Why buy Negatively Geared Properties? I think the calculations are wrong

[manoj]

Dan C

OK I will (also) try again

Ignore my income, the figures are as below (no depreciation)

rental income 22000 - cash received
costs (strata etc) 2000 - cash paid out
income 20,000 - net cash received

interest cost 30,000 - cash paid to the bank

loss from property $10,000 - net cash paid to be paid to the bank

tax loss claimed in my tax return - since i am in 41.5% bracket

I get a refund of $4,150 from the Government - cash received

net cash to be paid to the bank $5,850

Now i have to pay this cash to the bank. Right?

This cash has to come from somewhere
I am a employee - i work and then i get paid

Remember I need $5,850 CASH to pay to the bank - my annual salary is $120,000 or $10,000 a month.

My boss pays me $5850 CASH every month after deducting tax of $4,150 (for this example - let us not worry about withholding tax is correct or not)

I use one month salary to pay the $5,850 CASH to the bank as bank interest.

my one monthly salary is $10,000 = all of it is gone to own this investment property. It costs me $10,000 of my income to own this property


Am I right? There is no double counting of cash.


If i could salary sacrifice in super - this $10,000 of my one month salary - i would have more money in my super and somehow If could pay no tax on contribution - i could be better off - with Super Gearing - this is possible.


Those who have commented earlier - please find a mistake in the above.

I am not here to prove any one wrong - but maybe my method may be different - I do not blame those who have got it wrong - the problem is that the topic has been taught incorrectly by those who benefit - property developers and promoters


BV - the point is that Negative Gearing must now be replaced with Super Gearing = but we do not understand Negative Gearing correctly - they still think that owning the property will cost only $5,850 and not $10,000 of their income. I feel this has to be corrected, only then we will look at Super Gearing seriously. There will be some, who will still think that i am wrong - but if i have even put an iota of doubt in their minds - my job is done.

The tax man still gets their fair share - if they did not - NG would have been abolished a long time back. Do not forget the ATO is your partner in your property investment - they will get a cut when you sell the property in the form of CGT - but will not share if you lose - Capital loss is only carried forward and does not reduce income. And every year, when you pay to the bank - it is profit for the bank - and the ATO collects tax on that profit - they have no interest in removing NG.

If property is purchased in a SMSF - it is possible to reduce your CGT to Zero ie when you sell the property in pension phase.... every day ... more and more super fund members and property investors are finding out this fact and about 2000 / 3000 SMSF are being set up every month...

Hooray ... no offense taken .... I am used to this....



Manoj Abichandani
SMSF Specialist Advisor
SMSF Specialist Auditor
Tax Agent, FTIA, PNA, REA

 

[Hooray]

Hooray ... no offense taken .... I am used to this....

I bet you are. You would have to be, if you're a tax agent and you can't tell the difference between pre and post tax income.

It costs 10,000 of your PRE-tax income, yes. It only costs you 5,850 of you AFTER tax income.

I doubt you're going to find many clients to use your services for SMSFs if you try to mangle pre and post tax numbers.

 

[manoj]

I am not here to find clients.... In fact I am not even in tax practice - i retired some years back....

In Super fund gearing - there is no difference between pre tax and after tax dollars - however outside of super there is... I just wanted to bring that to light

 

[maloo]

Dan C

OK I will (also) try again

Ignore my income, the figures are as below (no depreciation)

rental income 22000 - cash received
costs (strata etc) 2000 - cash paid out
income 20,000 - net cash received

interest cost 30,000 - cash paid to the bank

loss from property $10,000 - net cash paid to be paid to the bank

tax loss claimed in my tax return - since i am in 41.5% bracket

I get a refund of $4,150 from the Government - cash received

net cash to be paid to the bank $5,850

Now i have to pay this cash to the bank. Right?

This cash has to come from somewhere
I am a employee - i work and then i get paid

Remember I need $5,850 CASH to pay to the bank - my annual salary is $120,000 or $10,000 a month.

