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

Should we buy IP in our name or in the name of the SMSF


  • Total voters
    21
  • Poll closed .
BV / Alex

My brother had 14 IP's - i sat down with him and did sums for each of his 14 properties - the loss (grossed up) he makes each year and the tax he will pay on sale - CGT and after working out the stamp duty and the agents commission on sale. The profit and loss of all the transactions showed that he was making no money - Now, I request you to do the same for all your properties and assume you will sell all of them today. Please do this exercise to see the "real benefit" of owning them, also do not forget the every year loss you are making "in hope" they will go up further - that hope is nothing more "but inflation" - the cost of laying one brick tomorrow!

What i am trying to say - owning a property outside of super is not a tax effective environment - as far as accessing super is concerned before the preservation age of 60 (65 is current Govt pension payment age) - that is possible if you are before you are retired and not working - so those who think you can not get your money out of super before you are 60 - please see your SMSF Specialist Adviser....

So the difference of owning the property inside of super is that "simply pay less tax on income and no tax on sale"

There is this huge "lack of knowledge" on super which needs to be filled - please do not ring your local accountant - you need a SMSF Specialist - you can visit www.spaa.asn.au and find one close to you.

Please do not turn around and say that you will never sell - i have this story about a Greek investor - who is 65 years old and owns 7 properties, all paid up - all purchased after CGT legislation for $200K - all the properties are worth about $700K today - good buys - but the problem is - they are in his and his wife's name - they generate $150K between them - since the properties are old - there is no Depreciation left to claim - Their taxable income is $75K each - which means that they will pay tax till they die. Further, it is too expensive to sell as the CGT will kill the fun - the option is to keep them till they die - after that if the kids will sell them - they will pay CGT - you cannot run away from paying CGT - which is basically tax on inflation based growth.

They have an option of buying another 5 and gear up at the age 65 - but they will end up with less cash - yes they will save tax - but when you have 7 properties at age 65 you do not want the hassle of another 5! - come' on the whole idea was to have fun - when they retired - so that they could enjoy the cash flow...


I do not know how old you are - but one day you will be 65 with 7 paid up properties with heaps growth (due to inflation) - Have you planned for that day?

The other option is to sell all the current properties today and buy a few in super
rent is tax free once you move to pension phase
no CG tax on growth
As far as needing cash is concerned for some sudden need - come' on that is a myth - when have you (or you know anyone) has ever required $100K in a hurry ! probably never! and if you - own a grand home with heaps of equity - refinance your own and you can access the $100K with a phone call....

If you live in a house worth $800K and own two IP of $500K each - you are better off as far as growth and tax is concerned with one PPR instead of three properties = the sums do not stack up - i would rather live in a $1.8M house - please do the sums with looking at NG / Growth / CGT aspect etc - do a spreadsheet - you might just get very surprised with the end result.... - it is all because of CGT - that is the most hated tax.
 
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BV / Alex

My brother had 14 IP's - i sat down with him and did sums for each of his 14 properties - the loss (grossed up) he makes each year and the tax he will pay on sale - CGT and after working out the stamp duty and the agents commission on sale. The profit and loss of all the transactions showed that he was making no money -

After seeing your calculations, I hope your brother got a second opinion!
 
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

That's an important point. It's the reason I don't have super or plan on contributing a cent to it, but I do understand that for others it's all they'll have come retirement.

But then super wasn't designed for the purpose of making you wealthy, just to get you off the Govt's back during your old age.
 
After seeing your sums, manoj, I doubt your results. Since when do sellers pay stamp duty, anyway? And would your brother have been able to buy 14 IPs if he couldn't refinance.

I would not have been able to buy what I have if I couldn't refinance.
Alex
 
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).

Spot on. I'm not sure why this is so hard to comprehend? :confused:
 
Now, I request you to do the same for all properties and assume you will all of them today. Please do this exercise to see the "real benefit" of owning them, also do not forget the every year loss you are making "in hope" they will go up further - that hope is nothing more "but inflation" - the cost of laying one brick!

Not sure about that 'brick' thing, but since my loan doesn't go up, nominal increases in property values due to inflation helps me.

What i am trying to say - owning a property outside of super is not a tax effective environment - as far as accessing super is concerned before the preservation age of 60 (65 is current Govt pension payment age) - that is possible if you are retired and not working - so those who think you can get your money out of super - please see your SMSF Specialist Adviser....

Why take the risk if I plan on accessing it well before 67 anyway?

