Hi everyone. Firstly i would like to acknowledge how much i have been able to learn from all your comments in the forum, so thank you.
I would like to share with you my case. My partner and I bought a property in 2010, where we are living, in a town south of Sydney with the idea of making it an IP. So we took on a IO Loan with and offset account so we can minimize the interest and have the money available to move to purchase to our home when the time comes around.
We bought this town house at 295.000$. The house is in my partner's name. We performed a cosmetic renovation. The property is currently value 330.000$. The loan is currently at 231.000$.
Considering LVR of 90% we have 66.000$ equity. The rental return of this property is approx. 390-420$ a week. With the current interest rate on the loan of 5.2% (which i am trying to refinance to bring down) it will be a nice positive cash flow property. The offset account has 85.000$. Adding to these factors we just a saw a house where we would like to buy to live given that match our life style and work location.
So we are a little bit unsure about taking the decision to move forward. I should say our combine income is 230.000$ pre tax.
1) If i decide to buy the home for my family should i use just the money in the offset. Would the use of the equity in this property be a poor decision given that can be use for other investment and in this way maintain
it tax deductible.
2) Today the IP property will be positive cash flow, however I am afraid if the interest rate rise to 7% it will become negative. i would like to know what is you opinion in regard with this topic and how would you manage this. I guess that one way to speculate will be the rise in rental income although i am not sure if i can match my rental every time the interest rate goes up.
3) What will be the most tax effective and cost effective Loan structure way to move my equity.
I should also add that we discussed with our accountant our future and they suggested to set up a company and a trust which we have done and have not have the opportunity to use yet.
So the next investment property we will be looking for it will be renovated and rented. Should we consider to use the company rather than the trust in this case in order to claim?
I look forward to you input.
Hi Manolo,
I was about to say "Welcome to the forum", but I see you have actually been around awhile !! So, well done on your first post.
You've posted a fairly complete scenario, so I wanted to swing by and add a few thoughts as an outsider. (Note that I am not an adviser of any kind, but others who follow often are – do listen to them over me as I could easily get things wrong, though not intentionally).
Here's what I think:-
Quote:1) If i decide to buy the home for my family should i use just the money in the offset.Makes sense to me. It would help keep things "cleaner" for your accountant.
Quote:… Would the use of the equity in this property be a poor decision given that can be use for other investment and in this way maintain it tax deductible.Yes, I would think that the extra equity would be better "spent" on further IP's (assuming that is what you wish to pursue).
Quote:2) Today the IP property will be positive cash flow, however I am afraid if the interest rate rise to 7% it will become negative. i would like to know what is you opinion in regard with this topic and how would you manage this. I guess that one way to speculate will be the rise in rental income although i am not sure if i can match my rental every time the interest rate goes up.Hmm, one thing often overlooked is the REAL increase as Interest rates tick up. e.g. a jump from 5% to 6% is just 1%, right??? Wrong !! It is actually a 20% increase in the Interest you pay on an IO loan. So, good luck with jacking rents 20% as Interest Rates tick back up (see 2007 to 2008 when the cash rate went from 6.25% to 7.25% – the major banks added a further 0.55% to that, making a 1.55% increase into a 25% increase – Eeekkk!!!) Know any tenants that will happily pay an extra 25% in just 12 months or so???
Of course, that was the time of the GFC – while the rest of the world was madly cutting Interest rates, Ruddy was talking ours up with comments like "The inflation genie is out of the bottle"!! . Fortunately, the RBA saw the error of their ways, and proceeded to cut them WAY back again (to almost unheard of levels – a real overshoot/undershoot story). Still a 25% increase is not an every day event – just one to be watchful for when Interest Rates start their Northward march again….
And right now, they are still WAY low – probably necessary to get our dollar back where it should be (but then, I'm no economist either….)
In answer to YOUR question, I'd think you should stick with other rental properties as they slowly tick up their rental rates – don't be too far behind, and add to your rent if/when you add extras that can command a better rental (one of the blogs from Steve – I think – mentioned some really good ideas re rentals – don't give money away, but reward good tenants with extras that actually add value to YOUR property as well as to their lives!!). If I find the link again, I'll pop it in here…..
Quote:3) What will be the most tax effective and cost effective Loan structure way to move my equity.Hmm, I'll pass on that one….. Specialist knowledge required, and that's not me !! :p
Quote:I should also add that we discussed with our accountant our future and they suggested to set up a company and a trust which we have done and have not have the opportunity to use yet. So the next investment property we will be looking for it will be renovated and rented. Should we consider to use the company rather than the trust in this case in order to claim?I'll be very interested in the comments of others re that question. For mine, I have often wished I had never heard of a trust….. But that is likely to be my failing more than a problem using trusts.