My boss pays me $5850 CASH every month after deducting tax of $4,150 (for this example - let us not worry about withholding tax is correct or not)

I use one month salary to pay the $5,850 CASH to the bank as bank interest.

my one monthly salary is $10,000 = all of it is gone to own this investment property. It costs me $10,000 of my income to own this property


Am I right? There is no double counting of cash.


If i could salary sacrifice in super - this $10,000 of my one month salary - i would have more money in my super and somehow If could pay no tax on contribution - i could be better off - with Super Gearing - this is possible.


Those who have commented earlier - please find a mistake in the above.

I am not here to prove any one wrong - but maybe my method may be different - I do not blame those who have got it wrong - the problem is that the topic has been taught incorrectly by those who benefit - property developers and promoters


BV - the point is that Negative Gearing must now be replaced with Super Gearing = but we do not understand Negative Gearing correctly - they still think that owning the property will cost only $5,850 and not $10,000 of their income. I feel this has to be corrected, only then we will look at Super Gearing seriously. There will be some, who will still think that i am wrong - but if i have even put an iota of doubt in their minds - my job is done.

The tax man still gets their fair share - if they did not - NG would have been abolished a long time back. Do not forget the ATO is your partner in your property investment - they will get a cut when you sell the property in the form of CGT - but will not share if you lose - Capital loss is only carried forward and does not reduce income. And every year, when you pay to the bank - it is profit for the bank - and the ATO collects tax on that profit - they have no interest in removing NG.

If property is purchased in a SMSF - it is possible to reduce your CGT to Zero ie when you sell the property in pension phase.... every day ... more and more super fund members and property investors are finding out this fact and about 2000 / 3000 SMSF are being set up every month...

Hooray ... no offense taken .... I am used to this....



Manoj Abichandani
SMSF Specialist Advisor?
SMSF Specialist Auditor?
Tax Agent, FTIA, PNA, REA?

Thats not how we roll in Oz bro.

 

[Rob Williams]

In Super fund gearing - there is no difference between pre tax and after tax dollars - however outside of super there is... I just wanted to bring that to light

Thanks for that.
I think you will find that this is well known among the savvy investors who frequent this and similar forums.
There are some folks playing keno at the local pub who might know know this.
But would they even be interested?

 

[BV]

Manoj

I agree that the $10K is gone.

If we salary sacrificed it into our super, our SMSF will still pay tax but only 15% so we would be left with $8500 to cover the shortfall.

So in theory we could afford to hold a more expensive property when we purchase using our SMSF or we can leave the extra money in our super and let it grow.

I've been doing just that and together with my employer contributions my super is growing nicely

 

[JamesGG]

my one monthly salary is $10,000 = all of it is gone to own this investment property. It costs me $10,000 of my income to own this property

Am I right?

Perhaps I am not the best person to be posting in this thread; I am amongst those who try to educate people about the differences between before-tax and after-tax cashflow.

However;

I still do not believe that you've established your point correctly, or at least not succinctly. In your example, the amount withheld (accurate or not) is not a cost of owning the property. It is a cost of earning income; ie, taxes. This would have been paid regardless of property ownership.

In your example, the amount withheld from wages will be returned via the tax system. So yes, the after-tax amount paid to the bank is not grossed up and does not consider the before-tax cost; but it shouldn't, as the difference is refunded.

I deliberately phrased my previous post to show the 'money in pocket'. That's the bottom line of what is left after paying the bank, and getting the tax refund. So, I am not sure how you came to figure that the tax paid through the withholding system is directly related to the negatively geared property?

 

[Rolf Latham]

few little add ons

SMSF will cruel your lending options big time, especially if u want a decent lvr, a moderate rate, or the flexiility to access the equity growth for external purposes.

Im not saying SMSFs dont have benefits for some, but this aribtary comparison isnt a reasonable one.

Just because a carrot and an orange are the same colour doesnt mean they are the same

ta
rolf

 

[BayView]

So If my loss is $10,000 (excluding depreciation) i can expect my refund to be $4150 which means that i will have to pay only $5850 from my pocket to own the property.

In raw terms, you are spending this amount of money ($5850) out of your earned income to hold the property.

