STRUCTURED GEARING

From: Steve Navra


I have received a great many emails requesting info on HOW to correctly structure the ‘Gearing’ for IP’s. (Following GURU CROFT’s original posting – you have much to answer for Sir Croft!)

Also, I note that a great many subscribe to the school of “ NEVER EVER NEGATIVE GEARING.”

Many of the VERY successful authors (Our very own Jan Somers included) use negative gearing to build substantial wealth through Investment property, so:

Maybe first some definitions:

NEGATIVE GEARING

The term ‘negative gearing’ simply refers to a situation where your cash outflow to maintain an investment exceeds your cash income from the investment itself.
For example, with a residential property, if the mortgage payment and expenses on your property exceeds the rental income from the property, it is negatively geared. In other words, the investment income is negative, which allows you to claim the interest costs on your mortgage or loan as a tax deduction.

POSITIVE GEARING (??? Is there such a thing, or is it just a positive cashflow?)

The term ‘positive gearing’ is perhaps the corollary of the definition above where the income exceeds the outflow of the investment.
For example, with an investment property, if the rental income exceeds the mortgage payment and expenses, it is positively geared (cashflow positive) In other words the income is positive, uuuugh, which strictly speaking means taxable and should be declared as such.

STRUCTURED GEARING
This means putting in place a structure, that allows all the valuable tax deductions of negative gearing, but which provides a cashflow, so as to make the incomes and outflows neutral. Or even which allows extra income (of a capital nature, therefore not taxable) if you choose to receive a passive income to live off.

EXPLANATION - By way of examples:

§ 1) NEGATIVE GEARING
Purchase of an investment property using a 100% plus costs loan. (Security might be another asset)
So, the rental income is less than the outgoings, which results in a LOSS, which is deductible against your income. This loss is claimable as a deduction. The resulting cashflow shortfall might be in the order of $50 to $100 per week per property.

Now what seems to offend the “School of Never Everers” is firstly the reliance on the tax deduction against their income, as a means to fund the asset. (What if my income changes, they ask) And also the cashflow required might be a scarce resource in their household situation. (Isn’t it for everyone?!!)

§ 2) POSITIVE GEARING
Purchase of an investment property using a deposit that will render the rental income equal to or greater than the outgoing mortgage payments and costs.

This way, there is no reliance on a tax deduction, or the need to use your own household cashflow to hold the asset.
BUT: What about the value of the dollars, which have been put into the asset (deposit) to render it positively cashflowed???????????

§ 3) STRUCTURED GEARING
Purchase the asset as per 1) Negative Gearing above, and then instead of placing dollars into the asset, (like a deposit in Positive Gearing) rather purchase an income stream, with these dollars. (By way of a cashbond – which in essence is the return of the capital over a time period) The income stream could be purchased so as to provide the $50 to $100 per week or more, which will cover the cashflow costs of holding the asset.
a) The benefit of a bona fide’ tax deduction is still valid
b) Your household cashflow is not effected (and enhanced if need be)
c) The extra income allows for extra borrowing capacity!!!
d) The dollars in the cashbond are easily accessible. (commutable)

I have found this structure to be most beneficial, especially when acquiring your 2nd, 3rd . . . IP’s. (As your borrowing capacity gets exhausted in the banks eyes.) I have also persuaded certain banks to recognize the extra income as valid for further borrowing capacity. Lastly, many of my clients use this structure to provide passive income to live off. (The income stream is purchased from the equity buildup in their IP’s)

For further info, see CAVEAT EMPTOR below.

Hope this is of interest,

Regards

Steve
 
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Reply: 1
From: Dave :)


Steve,

FANTASTIC post. This one will definitely end up in the Apprentice
Millionaire Forum.

I'm into minimal outlay for quality property in quality areas. If I'm
negatively geared, but cashflow positive, and have my net asset worth
growing faster than two salaries combined, I have no problems raising my
hand and declaring that I'm a negative gearer (ok, structured gearer)
and proud of it.

From the amount of critical recent posts I've read on negative gearing
lately, I was starting to feel as though what I'm doing is politically
incorrect. *grins*

Cheers,

Dave
:)
 
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Viva Politically Incorrect

Reply: 1.1
From: Paul Zagoridis


Of course you are politically incorrect! That is the goal on two levels:

1) Political Correctness ("Never Negative Gear") taken to extreme is ABSURD (love that word)

2) Do the opposite of whatever 80% of the herd are doing. That way you get the crunchy green grass and should avoid the predators attracted by the herd.

Paul Zagoridis
(coz some ppl don't know who Dreamspinner is)
 
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Reply: 2
From: Robert Forward


And Steve if you start it late enough, as in 6-7pm, I will also come and sit next to Michael and join in the heckling...