I do not know how old you are - but one day you will be 65 with 7 paid up properties with heaps growth (due to inflation) - Have you planned for that day?

Actually, yes.

The other option is to sell all the current properties and buy a few in super rent is tax free once you move to pension phase
no tax on growth

Yes, once I go into the pension phase. At age 67.

As far as needing cash is concerned for some sudden need - come' on that is a myth - when have you (or you know anyone) has ever required $100K in a hurry ! probably never! and if you - own a grand home with heaps of equity - refinance your own and you can access the $100K with a phone call....

Pure asset based lending. Sometimes, that doesn't work.

If you live in a house worth $800K and own two IP of $500K each - the sums do not stack up - i would rather live in a $1.8M house - please do the sums with looking at NG / Growth / CGT aspect etc - do a spreadsheet - you might get very surprised with the end result.... - it is all because of CGT - that is most hated tax.

Ok, we disagree. I would not have what I have without refinancing, and in super that's limited.

You do it your way, I do it mine. I have done the numbers. But then I make a distinction between pretax and after tax.
Alex
 
Thanks JamesGG and Dan C

The cost of the property is $10K - i think we both agree on this
because if I did not own the property - my income will be higher

This is so stupid, you can fill out a form and lodge it with the tax office so you don't pay tax on $100 000 you pay it on the $90 000 so you don't have to pay the tax and get it refunded.
 
The other option is to sell all the current properties today and buy a few in super
rent is tax free once you move to pension phase
no CG tax on growth.

Manoj

You're right, CGT is a killer
I was going to sell 1 IP this year (my old PPOR so there is no CGT) and the plan was to pay down debt but now you've got me thinking.

I think I should lend some of the cash to my SMSF to use as a deposit for 1 more IP and the rest I'll use it to suplement our living while we salary sacrifice the max we can into super.

I've also applied to access new equity and use it as a deposit for a property purchase on the south coast but I'm thinking that I should be buying this property through my super because my SMSF can afford to hold it and I don't want any more burdens.

We're nearly 50 and we'd like to now move into a new stage of our life, improving our lifestyle and also taking a few overseas trips.
What do you think about the idea of accessing equity to buy a nice car?

cheers
 
Could you please elaborate on this?

Simple example. If you make 60k package, your super contribution would be about 5k. If you have 40k of expenses you can package into your salary (whatever your employer allows), then your salary component is only 20k. In which case your 9% super contribution is only about 2k, since the 40k is paid to you as expense reimbursements which do not have super attached. So effectively your super contribution rate is about 3%.

You can't double-claim these expenses on your tax return, of course, so you don't get extra tax deductions. However, the 3k you don't pay into super gets paid to you as taxable income. The effect is more money goes to you personally (and taxed at your marginal rate) instead of going into super (lower tax but locked away).

Not all employers offer this, and different employers allow different things to be packaged, because there are a lot of complex rules about FBT and so on. Your employer would also have to pay you what it doesn't pay in super due to the lower 'salary'.
Alex
 
Thanks Alex, I have a slight understanding of salary packaging, very informative post, I guess most people aren't fortunate enough to be in a job where it is available to them either, especially not on large scale where they can package $30k+.
 
Thanks Alex, I have a slight understanding of salary packaging, very informative post, I guess most people aren't fortunate enough to be in a job where it is available to them either, especially not on large scale where they can package $30k+.

Depends on what the employer offers. The key to the employer is FBT and admin costs. If they offer it and you use it according to the rules they set out, any disputes will be between your employer and the tax office.
Alex
 
Hi Alex,

Correct me if I'm wrong, but using your calculations:
$60k package ($55k salary and $5k super)
If you salary sacrifice $40k, your taxable income would be $15k, and the required super contribution payable by your employer would be $1350 (9%)

By my calcs, you have lost $$3650 in super.

I don't think the $3k you have lost in super gets paid as taxable income, as you have stated, as the super is paid on your ordinary times earnings, which doesn't include payment of expenses.
 
Hi Alex,
Correct me if I'm wrong, but using your calculations:
$60k package ($55k salary and $5k super)
If you salary sacrifice $40k, your taxable income would be $15k, and the required super contribution payable by your employer would be $1350 (9%)

By my calcs, you have lost $$3650 in super.

I don't think the $3k you have lost in super gets paid as taxable income, as you have stated, as the super is paid on your ordinary times earnings, which doesn't include payment of expenses.

It depends on how your employer calculates your package. Agreed that if the 'lost' super isn't paid to you as taxable income, you're losing out. However, if your employer calculates on a 'total package' basis, as mine does, then you do get the 'lost' super paid to you as ordinary earnings.

