living off Equity , and pointing the way for those who are interested in finding out why some people have reservations.

I have no interest of being involved in a long debate that has been relived ad nausea on this forum.



See Change

 

[Rixter]

Couldnt agree more seech. Im just in it for the love of fishing like you

 

[Lplate]

The one certainty in the cashbond approach is the compounding interest on the loans.

From comments in threads, the system has many proponents and it can now be tested in conditions where annual growth is less certain.

However Steve's approachs must have other facets that appeal apart from the use of cashbonds (which remain as an option). Perhaps these other facets could be described.

 

[duncan_m]

The one certainty in the cashbond approach is the compounding interest on the loans.

From comments in threads, the system has many proponents and it can now be tested in conditions where annual growth is less certain.

However Steve's approachs must have other facets that appeal apart from the use of cashbonds (which remain as an option). Perhaps these other facets could be described.

The "Living On Equity" approach is my intent.. But I dont intend making use of the approach until a "springboard" event has occurred. ie a sustained rise in prices giving me a significant buffer.

I also intend that each year I only use HALF of an inflationary rate of growth of the total value of my portfolio.

Add into the mix, the willingess to return to work if I _HAD_ to for a 1-2 yr period even if only in a relatively unskilled job.

My forecasts for my own personal situation suggest that a sustained lull in prices can easily be weathered.

 

[Lplate]

Duncan

Thank you. I really must get to Steve's course.

It is about overcoming fear but I guess at some age there must be a reasonable lifestyle too and freedom from the workplace is parrt of that.

Lplate

 

[Merovingian]

My understanding is that you end up with more dollars in your pocket because:

Interest @ 7% on $100,000 = $7,000pa
IncomeTax on $100,000 = substantually more than $7,000.

Just need to make sure that your assets are appreciating at a greater rate than your spending from the LOC

My train of thought may be a bit messed up, but here goes...

Would this $100,000 withdrawn from the LoC have to be declared as taxable income? Why/why not?

Thanks.

 

[duncan_m]

My train of thought may be a bit messed up, but here goes...

Would this $100,000 withdrawn from the LoC have to be declared as taxable income? Why/why not?

Thanks.

No its not taxable income, it's a Loan from a bank. Loans have never been taxable because they're not income.

 

[Rixter]

My train of thought may be a bit messed up, but here goes...

Would this $100,000 withdrawn from the LoC have to be declared as taxable income? Why/why not?

Thanks.

This $100k would NOT be declared as taxable income because it is funds drawn from a loan account.

Cheers

 

[Merovingian]

Thanks guys — I knew there was a simple answer.

Better to be a fool for five minutes and ask the question, than be a fool for life and not ask the question...

 

[Peter 14.7]

My train of thought may be a bit messed up, but here goes...

Would this $100,000 withdrawn from the LoC have to be declared as taxable income? Why/why not?

Thanks.

I would thought YES in the long term via CG.

I may be wrong but as I understand it and keeping the numbers simple (Ignore market swings, compund and such) as I see it:

1. So lets say you have $1.5M property that is neutrally geared going up at 10% CG pa. You get $150k CG, take $100K, bank is happy with LVR.

2. You drawn down $100k a year of the CG as loan. You give back $7k to service that. You have $93k Understood.

3. Lets say you do that for ten years. Keeping it simple ( no compound) You property is worth 10 x 150K so $1.5M plus base of $1.5M so $3M.

But you also have to service the $7k each year so by year ten you are paying back from your $100k, $70k in interest so you have only $30k to live in.

4. Your debt is $100k x 10 so $1M so you are acutally ahead from a base of $1.5M + $1.5M less $1M so you have gone from $1.5M to $2M and not worked. Well done

5. You sell you IP which lets say you bought for $1.5M so you have to pay CGT tax on $1.5M which they half to $750k which you pretty much have to pay tax around $340k. So you have $1.16M cash in hand.

7. You owe the bank $1M for the draw downsover 10 years (10 x $100K) so you have to $160k left over.

It seems to work but each year your income must meet your expenses on the original investment of $1.5M or you will have to pay tax. You cannot simply include the draw downs unless they are called fees and in doing so they are taxed again.

Obviously very dependant on CG staying above interest rates over the term but I note that that is likely over a long term. Also that rents meet all the base costs.

Also there is compound growth in your base but each year you have less of the $100k as last years interest comes in.

Any comments on my thoughts?

Again it seems to work.

