Sorry, I know it’s bad etiquette to reply to one’s self…

And please excuse me suzieq for hijacking your thread.

I’m really curious about this now. I need somebody to explain to me how the different parts of IP costs are treated, taxation-wise. Here’s my thought, please correct me where I’m wrong.

Expenses are either:
– Non-deductible
– Deductible against income
– Deductible against capital gains

Am I on track so far?

So back to my original reason for posting.

Let’s say I borrow $200,000 to buy an IP. The IP costs $160,000 (whoa, a 125% loan? Nope, just a bit of equity withdrawal and 80% LVR financing). Now supposing I spend $5,000 on purchase costs, $10,000 on stamp duty and $25,000 on repairs.

Am I right in thinking that:
– I can claim the annual interest on $160,000 against my annual income
– I can claim the $5,000 in purchase costs against my annual income, but this must be done over 5 years. I can’t claim interest costs on this part of the loan can I?
– I can claim the $25,000 in repairs as capital improvements, ie offset capital gains on sale. I can’t claim interest costs on this part of the loan can I?
– I can claim the $10,000 in stamp duty as a capital cost, ie offset capital gains on sale. I can’t claim interest costs on this part of the loan can I?

Thanks in advance,

F. [cowboy2]

Wouldn’t that equity be ($130,000 * 80%) – $100,000? I make that $4,000. Is this right? I too am trying to learn this works.

F. [cowboy2]

There’s an old saying in investment circles – “You’ll never go broke taking a profit”. It’s true.

If you sell and clear $70,000, you’d get a guaranteed 7.5% pa compounding return on that money by paying down your mortgage. On the other hand, the property would only need to appreciate by around 2.5% pa to equal that rate of return (leverage, depending on LVR).

So you’ll need to weigh up the odds. What are the odds of the IP returning <2.5%, around 2.5%, >2.5% over the next few years? If you believe the odds of >2.5%pa are less than 50%, you’re saying it’s likely you’d lose money by holding onto the property.

Some may say that your property will average 7% pa over the long term. If so, a 70% increase over 2 years represents 8 years worth of expected appreciation, ie it’s already hit it’s 2013 price. I don’t know if that reflects reality, but it’s interesting, huh?

F. [cowboy2]

Thanks Dazzling! [thumbsupanim]

Not strictly true, I’ve made various statements concerning my investments over the years, including in answer to questions from you! Example:

http://propertyinvesting.com/forum/topic/18742/2.html

As an update, I sold the last of my shares in December – GDR, for a significant (~300%) gain. That property never sold and the owners never reduced the price. It’s no longer on the market.
I’ve a bit more gold and silver than I had then, but stopped buying when gold passed AU$720/oz.

I’m all for cash. There is too little chance of gains currently in most other investments, too great a chance of loss. All with thanks to the debt bubble – too much money chasing too few assets lifted prices too high, leaving risk seriously underpriced.

The obvious response to this is to laugh!

“Haaa! CASH! After the tax-man steals half of your profits and inflation takes 2/3rds, you’re losing money!!!”

That’s fair enough. But I’m gaining purchasing power compared to many in my age-group, who are struggling just to stay solvent. These people can’t save a penny after paying the mortgage, bills etc. Meanwhile if I can save $500 per fortnight, I’m $500 per fortnight ahead! And I’m ready and able to move very quickly into any opportunity that arises.

I’ve got to admit, I still haven’t got around to selling my beach-shack yet. The emotional is currently beating the financial even though I am 100% certain there will not be a better time to sell it for decades… call me a hypocrite.

F. [cowboy2]

Many people followed this kind of logic during 2002 and 2003 in Sydney and Melbourne. Many of those people have had, or are facing a “personal financial disaster”. Most of the others are holding on, but losing $10,000 to $15,000 per year in interest payments (above the cost of renting the equivalent home).

If they’d chosen to rent 4 years ago they would have the tidy sum of ~$70,000 to put towards a better house for less money than they would have got 4 years ago! Hardly a personal disaster. Even if they’d frittered away their savings, they’d have enjoyed a higher standard of living and still not been any worse off!

