Which is more tax effective?

[lenovo]

Been reading for a while and we have finally set a date to get us started. But before we do, we just want to confirm some things to make sure where making the right step.

We bought our PPOR valued at 500K last April 2007 and plan to buy an IP in Feb/March 2009. We're a bit confused at the moment as to whether to buy a new PPOR and convert our current home into an IP or just buy an IP and stay where we are. We don't mind staying for a while as we are still happy with the area we live in but we also don't mind a new scenery. The new PPOR or IP will be around 400K as this is the price we are comfortable with at the moment.

So in Feb/March next year, our current mortgage will be:

PPOR:
500K loan
350K remaining on loan (including 50K redraw)
100K in offset
50% LVR

Scenario 1: Buy IP (deposit is 70K for example, 10K extra expenses). Put 30K from offset into loan so that redraw account would total 80K. Redraw 70K so that deposit would be tax deductible and use 10K for any tax deductible expenses for IP. The end result would be:

PPOR: 500K loan
400K remaining on loan (redrawal account is NIL)
70K offset
66% LVR

IP: 400K loan
70K deposit
10K expenses
between 80%-83% LVR

Question: If we'll use our salary afterwards to finance the maintenance of our IP, would that be tax deductible? Or should we still need to get the expenses from the redraw account to make it deductible? Will it be the same if we take the expenses from the offset? We don't want to create a LOC if we don't have to at this point. We plan to get a LOC in the future from the IP and not the PPOR.

Scenario 2: Buy new PPOR and convert current PPOR into IP. We cannot use the 50K from the redraw account in this case since it will cause problems later on during tax time (or will it not? We're not sure...). We can just use the 100K offset account. Withdraw 100K offset and use 80K for deposit and the remaining 20K into the PPOR offset for current living expenses.

IP: 500K loan
350K remaining loan
70% LVR

PPOR: 400K loan
320K remaining loan
80% LVR

Question: We have no choice but to use our salary to fund expenses for our IP. Again, would that be tax deductible? Our PPOR LVR is more than our IP LVR which we think is not very tax effective.

We would think that scenario 1 would be the better option. we also thought about going back to renting but we don't want to go that path as our lease was cut short last time and we were evicted without any reason (turns out that the owner sold the unit to his brother as a PPOR). We don't want that hassle again.

What do you guys think? We would also appreciate comments on anything we missed out on. Thanks!

 

[Bandita]

Hi Lenova,

Some thoughts in blue

Been reading for a while and we have finally set a date to get us started. But before we do, we just want to confirm some things to make sure where making the right step.

We bought our PPOR valued at 500K last April 2007 and plan to buy an IP in Feb/March 2009. We're a bit confused at the moment as to whether to buy a new PPOR and convert our current home into an IP or just buy an IP and stay where we are. We don't mind staying for a while as we are still happy with the area we live in but we also don't mind a new scenery. The new PPOR or IP will be around 400K as this is the price we are comfortable with at the moment.

So in Feb/March next year, our current mortgage will be:

PPOR:
500K loan do you mean value?
350K remaining on loan (including 50K redraw)
100K in offset
50% LVR

Scenario 1: Buy IP (deposit is 70K for example, 10K extra expenses). Put 30K from offset into loan so that redraw account would total 80K. Redraw 70K so that deposit would be tax deductible and use 10K for any tax deductible expenses for IP. The end result would be:

PPOR: 500K loan value?
400K remaining on loan (redrawal account is NIL)
70K offset
66% LVR

IP: 400K loan value?
70K deposit
10K expenses
between 80%-83% LVR

Question: If we'll use our salary afterwards to finance the maintenance of our IP, would that be tax deductible? The expenses (presuming for property investment will be tax deductible off of your assessable incomeOr should we still need to get the expenses from the redraw account to make it deductible? You can do that as well - the interest on the redraw loan will be tax deductibleWill it be the same if we take the expenses from the offset? if you take the funds from the offset - as the offset is against your PPOR loan, the increased interest you'll now be paying on the PPOR won't be tax deductibleWe don't want to create a LOC if we don't have to at this point. We plan to get a LOC in the future from the IP and not the PPOR.