And I'll bring Yuch and Ms Flip too. Only cause they will be in my car coming down from Sydney and they have no choice. haahaa.

Robert
 
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Quick Update on Positve Gearing (Cashflow)

Reply: 2.1
From: Kevin Forster


Although Steve's post was very good at explaining negative and structured gearing - it lacked quite a bit on positive gearing.

I do agree that any property with a large enough deposit can be positively geared. I've even said to real estate agents that I only buy positively geared properties and they said if I put down a 30% deposit it would be positively geared. So there is positively geared and positively geared.

My rules are:
10% cash deposit on the property.
All closing cost, stamp duty, conveyancing etc are capitialised. I guess I capitalise at approximately 94% of the value of the property.
All income from rent (calculated at 50 weeks a year) must cover all expenses such as loan interest, maintenance, rates, insurance, agent fees, etc.

If at the end of that I end up with an income then the property is positively geared (cashflow).

Any tax deductions are just icing on the cake and improve my return.

You have to pay tax on the income but putting properties in the name of the lowest income earner can alleviate losing 48 cents in the dollar in tax.

I don't recommend paying more than 20% in cash on a property to make it positively geared - you are just tying up too much money in one property. 10% is better and 0% is best.

I like positive gearing as I'm a contrarian and don't like doing what the 80% do ;).

Hope it helps

Kevin
 
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Quick Update on Positve Gearing (Cashflow)

Reply: 2.1.1
From: Steve Navra


Hey Kev,

These days, being a contrarian might mean Negative Gearing!!

Seems 80% are NO LONGER doing it this way.

Aaaah well, back to my herd then.

Ha ha

Steve
 
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Quick Update on Positve Gearing (Cashflow)

Reply: 2.1.1.1
From: Kevin Forster


Steve

I agree that on this forum a lot people do not negatively gear and some are quite anti negative gearing. The wider community tends to accept negative gearing as the way to buy investment properties.

I was watching Money on TV and even Paul Clitheroe was recommending a soldier negatively gear an IP. The soldier, a junior NCO would be lucky to gross $40k.

I don't quite understand structured gearing - is a cash bond like a term deposit from the bank or is it like a deposit bond? Where do you get them from?

Kevin
 
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Quick Update on Positve Gearing (Cashflow)

Reply: 2.1.1.1.1
From: Steve Navra


Hi Kev,

Cashbonds are available from the major Life Insurers.

I describe them as similar to a fixed deposit, with amounts returned to the investor at regular intervals. (Annually, monthly or fortnightly if you wish)

Email me and I will give you a more detailed response. (Too loooong to explain properly on the forum.)

Steve
 
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Re: Quick Update on Positve Gearing (Cashflow)

Reply: 2.1.1.1.1.1
From: Ian Findlay


Steve,

Its Ian again.

Can you send me details of the cashbonds and how they work?

Ian


> From: "Steve Navra" <navs@ozemail.com.au>
>
> Hi Kev,
>
> Cashbonds are available from the major Life Insurers.
>
> I describe them as similar to a fixed deposit, with amounts returned to
the investor at regular intervals. (Annually, monthly or fortnightly if you
wish)
>
> Email me and I will give you a more detailed response. (Too loooong to
explain properly on the forum.)
>
> Steve
>
>
>
> To reply: mailto:propertyforum.5313@bne003w.webcentral.com.au
> To start a new topic: mailto:propertyforum@bne003w.webcentral.com.au
> To login: http://bne003w.webcentral.com.au:80/~wb013
>
>
 
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Quick Update on Positve Gearing (Cashflow)

Reply: 2.1.1.2
From: Michele B


Seems to me that the neg gearing debate is about as productive as the property vs shares one and is even approaching religious fervour for some! Must be very confusing for new investors.

Surely investment methods are just tools to achieve an end - you use specific tools or a combination of tools to get the desired result. And your choice also depends on where you are headed and how fast you want to get there. Experienced investors use a combination of methods - cash pos properties often fund quality B&H (usually neg geared initially) properties. I think there's too much focus on using the 'right' process and not enough on the ultimate aim.

You want to go to the beach? You can walk or go by car, bus, tram or train. Some methods and routes are faster than others, some are riskier. And because the method you choose depends a lot too on where you start from, your tactics are likely to be completely different from anyone else's.

Michele
 
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Quick Update on Positve Gearing (Cashflow)

Reply: 2.1.1.2.1
From: Steve Navra


Michele,

You are OH SO RIGHT!

Ultimately the structure DOES depend on where you are trying to go and what you aims are.

Mostly though, one needs to know where one is coming from! Hence the many hours of research and due diligence on FIRST getting your existing asset structure 'Optimised'.

There are many different vehicles available to 'get you there', wherever there is?

