PPoR into IP

[celtics]

Hi all,

Long time lurker, but first time poster. Have learnt a lot on these forums!

I have a complex question. My parent's own their own PPoR (5 year old house) valued at $1.5m with a loan of $530 000. They meet repayments on this loan comfortably but not much more to be able to invest or save.

I'm 25, living out of home have just bought an investment property valued at $400 000 (loan at $350 000) and managing that comfortably. I earn about $120 000 p.a. which will rise by about $30k every year.

We (as a family) would like do some more investing and would like to unlock some equity in this house. I've been doing a bit of research and thought of the option of buying the family PPoR at a reduced rate (say $900k) and then renting the house back to parents as an IP.

With a loan of about 900k, the loan repayments would be $4125 p/m. Under this situation, my parents would be paying market rent around $3200 p/m and I would cover the remainder. Just a rough estimate (@5.5% pa)

The pros for this as far as I can see:
- tax breaks (negative gearing/capital works deductions/depreciation), works well given my income
- unlocking equity for me to able to invest in the future and lend to my parents if required
- release of 300k equity/buffer for my parents to invest further
- keeping a $1.5m well located and appreciating asset
- having my parents as tenants, makes it easier (never intend to sell this home)

Cons
- mixing family and business
- paying ~70k in stamp duty
- buying at a reduced rate, means 600k in cash that my parents won't get, but obviously will borrow this out further if needed

My parents have helped me out a fair bit, and my philosophy is to help them out in return. I know the other options are to downsize, but that involves moving, a fair amount of legal/conveyancing/stamp duty issues both selling and buying. The option of having my parents borrow more equity has been looked into, but the banks are not willing to lend any further.

As far as I've looked into this method keeps everything else the same, just involves shuffling money around to make it work better. Sorry for the essay but I wanted to put this to the wise folk on here to see if I've missed anything.

Any thoughts and advice are appreciated

Cheers

 

[Terry_w]

Factored or considered:
- Loss of main residence CGT exemption? You may get this if you live in it, but not if you rent it. They would also not be utilsing theirs.

- Stamp duty on $1.5mil is a lot!


- Land tax issues

- How will you negative gear if you are living there? If renting out a portion then loss of CGT on that portion.

-Eating into serviceability

- Social security effects - if any?

-Estate planning aspects. I

 

[celtics]

Thanks for the quick reply.

1. Loss of CGT exemption
- Parent's not utilising this is one thing, something we will have to forgo to pursue other benefits
- Have the option of living there for three or six months and then converting to IP to get 6 years worth of CGT exemption and negative gear

2. Stamp duty
- On $1.5m is 69k which is a fair amount but the benefits in this situation outweigh this one off cost
- Though capital growth of ~4% p.a. is equivalent to $60 000. Similarly turning this into IP will roughly yield $10 000 tax refund due to to tax deductions.

3. Land tax
- good point, hadn't thought about that, although again tax deductible
- had a quick look, works out to be around $5000 p.a.

4. No social security. No estate planning, though should probably get my parents to look into that.

I guess serviceability is a key issue here. I may have to wait until my income rises further to be comfortable with this arrangement. The long term aim is to invest in professional development, increase income and use equity in this house to invest further with the aim of capital growth and reducing tax commitments. Tapping into the already existing equity has the potential to accelerate this further.

Great points though. Thanks very much!

 

[Terry_w]

Some estate planning issues:

When they die they cannot leave it in their will
- If you have other siblings, relatives etc they want to benefit they couldn't with the property. But they may have cash or other investments
- No ability to leave it to you via a testamentary discretionary trust which has many advantages.

Asset protection issues
- you and family law
- you losing the property through blowing the money (e.g. developments
- you dyinng and leaving it to someone else, or your estate being attacked

Asset protection issues from their side:
- undermarket value transaction = clawback provisions in bankruptcy act and conveyancing acts
- family provision aspects if they were to die within 3 years of gifting

etc etc

 

[Terry_w]

What are the alternaitves?

1. Could you parents borrow to get a LOC set up and then onlend you the money?

2. Could you do a joint purchase and use their property as additional security? i.e. cross collaterlatise

3. Could a trust be set up with you and a parent or both as trustees or directors of trustee company which then gets a LOC on the property owned by them? This trust may then lend to you or to another trust to purchae property.

It is a shame to have to sell a property only to buy another property as this 'wastes' betwee 5 to 10% in fees and taxes. This money could be better used elsewhere.

It is also a shame to needlessly incur land tax on what is otherwise exempt and also a double shame to convert a CGT free asset into a CGT asset and not have another asset which is CGT exempt.

 

[celtics]

1. The difficulty is that my parents have looked into borrowing further, however the banks deem my parent's income insufficient to maintain these repayments and have not been willing to lend further

2. Not keen on cross collateralising properties

3. Haven't looked into the trust idea. May be worth looking into, but I must admit, don't know much about trusts and how they function. Will the trust structure avoid any CGT and stamp duty commitments?

Agree, it's a shame to have to sell the property, but converting the property into a tax deductible loan is a huge benefit. Is it possible for me to live in the property for six months and claim it as my PPoR and then rent out to parents?. Land tax is not ideal too.

 

[The Y-man]

I'm 25, living out of home have just bought an investment property valued at $400 000 (loan at $350 000) and managing that comfortably. I earn about $120 000 p.a. which will rise by about $30k every year.

