Negative Gearing: Turning fully owned PPoR into IP, and using equity to fund new PPoR

[Witzl]

Hi guys... this is a bit of a question to ask on my dad's behalf. He's not an investor, but he is having a few problems with some of the tax advice he's been getting.

He owns outright his old PPoR in Castle Hill, and has been renting another home for the past year. He has "off the books", been renting out his old PPoR to my sister during that time, so the property hasnt been an investment property during this time.

Now he has found his dream retirement home overlooking the water on the Northern Beaches, and wants to cash in his equity from the old house to fund the purchase of the new house.

He has been told that since there is no existing loan against the old home, that he wont be able to refinance it as an IP and use the interest on that mortgage as a tax deduction, and use the refinanced funds as a massive deposit for the new home.

This doesnt sound right to me, as we investors regularly refinance properties and use the new interest repayments as tax deductions - however i dont know of anyone who has done this on a property that was owned outright.

So yeah - some advice from anyone with experience on this matter would help.

Thanks,
Karl.

 

[Mr. Fabulous]

The accountant is correct. If you're using the equity to purchase a new PPOR then the interest isn't tax deductible. It's not where the loan comes from, it's what the purpose of the loan is for that determines tax deductibility.

Mark

 

[alexlee]

He has been told that since there is no existing loan against the old home, that he wont be able to refinance it as an IP and use the interest on that mortgage as a tax deduction, and use the refinanced funds as a massive deposit for the new home.

This doesnt sound right to me, as we investors regularly refinance properties and use the new interest repayments as tax deductions - however i dont know of anyone who has done this on a property that was owned outright.

The advice is correct. The deductibility rule is based on the PURPOSE of the loan proceeds. So if your dad refinances and uses the loan proceeds as a deposit on a PPOR, he cannot deduct the interest. It has nothing to do with whether he owns the property outright or not.

When we do it, we refinance properties and use the proceeds for income producing purposes (such as an IP or shares). Then the interest is deductible.

The following is not advice, just some ideas. In this case, since your dad has been renting another place, the Castle Hill place is still his PPOR (ignoring the 'off the books' renting to your sister for the moment). That means he should be able to sell it and pay no CGT, and use the proceeds as a deposit on the new PPOR. Especially if he's not an investor (i.e. I won't give my usual blurb about building an investment portfolio blah blah blah) that might not be a bad way to go. Your dad probably isnt' very comfortable with debt anyway?
Alex

 

[Witzl]

Well that kinda sucks.
I wonder how he could make it tax deductable then?

Could he sell the property to me now, without any CGT (due to it being current PPoR), and then just give me the shortfall on the cashflow, so that i'll reap the tax benefit on his behalf?
I can then sell whenever he sees fit and give him the profit.

Is there anything *legally* wrong with doing that?

 

[Witzl]

The following is not advice, just some ideas. In this case, since your dad has been renting another place, the Castle Hill place is still his PPOR (ignoring the 'off the books' renting to your sister for the moment). That means he should be able to sell it and pay no CGT, and use the proceeds as a deposit on the new PPOR. Especially if he's not an investor (i.e. I won't give my usual blurb about building an investment portfolio blah blah blah) that might not be a bad way to go. Your dad probably isnt' very comfortable with debt anyway?
Alex

He would like to keep the property, as he knows that now is a bad time to sell (he understands property market, just isnt an investor).

He doesnt have a problem with the debt now, because he knows that CG will take hold soon, and he will be able to sell in a few years for far more than what it will cost him to keep it in the meantime.

Selling it now is basically his least preferred option. We are just trying to come up with ways to keep the property, and try and minimise the negative cashflow on it by getting some deductable interest.

 

[alexlee]

Well that kinda sucks.
I wonder how he could make it tax deductable then?

Could he sell the property to me now, without any CGT (due to it being current PPoR), and then just give me the shortfall on the cashflow, so that i'll reap the tax benefit on his behalf?
I can then sell whenever he sees fit and give him the profit.

Is there anything *legally* wrong with doing that?

Probably not, if he sells to you at market price. But you're talking about buying a property from your father while it's being 'rented' to your sister, and 'under the table' (though that can just be construed as gifts) payments from your father to yourself for the shortfall. The alarm bells are ringing so loud my head hurts. One of my rules is not to have financial relationships with family. This is a 3-person straitjacket.

I have to ask, though. If he's comfortable with debt, why hasn't he refinanced before? Also, does he have other investments? (Mainly rhetorical, as that's his private matter. But you have to look past what a person is saying to what they've actually done.)

While it might not be the best time to buy, it MIGHT be an ok idea to sell the house at Castle Hill, buy the new PPOR, then refinance THAT to buy some IPs. Also ask yourself, does your dad want to keep the place because your sister is living there? There are far too many non-financial issues here.
Alex

 

[BV]

Well that kinda sucks.
I wonder how he could make it tax deductable then?