Therefore, it costs you this amount of money to hold it. Not the $10k.

Now, to me; this is a good deal.

Why?

Because most people don't save ANY money, and lose a good portion of their income to income tax which is never recouped.

You are actually saving, and putting it into an asset that will appreciate at a rate way more than you can ever get at the Bank. You will be way ahead.

If you had no financial intelligence, and savings in a Bank was the most outrageous investment you could do, then to own one IP and pay out $5850 per year to do it is great.

But, to someone who is earning minimum wage; a shortfall of nearly $6k is not good.

This is why each person's individual circumstances must be considered in this caper.

Some one on minimum wage can do the IP journey, but they would need to start small, start cheap and really maximise the cashflow and rental yields etc.

Someone on $200k per year and still living with Mum and Dad can afford three or four $6k shortfalls per year.

 

[pickle pickle]

I do not understand how a $100 dinner costs $171. Doesn't a $100 dinner cost $100? Where did you get $171 from?

As for the property if you have a lost of $10,000 a year in holding costs, then yes you could say it costs $10,000 to hold the property. However if you are on the 40% tax bracket, one would get $4,150 in tax back. So the net cost position is $5,850.

If one was to salary sacrafice $10,000 into super rather than than have a negativiely geared property than the cost would be $1,500 (tax on the super) and the benefit is $4,150 tax savings. So investing into super a person would be better off by $2,650.

It would be better for your argument if you said that assuming the returns on property and super are excatly the same, holding a negatively geared property rather than making a super contribution will cost a person $8,500. ($5,850 + $2,650) = $8,500. I'm not going to go into extra management costs that may be incurred that will be incurred by investing more into super as I think this would be minimal (maybe $100 a year).

However the tax position is not the only consideration in determining an investment decision.

 

[manoj]

BV

Once you purchase one Super Geared property and once it is neutrally geared - do not attempt to repay the loan - there is no such thing as a redraw facility or refinance in a SMSF borrowing situation - you just cannot do it.

What next you must do is sacrifice maximum salary, if you afford it, for over 50 years old it is $50K and for others it is $25K. Try to bring taxable income down to $35K as after that you pay tax @ 31.5% - however, if you need more money to live - it is cheaper to borrow from home loan offset account at 6% instead of paying tax @ 46% - if you pay tax at the rate of 31.5% a dinner of $100 will cost you $146 (less 31.5% tax) - but if you borrow $100 from the bank, for dinner, it will cost you $106 (6% interest) - if are ready to retire within 6 years (cumulative effect 6% times 6 years = 36% but cumulative effect is still cheaper than 46% - still cheaper to borrow from home loan).

If there is equity in IP, sometimes it is better to sell IP outside super and salary sacrifice the whole lot in super and live on equity in IP (remember the 50% discount is not taxed and since you have salary sacrificed the whole salary in super - your taxable income will also be low) - the longer you keep property outside super - the higher the CGT. Sell the one which has the least CGT first to release equity, remember you pay tax on income, not on your own money.

I am not against property ownership - I am against property ownership in "high tax environment" - so you are allowed to buy property in super and up grade your own home - on sale - both the properties can be C G tax free!

So if you sell IP outside super - at the same time - you can purchase one in super - after all, all investments are for passive income for retirement years! for tomorrow.. so why pay high tax today, whilst we are working.

 

[alexlee]

Once you purchase one Super Geared property and once it is neutrally geared - do not attempt to repay the loan - there is no such thing as a redraw facility or refinance in a SMSF borrowing situation - you just cannot do it.

A massive limitation of using a super fund. My portfolio would be cut to a quarter its size if I couldn't refinance and use the equity to buy more.

What next you must do is sacrifice maximum salary, if you afford it, for over 50 years old it is $50K and for others it is $25K. Try to bring taxable income down to $35K

If I'm making well above 60k that doesn't help me much, does it?

if are ready to retire within 6 years (cumulative effect 6% times 6 years = 36% but cumulative effect is still cheaper than 46% - still cheaper to borrow from home loan).