Beach sounds fine to me

Steve
 
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Reply: 3
From: Apprentice Millionaire


Hi Steve,

Excellent post. I will not enter the debate about positive or negative gearing (it's all horses for courses anyway), although I do espouse the strategy of making sure that my cashflow is positive in the end.

Hence my interest in your structured gearing.

So a few questions:
a) You and Michael Croft (Sir? :) indicate that the structured gearing strategy is really meant for people who have more than one IP, i.e. not for beginners. So would you suggest that the structure is or is not suitable for someone like me who is in the process of looking for his next (i.e. second) investment property acquisition?
b) Are cashbonds similar to income bonds? I must say that I am doing my own due diligence and trying to learn, and I found this about investment bonds:
"Benefits under the “income bond” are in the form of bonuses declared as a result of the Fund being invested mainly in interest bearing deposits and securities. Friendly Societies do not pay tax on investment earnings but the income bond bonuses declared each year are immediately taxable in the hands of the member, at their marginal rate of tax.
Bonuses may be reinvested in the fund but tax is still immediately payable by the member if
they choose this option.
Income bonds are capital guaranteed and members can access their funds at any time either in full or in part. On redemption or maturity members are entitled to receive their share of the fund including reinvested bonuses. For capital gains tax purposes, reinvested bonuses are taken to have been adding progressively to the cost base of the investment, and so no taxable capital gain
arises on maturity or redemption." (Source: Australian Friendly Societies Association's submission to the Business Taxation Reform Committee)
c) You do add that the structure "allows extra income (of a capital nature, therefore not taxable) if you choose to receive a passive income to live off." The not taxable bit refers to CGT, not income tax, does it? I.e. a cashbond will provide an income that is taxable, am I right?

I guess I have just exposed more of my ignorance. I would have loved to be in Canberra for the BBQ and your seminar, (cannot for family reasons), so if by chance you happen to be wandering down to cold and wet Melbourne, would you mind repeating the seminar if there was enough demand?

Cheers
Apprentice Millionaire
(aka Jacques)
 
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Reply: 3.1
From: Steve Navra


Hi AM,

Okay, so the subject of Cashbonds is a book in itself!

I am putting together a ‘dissertation’ (!) on this subject for all who are interested and will e-mail it to whomever requests.
(It really is too long for a forum post)

BUT, I will address a few issues here:

Yes even ‘newbies’ can use this structure, the point is that you need some measured growth in your asset/s to justify spending any of the income from the bond. (Otherwise you will be spending your capital.)

So if for example you acquire a bond for $50,000 and this generates an income of $11,500 for 5 years:
This creates borrowing capacity of $250,000 (rental income at 75%)

Hence you do your research and buy a $200,000 plus property. The $11,500 per annum should be directed back to from whence it came - in other words to pay back the $50K (loan) that was used to set up the cashbond in the first place. (Usually from a LOC)


Now the point is that you have an extra asset worth $200,000 which SHOULD be appreciating at 5%pa capital growth, which means it is increasing at $10,000 pa in value. (Compounding obviously) So, as long as you continue to prove to yourself that the asset has increased, then you can use (spend) up to the amount reflected as growth, from the income stream. ($10,000 in the example for the first year)

This might be used to cashflow the holding costs of the asset, or as passive income etc.

Where Sir Croft gets concerned (and rightly so) is that someone sets the structure in place, acquires assets that DON'T grow (Like the Gold Coast!) and then still uses the income. The danger is that at the end of the five years, the bond will be exhausted, and they will have spent their capital.

Now also, the bond is set up as a capital plus interest redemption, income stream:

So as per the above example $50,000:
Each year the income would be $10,000 (capital return) plus $1,500 (interest)
ONLY the interest is taxable! (So your Tax Rate X $1,500 = minimal) The interest return is very low (IRR at 4.98% : longterm bond rate), but note it is GUARANTEED. This is very important to me, especially when clients use capital from their homes for the bond. (Then I want to be absolutely sure that they are guaranteed to get it back!)

CGT does NOT come into the picture, unless you sell the property. Rather you would draw down against the accrued equity at the end of the five years, and roll this over into a new bond. (Note the original capital will have been repaid to the home / LOC)

So, just 'blank' e-mail me, titled: CASHBOND
and I will send out the full story.

Ahem, after we have recovered from the B-BBQ

regards

Steve
 
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Reply: 3.2
From: Apprentice Millionaire


Bonjour Michael,

>I subscribe to the theory that says; tell me and I'll forget, show me and I'll remember, but
>let me do and I'll understand.

I will subscribe to the same theory. I would add, as I still consider myself to be in the learning phase, that if you let me do, under the guidance of a mentor, I'll understand even better. Anyway, that's what I am trying to do by asking all my questions!

Cheers, and thanks for the guidance!
Apprentice Millionaire
(aka Jacques)
 
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