In practice, my employer says that my salary is 60k, and I elect how much of that to take as salary. So I could elect to take the 'full' salary of 55k and 5k goes to super. Or, I can take 20k salary, and the remaining 40k is 'held' and can either be paid as salary (taxable, and have to pay super) or can be claimed as expenses (no super). I'm sure not every employer does it that way, but mine does. I'm ignoring smaller items like payroll taxes and so on in this example.
Alex
 
It depends on how your employer calculates your package. Agreed that if the 'lost' super isn't paid to you as taxable income, you're losing out. However, if your employer calculates on a 'total package' basis, as mine does, then you do get the 'lost' super paid to you as ordinary earnings.

In practice, my employer says that my salary is 60k, and I elect how much of that to take as salary. So I could elect to take the 'full' salary of 55k and 5k goes to super. Or, I can take 20k salary, and the remaining 40k is 'held' and can either be paid as salary (taxable, and have to pay super) or can be claimed as expenses (no super). I'm sure not every employer does it that way, but mine does. I'm ignoring smaller items like payroll taxes and so on in this example.
Alex

Thamks Alex, that makes sense.
 
BV

Today is more important than tomorrow
Buy a Merc today!
you will never regret it...

Hi Manoj

You are telling me what I want to hear but we both know that the opportunity cost will be very high.
I think I'll get over my attraction to expensive cars by renting 1 instead ;)

cheers
 
Hi there,

What an interesting thread!

Manoj, firstly welcome to the forum and thanks for those very thought-provoking ideas and strategies you have mentioned.

And alexlee, wow, welcome back from the shadows! I would echo much of your thoughts.

I'll add my 2c below anyway...

Broadly speaking, I would say that exactly which approach one uses with respect to geared property investing will depend on a number of factors, as has been mentioned by others here already... namely:

(1) Your age
(2) Level and availability/access to gearing outside super vs. inside super (''super gearing")
(3) Level of risk one is willing to tolerate
(4) When you plan to retire

I would argue that if you are younger, eg. in your 20s to early 40s, you should be aiming to gear more aggressively eg. at LVR's of 85-95% stand alone, and should be able to tolerate a higher level of risk.

And also, if one is planning to retire well before say 45-50 y/o, eg. in your late 30s to early 40s... Then in this case, I would say that gearing outside of super makes far more sense.

I think that the super gearing strategy falls over in this younger age group due to the lower LVR's available and limitations on re-financing and equity access. You're very much dependent on cash injections from earned income (eg. 25-50k pa tax-deductible contributions, and of course employer contributions/co-contributions) to start and grow your asset base.

Putting more money into super at this age I think is an inefficient use of available cash/equity (with the only possible exception to this being if you are a very high income earner and won't really ''miss'' that 25-50k pa... eg. >>200k pa household income).

At super gearing levels of 60-70% LVR, youngsters will be waiting a fair while before they even get to that first deposit on a property in super.

What do you suggest these people do Manoj??

Your speed of asset accumulation is drastically reduced in this instance.

And I don't think we should underestimate the importance of TIME in the market here, and it's compounding effect, irrespective of TAX savings.

At this early stage, I think you should be focussing more on growing your asset base, not on saving tax, which appears to be your focus here Manoj... no disrespect intended.

Once you get say 10 years closer to the 55-60 y/o age group (ie. you are currently 45-50 y/o), and intend on retiring at near this time, then I think it is worth considering a re-orientation of your investing strategy to moving the bulk of your assets into an imminently tax-free environment in super.

For these people, I would argue that now is the time to consider tax-effective super strategies as Manoj has described here.

I think BV (without knowing his exact age), may be a good example of this.

Just some comments below on some of the posts made so far...

manoj said:
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?

It's a bit confusing, but yes, fundamentally I would say that you are correct in saying this and it does make sense to me.

JamesGG said:
For 2009 FY:

Without property

Taxable income: $ 100,000
Net rental: $ 0
Tax: $ 29,600

Money in pocket: $ 70,400


With property

Taxable income (before property): $100,000
Net rental: -$10,000
Tax: $25,350

Money in pocket: $64,650

Therefore, property costs you $5,750 to hold, after tax.


Salary sacrificing:

Taxable income: $ 90,000
Net rental: $0
Tax: $25,350

Money in pocket: $64,650

Same deal as the above 'with property' scenario, only you've kept the $10k in super.