Re using a Company, my book-reading has seen several authors saying a Company is NOT ideal for holding IP's (at least, not for the average IP investor – it might be fine if you run a business buying/selling property) Again, one for somebody else to answer more fully.
Benny
PS One final thought (re you buying a home that you like the look of). Somewhere on here there is a brilliant thread that talks of "How it is financially better to buy IP's and rent a home for yourself". If someone can post a link to that, I would appreciate it, and perhaps Manolo too.
Hi Manola
Have to say it is not a particularly complicated enquiry and one we get from forum clients all day long.
Couple of quick answers:
1) If the property is to be used as a PPOR then none of the costs or expenses will be deductible. For this reason you would want to reduce your LMI as much as possible so maybe a matter of releasing equity by way of a sub loan on your current property and combining this with the new PPOR loan.
Depending on the numbers you may even want to look at an secured loan outside LMI of 20K which you could use to cover your acquisition costs etc.
I am assuming that the existing loan is a true 100% offset account and not an offset redraw account. If so once the amount in the offset has been withdrawn the loan balance on the other side will increase accordingly.
2) You may want to look at fixing the rate of interest on the existing IP loan as well splitting the new PPOR loan between fixed and variable with 100% offset account.
3) You cannot release equity and claim it as a Tax deduction irrespective of the structure, entity or method you buy the property (One exception but i cannot see it being appropriate here so not worth mentioning) so this is not really relevant.
You are better off cleaning up the existing borrowing and trying to reduce the LMI expense going forward.
Cheers
Yours in Finance
Richard Taylor | Australia's leading private lender
HI Richard and Benny. Thanks for the feedback and suggestions. Makes more sense
Richards in regard to LMI suggestions, if this refer to loan mortgage insurance, I have been advice by my broker that given my partner and I are veterinarians, we are entitle to 90% loan without LMI. We still are in favour of 80% loans for PPOR and we will consider 90% for IP and Yes we do have a 100% offset account.
Thanks for the advice
Hi Manola
Yes that is indeed correct no LMI upto 90% lvr.
For this reason you probably don't need to touch the existing equity.
Cheers
Yours in Finance
Richard Taylor | Australia's leading private lender
Great work with getting your finance right for your first purchase. Most people get that wrong which causes problems when moving forward.
With regard to setting up the company and trust- why did your accountant advise this? I'm assuming for asset protection.
Wouldn't that give you the answer to under which entity to purchase newly acquired properties?
manolo76 wrote:Hi everyone. Firstly i would like to acknowledge how much i have been able to learn from all your comments in the forum, so thank you.I would like to share with you my case. My partner and I bought a property in 2010, where we are living, in a town south of Sydney with the idea of making it an IP. So we took on a IO Loan with and offset account so we can minimize the interest and have the money available to move to purchase to our home when the time comes around.
We bought this town house at 295.000$. The house is in my partner's name. We performed a cosmetic renovation. The property is currently value 330.000$. The loan is currently at 231.000$.
Considering LVR of 90% we have 66.000$ equity. The rental return of this property is approx. 390-420$ a week. With the current interest rate on the loan of 5.2% (which i am trying to refinance to bring down) it will be a nice positive cash flow property. The offset account has 85.000$. Adding to these factors we just a saw a house where we would like to buy to live given that match our life style and work location.
So we are a little bit unsure about taking the decision to move forward. I should say our combine income is 230.000$ pre tax.
1) If i decide to buy the home for my family should i use just the money in the offset. Would the use of the equity in this property be a poor decision given that can be use for other investment and in this way maintain
it tax deductible.
2) Today the IP property will be positive cash flow, however I am afraid if the interest rate rise to 7% it will become negative. i would like to know what is you opinion in regard with this topic and how would you manage this. I guess that one way to speculate will be the rise in rental income although i am not sure if i can match my rental every time the interest rate goes up.
3) What will be the most tax effective and cost effective Loan structure way to move my equity.
I should also add that we discussed with our accountant our future and they suggested to set up a company and a trust which we have done and have not have the opportunity to use yet.
So the next investment property we will be looking for it will be renovated and rented. Should we consider to use the company rather than the trust in this case in order to claim?
I look forward to you input.
Hi
Here is my take
1. Ideally you should borrow 100% of the new property in case it is ever rented out in the future. To do you you would get the 90% LVR loan and set up a separate split on the existing one for the remainder. Once you have settled on the new PPOR move all of your cash from the other offset to the offset on this one. Have the loan IO and just keep plugging money into the offset.