I think I was fairly even in my response. Ultimately it’s a personal decision. Weigh up the risks and rewards on either side, giving fair (not even) weighting to each outcome occurring, be sure to cross out those that have 0% chance of occurring (house prices to double in 7 years for example), then choose your path and take ownership of whatever path that is.

F. [cowboy2]

They may not have that option, what with the subprime MBS scandals and losses moving into the higher rated MBS and the Federally-sponsored ‘Freddie Mac’ publicly stating it will cease purchase of risky loan products .
More here
Some commentators are suggesting that as much as 25 – 30% of recent loans have been made under lending standards that are no longer available. Presumably such borrowers only used negative amortising / 100+% financing / no-doc or a combination because they needed to in order to get the loan (otherwise why pay the higher interest cost?).
If these reports are correct, as much as 30% of demand will evaporate shortly, and frankly, the housing market was already in decline!

F. [cowboy2]

Rent instead! Hehe… I can’t give anybody personal recommendation on what they should do. I can point to a few factors I might be considering if I was in your shoes.

• Rent vs Buy? At the moment it is so much cheaper to rent than buy that from a purely financial perspective it makes far more sense to rent and save the difference. Of course owning your own home is not purely a financial decision, but when purchasing something that is likely to be your highest expense for many years, this cannot be ignored.
• Big vs Small? Should you get the biggest mortgage you can to buy the biggest house you can afford, or a cheaper house that suits your needs? This depends on your outlook. If you think the market is going to track sideways for a few years, a smaller mortgage will save a fortune in interest payments and it will be easier to make extra payments, thus further reducing interest costs. The smaller house will enable you to build equity regardless of the market. If you think house prices are going to move significantly higher in the next few years, get the biggest and best located house you can. If you think they’ll fall, but really still want to buy, again, buy a smaller house then trade up to a more expensive one after the correction. Assuming all housing suffers an equal % decline, declining house prices make it easier to move up the ladder since the rungs are squeezed together, while appreciating house prices make it harder.
• Double-Dutch? Do you have friends in a similar situation who are also looking to buy? If so, consider buying a house each, then renting from each-other (at the lower end of ‘market priced rent’). In a few years once the helpful effect of the negative gearing is trailing off, swap into your own houses. This is seriously a no-brainer, but does hold potential pitfalls.

Sure. At the moment though, despite contrary reports in the media, new housing is being constructed (supply) at a rate that is easily meeting the needs of our growing population (demand). On the broadest measure (nation-wide), supply and demand are in balance.

While there may be regional imbalances if new dwellings are not being built in areas where new household formation is taking place (demand exceeding supply), this would only support higher prices at a local level. Providing the broad equation balances, this support would be offset by lower prices in another area where the houses were being built.

This may be one factor in the apparent “two-speed property markets” that exist in most capitals. Another factor worth considering is the type of buyers in the high-speed suburbs, for example:

A $300,000 house in a blue-collar suburb is purchased by a family with an annual income of $80,000. A $750,000 house in a white-collar suburb is purchased by a DINK couple with a combined income of $250,000. The ‘cheaper’ house would cost >$750,000 over 30 years with $0 deposit and be a constant struggle and source of stress for the family. The DINK couple could easily bring a $200,000 deposit and pay out the loan in 7 years for a total cost of $850,000. This is part of the “two-speed” puzzle – depending on the buyer, purchasing in down-and-out suburbs can be more expensive than exclusive suburbs! The DINK couple only need their house value to rise by 12%, while the family need theirs to rise by 150% to be ahead after interest costs!

And finally, you’ve referred to an “inevitable correction”, something I wholly agree with. However, I don’t claim to be smart enough to predict exactly when or what form this correction will take, only that it will happen, (might even be as I write) and that it will be very significant, far eclipsing the 1990s bust, and perhaps more like the 1890s…

Hope this has given you some chaff to chew.
Cheers, F.[cowboy2]

Point taken! [grad]

In future I’ll restrict my rabid, pompous, rambling and discourteous posts to threads originated by myself, and make pointed, polite, succinct, rational posts in others’.

