Hi All,
I am new to the game of IP's and have my first property being built now. I am motivated to increase my investment assets ASAP but would like to have more information about the "never sell" exit strategy. After all what good is loads of assets if you never turn them into cash? I have found this is a rarely discussed topic considering it's a means to turn an IP into the very thing that we all desire.
Can anyone fill me in regarding the detail of this strategy, ie re-finance and redraw a property every 7 to 10 years in order to fund a better lifestyle?
What are the tax implications of this strategy and is it better than selling one to pay off another?
Thanks for reading!
The reason why people don't like selling is that your profit is usually chewed in half by taxes. Buying and holding should see you have a generous positive cashflow income at anywhere between 3 – 10 years (in theory and depending on interest rates etc.) and alot of people build their wealth based on that. Re-Financing lets you free up any equity, BUT you then have to contend with higher interest payments because you have effectively borrowed that equity from the bank. By doing this though you can re-invest that equity into other investments which will increase your potential to gain capital growth
A common investment strategy is to buy properties with large blocks of land, and when you gain enough equity, you can borrow the money to develop / subdivide the property. Sell half of it off and pay off your loans and then you have one property you own outright!! Further to what Stu has said, you can also take your profit to a degree through living off the equity in your portfolio. This is without selling any of the properties of course.
The other way is to sell a couple of properties to pay out the debt and have debt free properties that provide you rent. The rent is now taxable as it is a positively geared cashflow. Still a good problem to have.
But let's look at equity draw downs.
This will occur after a number of years when the equity has built up and the rent income has increased to a level where the rent is higher (or close to the same figure) than the all the outgoings and the loan combined (positively geared).
The way it works basically is you have a redraw facility or Line of Credit (LOC) loan/s against your property portfolio. As your equity increases in the portfolio, you can draw down some of the equity to use in any manner you wish. Having said that, you should only draw down enough to not allow your LVR to reach a dangerous level. Banks will normally only let you borrow up to 80% of your properties' value (80% LVR). So your draw downs should leave you with way less than this figure for safety – say; 60%.
As a rough example; after 10-15 years of investing, your portfolio is worth $2 mill (this is not an unreasonable figure by the way) and your loans are at $1 mill. Your interest rate is 8% on average. the rent is now covering the loans, and with the tax deductions and depreciation associated with the potfolio you are cashflow neutral.
The portfolio is appreciating at a very conservative 5% p/year. So, as of year 1 of the equity draw downs, your equity is $1 mill, but you can only use 80% of the equity $1.6 mill. You still owe $1 mill, so your USABLE equity is $600k.
You decide to draw down $52k per year to live off – $1,000 per week.
The portfolio is going up by $100k (5% of $2 mill) in year 1, so your nett worth has increased after equity draw down by $48k.
Thanks Stumunro & L.A Aussie,
The information you posted helps me to join the dots but I still have 1 question remaining.
Tax deductions on redrawn interest. . . If I decide to draw down 50k from one of my IP's equity, can I still get a tax deduction on the additional interest that is attracted? If not my positive cash flow position could be turned negative very quickly and in extreme cases I could get stuck in a downward spiral of redrawing to supplement an ever increasing negative cash flow issue. This could end up with me having to sell all IP's and walk away with almost nothing.
Any opinions?
Does that count as a form of income Marc? Is there a need to pay tax on this draw down? Also keeping in mind that any equity you draw against will incur extra interest so if you are using that strategy to get out of working then you would need to be in a better position then cashflow neutral ?
Sorry if I'm confusing the situation
nvme8 wrote:Tax deductions on redrawn interest. . . If I decide to draw down 50k from one of my IP's equity, can I still get a tax deduction on the additional interest that is attracted? If not my positive cash flow position could be turned negative very quickly and in extreme cases I could get stuck in a downward spiral of redrawing to supplement an ever increasing negative cash flow issue. This could end up with me having to sell all IP's and walk away with almost nothing.As i understand it, you would only draw down enough that the increase in rent each year will cover the extra costs as the years go by.
You cannot claim the interest on money used for personal expenses. But you may be able to pay all expenses of your properties with your LOC, thus reducing your cash used leaving more for your lifestyle. If you do it properly you may be able to pay for any cashflow short fall with the LOC (if negative geared for example) OR you may even decide to borrow to pay the interest on your investment loans.
Other tax consequences: Leaving your CGT bill to the ATO.
Imagine if you purchased a $100,000 property and this grew to $2,000,000 over the next 20 years. If you then took out your loan to 90% of the value = $1,800,000 and used this money to have a great holiday, purchase that hip replacement, kidney transplant etc.
What happens when you die? The property will be sold and the loan paid back with $200,000 remaining, but a capital gain of $1,900,000. Assuming your estate only had this property it would have assets of $200,000 but a capital gain of $850,000. (tax of around $391,000).Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Stumunro wrote:Does that count as a form of income Marc? Is there a need to pay tax on this draw down? Also keeping in mind that any equity you draw against will incur extra interest so if you are using that strategy to get out of working then you would need to be in a better position then cashflow neutral ?
Sorry if I'm confusing the situation
No, there is no tax paid on these draw downs. It is not income.
You do pay interest on the draw downs of course, but the whole strategy invloves drawing down only enough money to live off, with out spending more than the equity increases each year including the interest you are paying on the draw downs.In the hands of someone with little discipline this strategy could be dangerous.
You need to have a fairly healthy LVR, and be in a neutral or positive cashflow situation. You possibly could do this with a neg cashflow, but it would have to be small, the LVR low.
For example; you own $2 mill of property, owe $1 mill and the useable equity is 80% of portfolio value = $1,600,000.
The Bank will only let you borrow up to this figure, but you already have $1 mill owing, so you can only use $600k.
The rent covers all the holding costs of the property by now.
The portfolio is increasing in value by 5% per year (a realistic projection based on history), so your portfolio is worth $100,000 more after the first year of the exercise.
You draw down $52k ($1k per week) to live off. The interest rate is 8%, so you pay $4,160 in interest on the $52k.
Your total draw down is $56,160.So, even after this spending, your wealth has still increased $43,840 in year one.
Also, as time goes by, the rents increase and improve the financial position even further.
nvme8 wrote:Thanks Stumunro & L.A Aussie,The information you posted helps me to join the dots but I still have 1 question remaining.
Tax deductions on redrawn interest. . . If I decide to draw down 50k from one of my IP's equity, can I still get a tax deduction on the additional interest that is attracted? If not my positive cash flow position could be turned negative very quickly and in extreme cases I could get stuck in a downward spiral of redrawing to supplement an ever increasing negative cash flow issue. This could end up with me having to sell all IP's and walk away with almost nothing.
Any opinions?
The interest on the draw downs is NOT tax deductible for personal use. If they are used for further investing then they can be tax deductible.
You would need to have the loans set up in a way that allows personal draw downs while retaining the separate loan/s for the I.P portfolio to keep the records for tax purposes separate.
This strategy only works when the draw downs aren't affecting the cashflow in any significant fashion. You can still go 'backwards' in equity doing this, as long as there is plenty of room to go backwards, but I don't think this is the purpose of the exercise.
A common investment strategy is to buy properties with large blocks of land, and when you gain enough equity, you can borrow the money to develop / subdivide the property. Sell half of it off and pay off your loans and then you have one property you own outright!! 
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