2. I wouldn't be afraid. If rates are rising that would probably mean the economy is heating up and rents could be rising faster than usual. Rates are probably going to just in 0.25% increases so it will take a long time before they hit 7%. The interest on this will be deductible too so this lessens the pain. And if you are worried you could consider fixing a portion of the loan.
Not sure why your accountant set up a trust before you intend to use it. What sort of trust and did you get advice on the land tax implications?
3. You could set up another split on the existing loan and then borrow to pay for investment related expenses and use this to keep spare cash in the offset.
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
Hi Terry, Catalyst, Benny and Richard
Your comments have been extremely valuable to us… thanks. Now i have more questions. I feel i need to take a good look at the value in having the trust and the company.
I have to say that my accountant tried to fit our needs and two years ago, i feel i had stronger knowledge over this issues back then. I remember there was a few possible combinations. Things have cooled down a bit by now as it is taking us a while go find another property… but the situation was that we were looking at having an investment structure apart from our work structure. Therefore the set up of a company with a trust as the share holder of the company was advised. In this way we will be able to be able to start investing without putting in risk the assets from work and vice versa. The first consideration was that if things were going to be negatively geared, as may happen in the first few years, we were going to be in the position to claim the losses against my partner and my tax deductions which are currently high (above a company 30%). On the other hand if profit come across in the investment pyramid we will be able to distribute profits after being tax at 30% from the company into a trust (shareholder) and in this way have a good protection over them. Probably this trust should not be related to anything.. .in this way it becomes very secure and unlikely to be affected in the future if i find my self in a difficult position. The other understanding i have about a trust is that in the presence of losses you are not in the position of claiming against them, so this type of entity is good in a situation where there is always a profit involved and to increase the a level of security over the property. So Certainly the trust will increase protection. Always i thought that will be a good way to put positive cash flow properties in as Steve has suggested in the past, however with time changing… i am not that sure at the moment… So in my current position. the property that i live now which is going to become my first IP is going to stay on my partner's name because changing this will involve paying stamp duty and we are not thinking in this. For the next IP (2) i will consider a trust. given that i can offset tax and protect the asset, however
1) Would i be able to claim in interest on the property?
2) Would i be able to move my profit into an offset account that is not related to the trust? How would you manage this?
If all of this is probably doable i will consider to set up a new trust to buy my next IP instead of buying with a company. Is this wrong or right….tell me your thoughts please.
Hi Manolo
I think you must have misunderstood your accountant as what you have written above is strange and wrong.
If the company is buying the property in its own right then the tax on the income will be fixed at 30%. The company can pay dividends to the shareholder which is the trust. But trusts cannot retain income (or be taxed at 45%) so the trust must distribute the income to beneficiaries. If you or your husband were to receive distributions you would pay additional tax. There is also no 50% CGT discount for companies so the company would pay at least 7.5% more tax than you would if a trust owned the property or your personally owned it. Also it could be much less.
The asset protection is not so secure. Directors of the company will need to personally guarantee any loan and if the investment fails the director(s) can lose their personal assets. If a tenant sues then you may be protected by the limited liability of the company.
If a company or a trust owns a property then losses can only be offset by that company or trust. Similar if you buy a property in your name, you cannot use the losses to offset your husband's income. However, if you are self employed there is a way you can negatively gear in a company or a trust and that is to distribute from one entity to another – depends on how you are set up.
The property you are in now – is that in VIC? if so you could buy out your spouse for no stamp duty and increase deductions.
your questions are unclear.
1 – if your husband owns the property you cannot claim anything. If a company or a trust owns it, same
2. what do you mean by profit? If you have money you could move that into an offset account. If the offset account is in your hushand's name then there are other implications but you could consider lending him the money or gift him the money to park in his offset account.
My thoughts are that you have probably not structured ideally.
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
Hi Terry. Thanks again. Probably i have to work in this matter. In order to follow your comments i have consider a few option along the next lines and i will try to clarify some unclear points.
The current property (IP1) is in my wife's name is in NSW.
Terry:"If the company is buying the property in its own right then the tax on the income will be fixed at 30%. The company can pay dividends to the shareholder which is the trust. But trusts cannot retain income (or be taxed at 45%) so the trust must distribute the income to beneficiaries. If you or your husband were to receive distributions you would pay additional tax. There is also no 50% CGT discount for companies so the company would pay at least 7.5% more tax than you would if a trust owned the property or your personally owned it. Also it could be much less."
Based on this, i do not see any point in buying in the name of a company in my situation. Do you agree?
Terry: "If a company or a trust owns a property then losses can only be offset by that company or trust. Similar if you buy a property in your name, you cannot use the losses to offset your husband's income. However, if you are self employed there is a way you can negatively gear in a company or a trust and that is to distribute from one entity to another – depends on how you are set up."
