What would you do?

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celieappleton
Participant
@celieappleton
Join Date: 2009
Post Count: 1
February 27, 2009 - 3:37 am
Hi – this is my first post to these forums! Very glad I've stumbled on such a knowledgable bunch.
Some background:
My husband and I own a townhouse in an inner-city suburb. This was our PPOR, so when we bought the place about 3 years ago we took our a P+I mortgage. Thanks to increases in value as well as repayments on the property since we took our the loan, we now have just over 100k in equity.
Due to various circumstances, we're now in the market for a larger home. When thinking with our hearts (which we might be accused of doing all too often!), we don't want to sell this townhouse – we're very fond of it, and have a family member who would benefit very much from using it for a long time into the future. So we prefer to turn the townhouse into a rental, refinance to an interest only mortgage, and use the equity to borrow for our new (larger) PPOR. We were thinking we would only sell it in the much longer term.
The townhouse would be cash flow positive by a small margin after all outgoings are taken into account.
Up until now, we thought this was an OK plan – until real estate agents have started questioning it. "You need to sell it", they've said. "You'll end up paying too much in tax".
I'm not about to run out and take their advice without questioning there's a good chance they just want the sale! But it has got me wondering if we should instead purchase our larger PPOR, then sell the rental and the funds to purchase a new investment property of similar value but with a higher mortgage in order to negtively gear. Servicing two loans while one is cash flow positive obviously doesn't pose many concerns to us (obvious risks surrounding tenancy aside) – but having one in the negative would need to be scrutinised against our budget more carefully.
Other info that might help: The original property is in both names – 50/50. We're expecting our first child in July this year, so I won't work at all for the first 9 months (at the very least, more likely to be 12). My taxable income for the next financial year is likely to be $0 aside from rental income, and that won't be enough for me to pay tax on. The only one getting taxed is my husband, on his 50%.
I've got a great mortgage broker, a good (although expensive) independant financial adviser, and a really crap accountant (time to find a new one). So far, I've only really asked the accountant about tax implications in various scenarios – they weren't much help. I'm going to sit with the other two and gather some advice there too…
But I'd really appreciate reading about how others would handle the situation. What would you do?
Thanks,
Celie
duckster
Participant
@duckster
Join Date: 2004
Post Count: 1,674
February 27, 2009 - 6:01 am
Celie, Welcome to the forum
If the first property is slightly positively geared then your tax is going to be slight on the small amount that is positively geared.
Now what you really need to think about is what is your husbands marginal tax rate
is it
30% for income between $30,000 to $80,000
or is it
40% for income $80,000 to $180,000
You will have a tax rate on your split of the net property income (after subtracting expenses from the rent income) of up to $6,000 on your share that is not going to be taxed as you only get half of this if you are not working. (tax free threshold)

What you will need to also be careful of is if you are negative gearing and trying to claim parenting payments from Centrelink a Negative Geared Loss is considered as income by Centrelink for calculating entitlements.
(This defies all accounting standards or logic but we are talking about Centrelink)
(plus if you are not working you aint getting a tax refund anyway and your working spouse is claiming 30% to 40% of this loss)
Also your property income may affect your family B payment depending on how much your spouse earns.
As your real estate person said you can pay a small amount in tax on a net property income profit.
or
lose as an example $10,000 a year so that you can claim back $3000 based on a 30% tax rate.
That is a $7000 loss so that you can get $3000 back. So you are throwing away $7000 a year.
UNLESS you can more than $7000 in capital gain you are losing wealth.
Yes when we used to get taxed at 58.5% a year it was a different story but the tax rates have reduced making negative gearing not as much of a tax deduction.
see
http://www.ato.gov.au/individuals/content.asp?doc=/content/12333.htm
If you do not have private health insurance then you have to consider the medicare surcharge threshold.
If your combined assessable income exceeds $100,000 then you incur a 1.5% surcharge in tax. So $100,000 * 1.5% = $1500 in additional tax. If you have children then the threshold is greater.
http://www.ato.gov.au/individuals/content.asp?doc=/content/34462.htm&page=4#P28_4333
This amount reflects a proposed change to the law for 2007–08 which at the time of publishing had not become law
There was a proposal to increase the threshold amount to $200,000 for families but I am not sure if this has been passed into law.
(Hopefully this is understandable and you can relate to your circumstances)
What happens is that your share of the net property income is added to your wage assessable income to come up with a new total taxable assessable income.
So if as an example say you earned $60,000 from your wage and your property made a profit of $6000 your share is $3000 so your assessable income is $63,000.
This extra $3000 has not had tax already paid on it as it is not PAYE (pay as you earn) so when you file your tax return a higher tax amount is calculated being 30% so $1000 in tax has to be paid on your tax return.
This can also effect rebates and offsets you may have been entitled to depending on their thresholds.
A good tax accountant will know these thresholds and what the likely hood is that you will miss out on an offset or family B payment or get hit with an extra medicare surcharge.