Scenario 2: Buy new PPOR and convert current PPOR into IP. We cannot use the 50K from the redraw account in this case since it will cause problems later on during tax time (or will it not? We're not sure...). If you use your redraw to purchase a PPOR, the interest on the redraw loan won't be tax deductible (it's the purpose of what the funds are used for that determines this - not where it can from)We can just use the 100K offset account. Withdraw 100K offset and use 80K for deposit and the remaining 20K into the PPOR offset for current living expenses.

IP: 500K loan value?
350K remaining loan
70% LVR

PPOR: 400K loan value?
320K remaining loan
80% LVR

Question: We have no choice but to use our salary to fund expenses for our IP. Again, would that be tax deductible? The expenses to hold your investment property will be tax deductible against your assesable incomeOur PPOR LVR is more than our IP LVR which we think is not very tax effective.


What do you guys think? I think you need to include some other factors - including rental return, depreciation, etc to make a good decision. Also, do you want to move (are you looking for a new PPOR anyways? If you are, you've set everything up correctly by having your excess funds in your offset account because if you use those funds to buy the PPOR, the interest remaining on the "old PPOR (now IP) will be tax deductibleWe would also appreciate comments on anything we missed out on. Thanks!

That's a start!

Cheers,
Jen

 

[Bandita]

Since your numbers are a little bit confusing - here's how I see it:

Current:

PPOR Value: $500k
Loan: $350k
Offset: $100k

Non-deductible debt: $250k

Scenario 1:

PPOR Value: $500k
Loan: $350k
Redraw: $50k
Offset: $70k

IP Value: $400k
Loan: $320k

Non-deductible debt: $280k
Deductible debt: $370k

Scenario 2:

IP Value (old PPOR): $500k
Loan: $350k

PPOR Value: $400k
Loan: $320k
Offset: 20k

Non-deductible debt: $300k
Deductible Debt: $350k

A couple of things - you haven't included the expenses of purchasing the property (stamp duty, lawyers, LMI, etc). You also need to look at the possible property depreciation of the 2 properties, as well as the rental return on each property.

Cheers,
Jen

 

[lenovo]

Hi JenD,

Thanks for your answers. I think it's a bit clearer now... Here's what I think you said...

1. If I use the redraw for IP expenses, the interest on the redraw loan will also be tax deductible.

2. If I use our salary for IP expenses, it will be tax deductible off our assessable income.

3. If I use our offset for IP expenses, it will be tax deductible off our assessable income but the increased interest on the PPOR will not be tax deductible.

4. If I use our redraw to purchase a PPOR, the interest on the redraw loan won't be tax deductible so it's better just to use the offset if we want to go this path.

I have some more questions if I may...

1. Will there be a problem putting the 30K of the offset first into the redraw account before buying the IP (say, a few weeks prior... so that everything in the interest would be tax deductible). Won't the taxman see it as a way to increase my tax deductions?

2. What I said regarding the IP should have the larger LVR than the PPOR is incorrect? What I should be looking at is the IP should have the larger deductible debt is that correct?

3. In you second post, I think you missed the 1st scenario... here's what it should be (I think...)

Current:

PPOR Value: $500k
Loan: $350k (including $50k redraw)
Offset: $100k

Non-deductible debt: $250k

Scenario 1:

PPOR Value: $500k
Loan: $400k (redraw becomes $0)
Offset: $70k

IP Value: $400k
Loan: $320k

Non-deductible debt: $330k
Deductible debt: $320k

Scenario 2:

IP Value (old PPOR): $500k
Loan: $350k

PPOR Value: $400k
Loan: $320k
Offset: 20k

Non-deductible debt: $300k
Deductible Debt: $350k

4. So right now, I think scenario 2 is more tax effective since the deductible debt is bigger? But you're right that I should also consider stamp duty, lawyers, LMI as well as depreciation and rental return on each property.