Then it will depend on the particular investor whether they can generate better profits (ie, expected capital gains) by losing $5,750 in negative gearing, or whether $10k in super will provide a better return. Either way, leftover cash for personal use is the same.

That makes sense James, and I think Manoj seems to be arguing that the 10k that is now in super could be used to support a negatively geared IP, INSIDE super, with no contributions tax being paid on that 10k going in as there is a loss in the super fund... ??

So you have the full 10k cash there supporting the loss inside super, not just the $5850 after-tax amount for a property outside super... ?

Manoj, can you confirm or deny... ?

Still, it doesn't appear to take into account the significant effect of how aggressively you can gear outside super vs. inside super, and the restrictions on re-financing/equity access.

Again, the younger you are the more important this is likely to be.

manoj said:
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.

Manoj, can you please clarify this point... how can you pay no tax on this contribution... ?

BV said:
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

That makes sense for what you are doing BV, but I would be interested in how or in what circumstances Manoj avoids the 15% tax... ?

Again, the limitation here is the degree of leverage available, which for your station in life may be more conservative, and hence this strategy may be more appropriate for you BV.

manoj said:
Once you purchase one Super Geared property and once it is neutrally geared - do not attempt to repay the loan

Strategically, for the right person, yes, that makes sense.

manoj said:
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.

Again, strategically, I think that makes much sense.

manoj said:
If you live in a house worth $800K and own two IP of $500K each - you are better off as far as growth and tax is concerned with one PPR instead of three properties = the sums do not stack up - i would rather live in a $1.8M house - please do the sums with looking at NG / Growth / CGT aspect etc - do a spreadsheet - you might just get very surprised with the end result.... - it is all because of CGT - that is the most hated tax.

That's a confronting idea for me, not having a CGT-free asset/PPOR at all myself...

Someone really needs to do the sums and put up a spreadsheet for general viewing... any takers?!

btw Manoj, are you able to explain how you can get 3.5% pa interest on your PPOR as per your website... I can't see the actual article there, just the topic title... ?
 
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Manoj

You're right, CGT is a killer
I was going to sell 1 IP this year (my old PPOR so there is no CGT) and the plan was to pay down debt but now you've got me thinking.

I think I should lend some of the cash to my SMSF to use as a deposit for 1 more IP and the rest I'll use it to suplement our living while we salary sacrifice the max we can into super.

I've also applied to access new equity and use it as a deposit for a property purchase on the south coast but I'm thinking that I should be buying this property through my super because my SMSF can afford to hold it and I don't want any more burdens.

We're nearly 50 and we'd like to now move into a new stage of our life, improving our lifestyle and also taking a few overseas trips.
What do you think about the idea of accessing equity to buy a nice car?

cheers

Nobody likes to pay tax.
But an investment decision should not soley be made (or not made) because of tax consequences.
Look at the BnB (Babcock & brown) Allco Finance, the Macquarie Satalite funds, these all blew up because of excessive financial engineering.

I prefer to be safe than sorry later on (even if that means giving up some of the potential return).
Capital preservation is very important to me. Capital preservation to me DOES NOT MEAN short term swings in asset values, it means a potentially permanent loss of capital through excessive gearing or failure to properly understand the investment asset.

In regards to gearing levels, this means controlling gearing on MY TERMS, rather than being dictated by market forces (which will probably mean receiving a substandard price for any asset disposals).

How do i control gearing on my terms:
Simple: the time to reduce gearing is when 'life is good'. If this means paying some tax so be it. At least this way i always live to fight another day, and i always have some powder dry to participate in any asset downturns.

Being fully invested at all times is like those old spanish galleons, large, bulky and full of treasure, but easy to sink in navel combat.
 
Hi
That makes sense for what you are doing BV, but would be interested in how Manoj avoids the 15% tax...

JIT
I would be interested to know as well
I guess we could use negative gearing plus depreciation and fully franked dividends to offset some of the tax


Hi
Again the limitation here is leverage, which for your station in life may be more conservative, and hence this strategy would be more appropriate for you

Yes, I'm less leveraged these days because I'm 49 yo and I can't afford to get it wrong, I also have sizeable loans and I feel that my exposure to interest rate movements is very high.

My SMSF is now part of my overall investment strategy and is providing me with the ability to gear further without additional risks.

Good to see you liked what Manoj had to say.
In the beginning it was hard to understand the point he was trying to make.
He's an interesting guy, I went to 2 of his seminars last year and found them very thought provoking
Cheers
 
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