We (as a family) would like do some more investing and would like to unlock some equity in this house.....

My parents have helped me out a fair bit, and my philosophy is to help them out in return.

1. Move back home.
2. Pay board - lots of it - uhh....about $1,000 per week? (hey, big house, furnished and cleanings done for you)
3. Parents use money to pay down debt.
4. Parent have more money to invest (that was previously going to pay interest)

The Y-man

 

[Terry_w]

1. The difficulty is that my parents have looked into borrowing further, however the banks deem my parent's income insufficient to maintain these repayments and have not been willing to lend further

2. Not keen on cross collateralising properties

3. Haven't looked into the trust idea. May be worth looking into, but I must admit, don't know much about trusts and how they function. Will the trust structure avoid any CGT and stamp duty commitments?

Agree, it's a shame to have to sell the property, but converting the property into a tax deductible loan is a huge benefit. Is it possible for me to live in the property for six months and claim it as my PPoR and then rent out to parents?. Land tax is not ideal too.

1. Could this be rectified?
2. If it could save you $60,000 and $5000 per year? And get the CGT exemption.
3. Yes as there will be no change in ownership

 

[celtics]

Terry,

1. Have looked into it for past six months with not much luck. Father runs a business which has variable income and mother earns an average salary ~65k, hence banks reluctance to lend more. Might be different if I go along with my deposit.

2. The only downside here is the $60k stamp duty and is a lot of money. However, negative gearing will yield around 10-15k tax refund according to my rough calculations. After five years, this would have covered the initial stamp duty fee not to mention ongoing deductions. Paying 5k p.a. land tax to get 10-15k tax refunds p.a. from tax breaks seems worth it.

I don't really plan on selling this property ever, realistically for at least 10-15 years. CGT exemption is still a possibility if I choose to live in for 3 months and claim as PPoR. My parents will also have the option to invest somewhere in an IP and then move into it when the time comes as a PPoR. By that time, I would have significant equity built up in the property and can either sell, borrow further to invest and continue renting it out and claim tax deductions.

3. Will look into the trust structure though. Sounds like it might work too as long as it provides us an avenue to access the equity without having to sell and my parents required to borrow further.

Y-man,
- Moving back and paying board is an option, but at the end of the day all this money will be going into the PPoR loan which will need to be redrawn anyway when the funds are needed. Unless you propose putting it in the offset account, and saving it for when we could use it?
- Even then this option would take 2-3 years, which is 2-3 years that all our money and funds are tied up on one property.
- This compared to the other model which releases equity immediately to have potentially two properties working for us not to mention without much change in cashflow commitments. I would be paying around ~1k per month to cover the property compared to ~1k a week to pay down non-deductible debt
- Not to mention, I'm not keen on living at home till I'm 30.

 

[jingo]

Cons
- mixing family and business

This is a huge con. Have you considered the position your parents would be in if the investments you buy don't work out? They don't have the time to rebuild their assets. You have plenty. Perhaps forging ahead on your own is the best course of action.

 

[Rolf Latham]

Don't assume that because lender x , usually the incumbent, says no more borrowings thank you, that this is actually the case with all lenders

Also, the family guarantee thing with a limited 25 % guarantee and the 80 lend secured to the ip may be acceptable

In any scenario make sure u have enough trauma income and life insurance..........
Ta

Rolf

 

[Terry_w]

These sorts of transactions make me worried - there are so many issues with it that you don't seem to fully understand.

Both you and your parents should get independant legal advice before doing anything.

 

[The Y-man]

Unless you propose putting it in the offset account, and saving it for when we could use it?

This is one case when I would suggest NOT an offset.

Check with accoutnants what happens to the interest costs (tax wise) when you dump money in the actual loan and then redraw for INVESTMENT purposes.

The Y-man

 

[The Y-man]

- Even then this option would take 2-3 years, which is 2-3 years that all our money and funds are tied up on one property.

Nothing wrong with that!

The Y-man

 

[stumpie]

1. The difficulty is that my parents have looked into borrowing further, however the banks deem my parent's income insufficient to maintain these repayments and have not been willing to lend further

2. Not keen on cross collateralising properties

3. Haven't looked into the trust idea. May be worth looking into, but I must admit, don't know much about trusts and how they function. Will the trust structure avoid any CGT and stamp duty commitments?

Agree, it's a shame to have to sell the property, but converting the property into a tax deductible loan is a huge benefit. Is it possible for me to live in the property for six months and claim it as my PPoR and then rent out to parents?. Land tax is not ideal too.

Celtic

have you looked into the following.

1. have your parents asked the lender whether its possible to release the equity in their PPOR to an LOC?
2. if the above is possible then use the LOC to buy an annuity this represents income for your parents which can satisfy the banks DSR so your parents can continue to invest
3. once the annuity has achieved its purpose terminate the annuity and return the funds back to the LOC

 

[Terry_w]

Celtic

have you looked into the following.

1. have your parents asked the lender whether its possible to release the equity in their PPOR to an LOC?
2. if the above is possible then use the LOC to buy an annuity this represents income for your parents which can satisfy the banks DSR so your parents can continue to invest
3. once the annuity has achieved its purpose terminate the annuity and return the funds back to the LOC

Or you the son buy an annuity in the parents name with your own cash....

Good thinking Stumpie