5. One last thing, my taxable income is around 65K and my partner around 35K (but in reality we recieve much more than that due to fringe benefits). Anyway, we're both on the 30% margin rate but with a few more deductions, my partner would be on the 15% bracket. If we negative gear, is it still wise to make the IP 50-50? Or should a larger percentage be on my partner's name?

 

[Bandita]

Hi Lenovo,

Hi JenD,

Thanks for your answers. I think it's a bit clearer now... Here's what I think you said...

Yep - note that I'm not an account, this is just my understanding and experiences

I have some more questions if I may...

1. Will there be a problem putting the 30K of the offset first into the redraw account before buying the IP (say, a few weeks prior... so that everything in the interest would be tax deductible). Won't the taxman see it as a way to increase my tax deductions? ?

I suppose it depends, but I wouldn't think so - an accountant would be able to comment, but I would see it as tax minimisation rather than avoidance. To be safe, once you have decided which was to go - and if you decide that you want to stay in your PPOR and purchase an IP - I would put the funds from the offset into the PPOR redraw immediately and then there would be several months before you needed to redraw them the funds for the purchase.

2. What I said regarding the IP should have the larger LVR than the PPOR is incorrect? What I should be looking at is the IP should have the larger deductible debt is that correct?

Yes, that would be my view - tax wise, the LVR makes little difference (except if higher than 80% which would call for Mortgage Insurance, which is deductible for an IP), but deductible vs non-deductible debt certainly does.

3. In you second post, I think you missed the 1st scenario... here's what it should be (I think...)

Current:

PPOR Value: $500k
Loan: $350k (including $50k redraw)
Offset: $100k

Non-deductible debt: $250k

Scenario 1:

PPOR Value: $500k
Loan: $400k (redraw becomes $0)
Offset: $70k

IP Value: $400k
Loan: $320k

Non-deductible debt: $330k
Deductible debt: $320k

The $50k redraw is being used towards the purchase of an IP - so it's deductible debt, so in the end you will have (from my understanding):

PPOR Loan: $350k (non-deductible)
Redraw: $50k (deductible)
Offset: $70k (offsets PPOR)
IP Loan: $320k (deductible)

Non-deductible debt: $280k ($350k less $70k in offset)
Deductible debt: $370k ($320k + $50k redraw)

5. One last thing, my taxable income is around 65K and my partner around 35K (but in reality we recieve much more than that due to fringe benefits). Anyway, we're both on the 30% margin rate but with a few more deductions, my partner would be on the 15% bracket. If we negative gear, is it still wise to make the IP 50-50? Or should a larger percentage be on my partner's name?

This is a question for you accountant as there are many factors. Generally though, if the IP is to be negatively geared, people put the property and the loan in the name of the higher income bracket earner for the greatest tax-effectiveness.


Cheers,
Jen

 

[lenovo]

Thanks again Jen.

Just one one more hanging in my head....

Isn't it that if the IP's value is 400K and I get the 80K deposit from the PPOR redraw, the total deductible debt is 400K (320K balance + 80K deposit)? Meaning, the interest on 320K will be tax deductible and the interest added on the PPOR due to the withdrawn 80K will also be tax deductible?

 

[Bandita]

Hi Lenovo,

Yes - if you put the $30k from your offset account into your redraw account, and then redraw the funds for IP deposit, the interest on the redraw (now 80k would be tax-deductible)

Quick question - when you say $350k PPOR loan including redraw - do you mean that the total loan is $400k (and $50k is in a redraw account making the effective balance $350k)?

Thanks,
Jen

 

[lenovo]

Hi Lenovo,

Yes - if you put the $30k from your offset account into your redraw account, and then redraw the funds for IP deposit, the interest on the redraw (now 80k would be tax-deductible)

Quick question - when you say $350k PPOR loan including redraw - do you mean that the total loan is $400k (and $50k is in a redraw account making the effective balance $350k)?

Thanks,
Jen

Yes, the current balance is 350K but if I withdraw all the contents of the redraw, the total loan loan would be 400K and redraw would be NIL.