Could he sell the property to me now, without any CGT (due to it being current PPoR), and then just give me the shortfall on the cashflow, so that i'll reap the tax benefit on his behalf?
I can then sell whenever he sees fit and give him the profit.

Is there anything *legally* wrong with doing that?

Witzl
You can do that and you can use 1 solicitor for the sale/purchase.
He will have to do a valuation to see what the market rate is
and you will have to pay stamp duty when you buy it, loan fees etc.
I don't know if there are any exemptions for family gifts etc
ask your accountant.
Cheers

 

[BV]

. One of my rules is not to have financial relationships with family. This is a 3-person straitjacket.

Alex

I know that sometimes financial dealings with relatives turn sour
but it's not always this happens and having this 1 blanket rule can sometimes stop your relatives or yourself from financial success in life.

My reasoning is that when people work together they can get ahead easier than if they worked on their own.

A well written agreement where all parties sign can avoid the problems you are thinking of.

IMHO

 

[alexlee]

I know that sometimes financial dealings with relatives turn sour
but it's not always this happens and having this 1 blanket rule can sometimes stop your relatives or yourself from financial success in life.

My reasoning is that when people work together they can get ahead easier than if they worked on their own.

I'll happily share information, contracts, give opinions, work through numbers, etc with anyone who asks. I will NOT get financially involved with family.

A well written agreement where all parties sign can avoid the problems you are thinking of.

Legal agreements mean nothing if you do not enforce them. How many people will be willing to force family members to do something they don't want to do using legal means?
Alex

 

[Witzl]

yes... there are a fair few non-financial issues here, sorry!
Thanks for bearing with me though.

He isnt comfortable with debt like a property investor is, but he is comfortable with this debt because he is pretty condifend it will pay off in the relative short term (when the market turns in castle hill).

I think that because of the time limitations, and non-financial issues involved... it might just be too hard to achieve. But I am willing to hear any suggestions.


BV - thanks for your suggestions, we'll have to weight up the costs of stamp duty, etc, to see if its worth the tax benefit. Im tending to think it wont.

 

[Mry]

I'll happily share information, contracts, give opinions, work through numbers, etc with anyone who asks. I will NOT get financially involved with family.

Legal agreements mean nothing if you do not enforce them. How many people will be willing to force family members to do something they don't want to do using legal means?
Alex

Pure gold. I can't begin to tell you how many people I know of who have lost money by breaking these rules.

 

[BV]

BV - thanks for your suggestions, we'll have to weight up the costs of stamp duty, etc, to see if its worth the tax benefit. Im tending to think it wont.

Witzl

He can use the equity in the existing place to buy his dream PPOR
first as an IP to start with and a year or 2 later when (& if) the markets peak up he can sell the old place and move into the new one?

He will have to rent the new one out,
Another option perhaps would be perhaps to live in part of it and rent some of it out, rent to your sister perhaps?

When you start claiming interest though your dad might be audited
so it will have to be a legit rent at market rates etc.
He will also need to have an income or he won't be getting any tax advantage.

As you can see there is no easy solution.
If it was me I would sell, but how old is your dad anyway and why does he need to buy a new PPOR?
At some stage he will have to pass all the assets over to you (his kids)
doesn't he?

Cheers

 

[Witzl]

Dad's 55... aiming for retirement in next 5-10 years, and earns a pretty hefty salary (banks allowing him to buy $million home based on income alone).

He needs a new PPoR because he deserves it He's worked hard all his life, so now he can have his Bigola views!!

The more I think about it, the more i cant find a way to get the refinance on castle hill tax deductable. Therefore i see two options:
- Sell Castle Hill now
- Hold onto castle Hill until next market boom (estimated 2-3 years)

I'm leaning towards 2nd option... but will do the sums with Dad on the weekend.

Thanks for your help everyone!!

 

[alexlee]

- Hold onto castle Hill until next market boom (estimated 2-3 years)

Optimism is all well and good, but do have a back up plan. What will you do if the boom doesn't come in 2-3 years?
Alex

 

[Witzl]

that was taken into consideration... and based on all the numbers, the old place needs to be sold.

Oh well - a worthy exercise. I've learnt something!

 

[AngusM]

Hi Karl

Your Dad can consider selling the Castle Hill property to a trust. There is no issue with the property being owned outright. The trust will pay stamp duty and there are also land tax implications of owning a property in a trust to be aware of.

regards
Angus Morrison
Consultant
Chan & Naylor
[email protected]

 

[alexlee]

Given that it's NSW, that's a lot of land tax.
Alex