What if I'm in my 30s and will be ready to retire by 40? What you're saying is if you're within 6 years of being allowed to get money tax free out of the super fund. Which is set by the government. Which can change.

I am not against property ownership - I am against property ownership in "high tax environment"

I'm negatively geared but with positive cashflow. Depreciation with a high marginal rate of tax helps me.

after all, all investments are for passive income for retirement years! for tomorrow.. so why pay high tax today, whilst we are working.

Because I intend to have enough passive income to stop working WAY before some 'retirement age' mandated by the government, thanks.

For what it's worth, I, for one, am salary sacrificing so that I can bring my super contributions DOWN. To the absolute minimum. Super can be a good vehicle; for those who are older, for those who wouldn't otherwise save, for those who aren't interested in investing themselves.

For younger people who plan on living off investment or business income early, super is a terrible vehicle. Too many limitations as to age, gearing and related party transactions. And who knows what the government will change next? I fully expect the retirement age to be increased well before I get there.
Alex

 

[turk]

Alexlee

Great to see you back posting, hope there are more to come.

Cheers

Pete

 

[geoffw]

Alexlee

Great to see you back posting, hope there are more to come.

Cheers

Pete

Agreed.

Thanks Alex for your contributions to the forum.

I hope you can get back into good contributions.

 

[MikeF]

BV

Once you purchase one Super Geared property and once it is neutrally geared - do not attempt to repay the loan - there is no such thing as a redraw facility or refinance in a SMSF borrowing situation - you just cannot do it.

Manoj - Whilst refinance of SMSF loans is still not allowed by the major lenders and redraw does not exist, the St George resi SMSF product does have an interest off-set option which will achieve the same outcome as redraw.

 

[BV]

Alex

I agree, buying IP's in super is not for everyone and certainly not great when you are very young but for those of us who have several IP's and don't want to stretch further outside our comfort zone it can be a great tool so we should explore the possibilities.

The way I see it I can gear my super money and make it work harder for me and I can reduce my income tax,
at a time when interest rates are low and I have no other means of reducing my income tax.
By investing through super I won't be paying any land tax either.

I've done my sums and in my situation it complements my investment strategy and does not hinder it.
So far I've got 1 IP in super and I want to buy 1 more.
Unfortunately if we are under 50 we can only contribute $25K per year
but if our wife is working she could be contributing $25K as well.

Food for thought....

 

[BV]

BV

Once you purchase one Super Geared property and once it is neutrally geared - do not attempt to repay the loan - there is no such thing as a redraw facility or refinance in a SMSF borrowing situation - you just cannot do it.

What next you must do is sacrifice maximum salary, if you afford it, for over 50 years old it is $50K and for others it is $25K. Try to bring taxable income down to $35K as after that you pay tax @ 31.5% - however, if you need more money to live - it is cheaper to borrow from home loan offset account at 6% instead of paying tax @ 46% - if you pay tax at the rate of 31.5% a dinner of $100 will cost you $146 (less 31.5% tax) - but if you borrow $100 from the bank, for dinner, it will cost you $106 (6% interest) - if are ready to retire within 6 years (cumulative effect 6% times 6 years = 36% but cumulative effect is still cheaper than 46% - still cheaper to borrow from home loan).

If there is equity in IP, sometimes it is better to sell IP outside super and salary sacrifice the whole lot in super and live on equity in IP (remember the 50% discount is not taxed and since you have salary sacrificed the whole salary in super - your taxable income will also be low) - the longer you keep property outside super - the higher the CGT. Sell the one which has the least CGT first to release equity, remember you pay tax on income, not on your own money.

I am not against property ownership - I am against property ownership in "high tax environment" - so you are allowed to buy property in super and up grade your own home - on sale - both the properties can be C G tax free!

So if you sell IP outside super - at the same time - you can purchase one in super - after all, all investments are for passive income for retirement years! for tomorrow.. so why pay high tax today, whilst we are working.