I was not aware of this. It is very interesting. I am thinking that in my situation probably i should start clean using a trust as the entity to purchase my next IP2. Currently our source of income is 80% as employee and 20% of the income is as a sole trader. What do you think about setting a new trust and using my company as the trustee?. I am thinking that if in the future i buy 3 properties with 3 different trusts and the 3 trusts have as a director the same company i would be able to distribute the gains and losses. I have read somewhere that in this scenario if one trust incurred losses from one property…. then this can offset the gain of the other two IP-trusts structure, consequently evening the gains across the investing structure and therefore producing a more effective distribution across the beneficiaries. Is this right?
My apologies about unclear questions:
1 – if your husband owns the property you cannot claim anything.If a company or a trust owns it, same… Clear thanks.
2. what do you mean by profit? If you have money you could move that into an offset account. If the offset account is in your hushand's name then there are other implications but you could consider lending him the money or gift him the money to park in his offset account. – This answer my question. thanks. Based on what is discussed in other threads about offset accounts and structure, if my IP1 produce positive cash flow, then this money should be move to an offset 100% account. As a consequence salaries, rent, tax return and other capital return are going to be parked in this offset account (ideally linked to my PPOR or in the property that i am living). I was concerned that from the tax point of view this can lead to some issues.
This is leading to another question I should've discuss this time ago with my accountant. What is involve in the process of re-using the money distributed to the beneficiaries back into further investments?
M: Based on this, i do not see any point in buying in the name of a company in my situation. Do you agree?
T: There can be some reasons to buy in the company name. One is land tax. But this would depend on where you are buying
M: I have read somewhere that in this scenario if one trust incurred losses from one property…. then this can offset the gain of the other two IP-trusts structure, consequently evening the gains across the investing structure and therefore producing a more effective distribution across the beneficiaries. Is this right?
T: One trust could distribute to another trust, depending on the trust deed and some legal issues. So a trust with a loss could receive a distribution from the trust with the income.
You may also be able to set your business up with a separate trust so profits from the business could be distributed to the trust with the loss.
M: if my IP1 produce positive cash flow, then this money should be move to an offset 100% account.
T: If you are talking about cashflow from the property then this is best put into a 100% offset account attached to the PPOR loan as this interest is not deductible. This is just income so there are no tax consequences. If you are talking about withdrawing equity (ie borrowing) then you should never deposit this money into a savings account.
M: What is involve in the process of re-using the money distributed to the beneficiaries back into further investments?
T: Distributions to beneficiaries means the money belongs to them. They could use that money to pay down non deductible debt or lend it back to the trust or gift it back to the trust. There are various legal and tax consequences involved and things should be considered carefully.
If a distribution hasn't been handed over to the beneficiary then this is called an Unpaid Present Entitlement. The money belongs to the beneficiary and it is treated as a loan by the beneficiary to the trust. There are various legal issues here such as what happens if the beneficiary demands repayment and the trust hasn't got liquid assets to make the repayment? This can often happen on death and can lead to the estate suing the trust (seen if happen with one of my clients).
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
Hi Terry. Thanks. I will dig a little bit more in depth after your comments.
In regard to the land tax… we are in NSW.
By the way what is the current situation with non working children as beneficiaries of a trust
manolo76 wrote:Hi Terry. Thanks. I will dig a little bit more in depth after your comments.In regard to the land tax… we are in NSW.
By the way what is the current situation with non working children as beneficiaries of a trust
Hi M,
It doesn't really matter where you are, but where the property is located!
Children can earn $416 pa without having to pay tax – from inter vivos trusts. But make sure you have a trust in your will because they can earn over $20k pa and not pay tax for income received from a testamentary trust.
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
Thank Terry.
I was referring to the property. I will think about it
Hi Terry
Can you elaborate more about
"they can earn over $20k pa and not pay tax for income received from a testamentary trust"
I thought children < 18 can only earn up to A$416 without paying tax.
god_of_money wrote:Hi TerryCan you elaborate more about
"they can earn over $20k pa and not pay tax for income received from a testamentary trust"
I thought children < 18 can only earn up to A$416 without paying tax.
s102AG ITAA36
income from a will or a trust set up on death is excepted trust income and taxed at adult rates. Can also apply for a child maintenance trust and income from insurance proceeds.
If you are divorced and pay to pay $20,000 in child support, you may have to earn $40k pa to pay this, but if you set up a child maintenance trust the trust could pay the children $20,000 and no tax payable. Many restrictive rules however.
Dying makes things easier as you could leave your extensive property portfolio to a discretionary trust set up in your will and the income to go to minor children – also reduces chance your spouses new partner getting at your money.
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
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