F. [cowboy2]

Okay, so your $20k will cover stamp duty and buying costs on the $250k house, so you’d have a $250k loan. Remember, this is a sub-median property. To comfortably afford a mortgage, it should really be no more than 1/3 net income. At a stretch, you might consider 1/3 gross income. Repayments on this loan would be $800 per fortnight over 30 years at 7.5%. Using 1/3 gross income you’d need to be earning $63,000 pa. Using 1/3 net, you’d need to be earning around $90,000.

Let’s look at the other side of the equation – income. The average income in Australia is $43,000 per year (gross). Forget the $60,000 figures that are often quoted. They’re rubbish. The median income in Australia is somewhat less than the average (just as the median house price is less than the average), and the demographics of first-time buyers tends to put them even lower down the scale. Remember, if the median income is less than $40,000, that means half of all employed people in Australia earn less than that!

Using the 1/3 test again, less than 50% of all employed people could afford a mortgage repayment of $384 per fortnight (comfortably) or $513 (at a stretch). So less than 50% of all employed people can afford a mortgage of more than $120,000 (comfortably) or $160,000 (at a stretch)…

Am I getting the message through yet? Give some examples from realestate.com.au of the kind of first homes these people should be buying?

Another tack – more than 50% of houses are over twice the maximum price that half the population could pay…. Still not making sense?

Try another – how many people do you know who could afford to purchase the house they currently live in if they had no ‘equity’ in it or other houses? (Hint – it’s below 30% of owners with mortgages). Are we getting it?

Let’s go macro – The fact is, there is only so much debt that can be tolerated by our economy. All debt (‘good’ or ‘bad’) must be repaid, or at the very least, maintained. Every dollar in interest or capital repayments is a dollar that cannot be spent productively, either through consumption or investment in other areas. To maintain current house prices, housing debt must continue to grow for many years until it has passed the point where so much money is being diverted from economically productive activity to feeding the debt that a recession occurs. If house prices trend up again, this point will be passed sooner.

There is a positive flip-side. Almost every dollar borrowed works its way into the general economy. If a person who paid $120,000 for a house sells it for $300,000, much of the extra $180,000 will be spent on consumption, investment, construction of a new house or purchase of another existing house. In the last case, the money is simply transferred to another person – somewhere along the chain it will pop up in consumption, investment or construction. Thus the economy thrives while borrowing continues. Consumption boosts employment, investment boosts shares, construction boosts the housing industry, the buying and selling boosts the real estate and banking industries. All good, right?

Well, yes, but only if this level of debt-growth is sustainable. If private debt is growing faster than private incomes, this is unsustainable. If total debt is growing faster than GDP, this is unsustainable. If debt-growth is unsustainable, then it must at some point slow, and the areas that are being boosted must contract. Remember, this is completely independent of the previously mentioned impact of debt servicing on economic performance. The problem is, the two are likely to occur simultaneously. Furthermore, one must wonder whether our economy has really been growing in a productive manner over the last decade, and how much of GDP growth has been boosted by borrowing?

So how does the general economic future look? Not good. We’re faced with 2 options:
– continue to borrow at an unsustainable rate until the tipping point is surpassed and recession ensues.
– slow borrowing to a sustainable rate at which point we’ll go into recession.

How does the future of house prices look? Not good also. The options are:
– slow borrowing to a sustainable rate at which point house prices will fall drastically and recession ensues.
– continue to borrow at an unsustainable rate simply to maintain current house prices even though this means the national LVR will increase (negative wealth effect) and the tipping point is surpassed, recession ensues and house prices fall.
– increase the rate of borrowing to provide another lift in house prices, a further boost to the economy, and ultimately ensure that one of the first two options must be taken much sooner, and the negative consequences much more severe.

Hmm, no wonder I’m concerned.

Still no clearer, huh? I’ve tried my hardest. Maybe it’s you not me?

F. [cowboy2]

No, but it’s still about 8x the average income of a first-time-buyer… To comfortably afford a $300k PPOR you’d want to be grossing over $100,000 pa.

Does this clarify the problem?

F.[cowboy2]