Manoj
You've got an interesting way of thinking.
I'll certainly sit down and rethink my whole investment strategy and try to make use of your ideas.
Thanks for sharing them with us.
cheers

 

[alexlee]

Alex
I agree, buying IP's in super is not for everyone and certaily not great when you are very young but for those of us who have several IP's and don't want to stretch further outside our comfort zone it can be a great tool so we should explore the possibilities.

The way I see it I can gear my super money and make it work harder for me and I can reduce my income tax,
at a time when interest rates are low and I have no other means of reducing my income tax.
By investing through super I won't be paying any land tax either.

I've done my sums and in my situation it complements my investment strategy and does not hinder it.
So far I've got 1 IP in super and I want to buy 1 more.
Unfortunately if we are under 50 we can only contribute $25K per year
but if our wife is working she could be contributing $25K as well.

Food for thought....

I agree super can be a great vehicle in certain circumstances. Yes, your partner could contribute 25k as well. I don't have that option.

The big question, to me, is when do you expect to have enough investment / business income to stop working? If it's well before 67, then super isn't a great vehicle. To me, super puts a lot of restrictions on your money until your 60s, but then is tax free after that.

If you're not looking to expand the portfolio, then the difficulty in refinancing isn't as big an issue. If you're older or don't plan on living off investments until you hit the government retirement age, then that's not an issue either.

Super CAN be a good vehicle, but certainly isn't always. The problem I have with superannuation advocates is that they just assume it's the best vehicle for everyone.

For younger people who plan on investing aggressively by buying multiple properties, who make decent amounts of money (making the 25k contribution relatively small), and who plan on living off investments well before 67, super is a terrible vehicle. However, for young people who can't save and wouldn't otherwise invest, contributing the max to super isn't a bad idea.
Alex

 

[dan c]

Dan C

OK I will (also) try again

Ignore my income, the figures are as below (no depreciation)

rental income 22000 - cash received
costs (strata etc) 2000 - cash paid out
income 20,000 - net cash received

interest cost 30,000 - cash paid to the bank

loss from property $10,000 - net cash paid to be paid to the bank

tax loss claimed in my tax return - since i am in 41.5% bracket

I get a refund of $4,150 from the Government - cash received

net cash to be paid to the bank $5,850

Now i have to pay this cash to the bank. Right?

This cash has to come from somewhere
I am a employee - i work and then i get paid

Remember I need $5,850 CASH to pay to the bank - my annual salary is $120,000 or $10,000 a month.

My boss pays me $5850 CASH every month after deducting tax of $4,150 (for this example - let us not worry about withholding tax is correct or not)

I use one month salary to pay the $5,850 CASH to the bank as bank interest.

my one monthly salary is $10,000 = all of it is gone to own this investment property. It costs me $10,000 of my income to own this property


Am I right? There is no double counting of cash.


If i could salary sacrifice in super - this $10,000 of my one month salary - i would have more money in my super and somehow If could pay no tax on contribution - i could be better off - with Super Gearing - this is possible.

No, no, no.

You pay $10,000 to the bank, no $5850. Then the govt refunds you the $4150 tax that you have paid on this $10,000.

You are confusing yourself why asking what it takes 'before tax' to earn $5850 after tax.

Because the interest is tax deductible, your calculation is irrelevent. You pay NO TAX on the interest paid to the bank.

On your tax return, your income will be down $10,000, but your tax payable will also be $4150 less. This means it costs you $5850 OUT OF YOUR POCKET to own the property.

Manoj, it is the same as salary sacrificing to super. If you sacrifice $10,000, your income is down by this amount, but your tax is $4150 down aswell, just like the property.

Are you trying to drum up SMSF business by saying it's better to sacrifice into super than own a negative geared property? Because in effect, they are taxed the same.

 

[dan c]

Your overall position without property

Income $100,000
Tax $ 27,500
Net $ 72,500

With property, negatively geared, showing $10,000 loss without depn.

Income $ 90,000
Tax $ 23,350
Net $ 66,650

Difference is $5850.

Let's say you saved all of this income. How much less would you have if you had the NG property? The answer is $5850. ($72,500 less $66,650).