Urgent help! Buying family members' house as rental...

[Sami]

Hi all,

We are being somewhat rushed into buying an investment property before we are ready, because a family member's house is about to be sold at a mortgagee auction. We have agreed to buy it below valuation (but probably only about what they'd get at auction, after costs), and then rent it out to another family member who is going to move in and pay market rent. This will still involve a loss for us, of a whopping $200 per week.

We own our own house, with good equity (about 65%), and both have good salaries, so the finance should be okay and we realise we will have to pay extra to cover the outgoings. We had always planned to buy a rental as a retirement scheme, so are in this for the long-term. We are having to use our own house as security on the new house loan.

My questions are:

1) Can't we still offset rental losses against our personal tax even if we just buy the house in our own name? I've read so much on this site about trusts and LAQCs I'm now more confused than ever. We are both on the top tax rate, and I have a student loan that might be paid off before I die...Trawling through this site I still can't see the advantage of an LAQC if we only want the one rental property, long-term?

2) Will the fact that we bought the house for less than RV cause any problems with IRD when we offset these losses at tax time? Although I know investors often make ridiculously low offers to sellers at mortgagee sales, I feel it might not look so good as we are related!

Exact figures:

RV on house: $315,000
Our purchase price: $258,000 (entirely borrowed, by mortgage)
Agreed rent to be paid: $320.00 per week

Any advice, would be much appreciated...we had always planned to go into this carefully, but there just isn't any time left on this one.

[SuperDad]

Hi Sami,

Welcome to PT.

First, the good news. Yes, you are able to offset losses against your personal income if you own the property in your own name. The advantage a LAQC offers is that you are able to distribute losses in proportion to the shareholding of the company. For example, a couple with one income earner on 39% and one on 19.5% can have the higher income earner hold 99% of the shares in the LAQC, and so receive 99% of the losses.

Further, I don't believe there are problems arising from the fact that you are purchasing below RV from a family member, as far as offsetting losses is concerned. There might, however, be gifting issues - I am not sure about this. It is something you might want to look into, however.

The bad news? Let's just put it this way: I'm glad I'm not in your shoes.

Paul.

[drelly]

Hi Sami,

Why are you buying the house?

cheers,
Dave

[CJ]

Why are you buying the house?

Looks like good equity on purchase???

As far as using tax losses, holding it in your personal name is the same as an LAQC. The advantage of an LAQC is that it gives you flexibility in the future (easier to transfer it to a trust should you want to etc).

Couple of possible issues with purchasing of an associated person (a defined term though I haven't looked at the sections and you haven't said how close the relationship is anyway so I cant check - and dont want to either):

- you may be deemed to have purchased it for market value (not sure if this effects gifting due??)
- for depreciation purposes you may be deemed to have purchased at their original purchase price (ie. you will get lower depreciation)

[drelly]

Looks like good equity on purchase???

I guess that depends on when the RV was done and how accurate it is. IMO, I wouldn't buy anything in this market that wasn't at least close to paying for itself.

[ambitious]

agree with CJ, good equity, and you can utilise losses against personal income tax. LAQC suggested wrt utilising higher tax losses with party on higher tax rate. Also, if it's 100% geared then claiming 100% intyerest is okay against the rental property. If it was not, then set up of LAQC would be needed, to structure loan to get LAQC 100% borrowing. Think it should be ok with what you are doing here. Hope this is of some help.

[outspoken]

agree with CJ, good equity, and you can utilise losses against personal income tax. LAQC suggested wrt utilising higher tax losses with party on higher tax rate. Also, if it's 100% geared then claiming 100% intyerest is okay against the rental property. If it was not, then set up of LAQC would be needed, to structure loan to get LAQC 100% borrowing. Think it should be ok with what you are doing here. Hope this is of some help.

What? It must be me, I found that hard to read.

You don't need to set up an LAQC if, as stated, they are both in the 39% tax bracket.
They also state that they are borrowing 100%, so yes the Interest is deductable, only the Interest. In this case interest only loan/s may be the way to go to avoid topping up too much. They can always use a revolving credit to pay down principal with lump sums.
Probably advisable to split the loans with different lenders too, as stated, using colateral from one property with one lender, and the balance of purchase with another.

Sami? do you HAVE to buy this property? is it in a good area? does it have upside? ability to renovate? subdivide? or are you just helping a family member out of the poo?

If not, on the face of it, it doesn't seem such a great deal. You're getting a 6.4% yeild which is historically pretty average, and that's before rates, insurance and maintenance. Once you factor those in it's probably more like 4.5%.

At least you have a good tennant? :-) dealing with family can cause stress & tension too.

If the family member would acheive much the same result at a mortgagee auction, and end up with a shortfall, they can negotiate to repay that shortfall, sometimes for cents on the $ if it is large and the mortgage was re-insured.
Hard decision, think it through carefully.

[drelly]

Sami,

Outspoken has expanded where I probably should have. If you're doing this to help someone out, then maybe reconsider. There seems to be little benefit to you other than some "paper equity" that may or may not exist. Purchasing your first IP with negative gearing puts you behind before you've even started the race. As Outspoken says, you're only getting 6.4%, when you can do much better without too much difficulty in this market. The rent would have to increase to $421 a week before it hits 8.5%. Being able to "utilise tax losses" translates into "losing money". Even with depreciation, it's only a deferred cost. Eventually, depreciation does materialise in the form of real repairs and maintenance bills.

[pgflt]

It's all in the Buying

Sami,
If you are using this proposition as a retirement strategy think very carefully before you proceed. You make your money according to how well you purchase. If you have a negative cash flow of $200 per week at purchase it will take a long time before this becomes positive and you will be haemorrhaging capital to the banks. I suspect your motivation for this deal is emotional in order to assist your family. There is nothing wrong with that, but if you examine the proposition from a strictly business perspective you might be running in the opposite direction by now.
Good luck.
Paul

[Perry]

Sami

You and your partner can simply form a partnership
for your rental activities. By default, that will be on
a 50:50 basis, so profits and losses are divided
equally. KISS. As with other comments from PTrs,
I commend you for 'reaching out' to a family member.

But are there better ways?

[mortgage broker]

Hey I thought of something how about preparing a sale and purchase so that they buy the property back of you in five years for a set amount if you can not get it from the market. Or compensate you with a sum. Just incase the family ends up winning lotto and you are stuck with a bunk property.

[Keys]

Hey I thought of something how about preparing a sale and purchase so that they buy the property back of you in five years for a set amount if you can not get it from the market. Or compensate you with a sum. Just incase the family ends up winning lotto and you are stuck with a bunk property.

Nope, bad idea unless you want to pay tax on possible increase in value. Also, possible tainting for further purchases (you never know).

Don't forget to write into the TA that:

The Residential Tenancies Act 1986 may exclude this tenancy under Section 5 (n) Quote: “Where the premises continue to be used, during the tenancy, principally as a place of residence by the landlord or by any member of the landlord’s family” Therefore, pursuant to Section 8 (1) the parities specifically contract into the Residential Tenancies Act 1986 and wish it to be applied to this tenancy.