Peter 147

 

[Les]

G'day Peter,

Thought I could "leave a note" when editing, but it didn't work for me

The change I made was to this:-

Obviously very dependant on CGT staying above interest rates over the term

As I was pretty sure you meant that Capital Growth should stay above Interest rates (not Capital Gains Tax), I made the change.

Regards,

 

[Les]

G'day Peter,

Referring to this:-

Also there is compound growth in your base but each year you have less of the $100k as last years interest comes in

Simplistically, you're right. Compoundically, you may not be

Part of the charm of compounding (the eighth wonder of the world) is that, at a compounding rate, a 10% increase per year takes only 7.2 years to double in value.

Your example (using only simple interest) was useful anyway, as it showed that you are STILL ahead - even after CGT - BUT the one downfall was the decreasing amount available to live. Hmmmmm!


So, let's expand your example to use compounding, and see what happens:-

Year Startvalue 10%_gain  Endvalue 66.6% Interest Living
Yr_1    $1.50m    150k     $1.65m  $100k   $7k     $93k
Yr_2    $1.65m    165k     $1.81m  $110k   $15k    $95k
Yr_3    $1.81m    181k     $1.99m  $121k   $24k    $97k
Yr_4    $1.99m    199k     $2.19m  $133k   $33k   $100k
etc......

Of course, we all know that property doesn't go up "x% per year" in a uniform amount - as such, the above is also a "simplistic example" - but I think most of us understand that property does "double in 7 years" or "double in x years" (etc) depending on the individual property itself. And I wanted to include the compounding bit, as it belies your comment about "having to live on $30k per year after 10 years". But, of course, I'm also assuming a constant 7% Interest rate too.....

Edited later:- Almost screwed up there - I'll rethink and get back later.....

You requested comments, Peter147 - there's mine

Regards,

 

[Peter 14.7]

Your comments and correction are welcome Les.

The fact my simple appraisal still works proves there are more than one way to earn and income.

I may do the course myself as $172 is a fair ask.

It makes me think of one of rules of investing I learnt which my working class family could not and still dont understand.

"Learn to love your debt"

As working class you are always told never have debt. Pay cash or not at all. Work hard and struggle. Any debt is bad. Obviously this is not true.

Perhaps another rule is increasing debt is ok provided the debt "D" is less that the gain "G".

Peter 147

 

[Les]

Sheesh, Peter,

You've certainly stirred up the grey matter on this one. Sticking to my original "compounding" example, the end is not as good as I'd first imagined.

This is what I found:-

At year 10, you sell the property for $3.9m (sounds nice)

But, you have to pay back the original Bank loan of $1.5m (I would've said $1.2m, Peter, but I wanted to replicate your example as closely as possible)

And, you've borrowed an extra $1.85m over the last 10 years (drawing down the 10% Equity - or 66% thereof) - that's $3.35m total...

And, you are adjudged as owing $580k in CGT

Over those 10 years, you've received $1.2m (after paying interest on the borrowings) for "living expenses" - I hope you kept a bit back, or invested most at a good return while the year progressed.... Because, after settlement, (and NOT yet taking RE fees, solicitor fees into account) you are now $30k short !!!!

Ewww!!!! In a few words, it surely shows that "Living off Equity" needs to be carefully monitored.

Perhaps loans at 50% (rather than 66%) might be optimal. And Dunc mentioned this very thing earlier in the thread - I simply used Peter's figures, and ended up with this (above).

But, hey, if you're down $30k (PLUS selling costs, etc - say $100k all up?) then that equates to $10k per year. Could you live on $85k, or even $70k (tax-free?) rather than spending ALL of the borrowings? Or invest the excess for most of the year? I still think this "living off equity" thing can work - but just be sure to monitor your progress as you progress.

And thanks for the point of view Peter

Regards,

 

[Terryw]

Les,

That could be a minimised with a good Estate Planning strategy.

Have most of your assets in trusts, while you draw down equity on your non trust property. When you die, the trust assets continue as before (with a new trustee), but your estate suffers a huge capital gains tax bill. Your estate is left with nothing, but you kids will still benefit from the trust assets.

Most people have the first few properties in their personal names, and it may be these that have the most equity.

Terryw

 

[duncan_m]

Any comments on my thoughts?

Peter,

Time MUCH better spent in Excel would be an attempt to work out a strategy for making the "living expense drawdowns" tax deductible. Achieving this has a twofold benefit!

1. No (maybe) nasty CGT shortfall
2.The whole strategy becomes that much more tax effective.

I'm sure within a few minutes of turning your mind to this task you'll have a list of 3-4 options that would be quite legitimate.

Simply drawing down funds and spending them is NOT a good strategy.