My first deal - Yippie!!! Episode II

[waiopehu24]

Well I have finally found something that fits in with my rules.
It is a 3 bedroom house with an attached 4 bedroom sleepout. AND a garage.
I am paying fair market price of 225k.
I plan to rent out the rooms at $70 p/w each room + expenses to responcible guys in the army. While im going to live in the garage.
There are 2 bathrooms, one inside the house with a bath, basin and toilet; one outside by the laundry with a shower, basin and toilet.
I have never lived in a flating situation, let alone managed one, so this is bound to be a big learning curve for me.
The house was previously rented out to a mother with 2 kids for 7 years, who leased out the 4 sleepout rooms to students.
The whole property was obviously built for students as each room has a built in desk and are all pretty much identical.
When I placed my offer there was already a contract underway on the property, so mine was a backup.
Also my offer was being presented along with another, so I did not think much of the deal and moved on.
Upon calling up the agent a few days later on, I think it was monday, I found that my offer had been accepted and it was likely that the other purchasers contract would fall through.
The other party had until wednesday to confirm or drop the contract.

My conditions are: Subject to me approving a builders report within 5 working days and to allow access for me and my tradesmen to do improvements to the property between unconditional and settlement.

My contract I believed would take effect 5pm wed 28th, and I have until wednesday the 5th.
My backup offer was accepted on monday and I infact had until monday the 3rd to confirm.
I find this out wednesday, after the fact is brought up from another agent in the company.
I call the listing a*"&%t im dealing with (The same one who assured me I had until wed 5th) and he says he'll find out tomorrow.
The next day my lawyer informs me that I do have until monday.
I apply for a 2 day extension and it is granted.
I like to think that the agent genuinally thought wrong, I will now be more careful in future when putting in back up offers, or any offers for that matter.
Anyway I am working with a good mortgage broker but it looks like I will not be quiet able to get the finance based on my income.
I would be pursuing 95% borrowing as the size of my deposit will not allow for less.
I am this weekend looking to have my grandparents act as guarentors until I can build up enough equity to be self sufficient.
This would solve my finance dilema. (I intended this as a last resort and will only use this option if absolutely neccessary.)
I have had a valuer go through and the report will be done by monday.
A builder has done a through inspection on the property and I am aware of all the repairs needed.
I will own the property under my own name so as to get DTLS (a loan subsidy paid by the army - 3.4% of a principal reducing mortgage up to 150k, about $100 extra per week.).
Who can offer advice on how the tenency agreement works?
Does each tenent have their own contract with me?

Given my situation I would appreciate any suggestions on how I could lease the rooms, and advise me of any tax or other issues that could come to play.

Figures:

Price: 225k
Loan: $213750

Rent: $70 per room x 7 rooms = $490p/w
Income=$24010 - 3 weeks vacancy per room, PA.
Expenses:
Interest:$17100
Rates:$1400
Insurance:$600
Maintenance:$1500

Expenses: $20600

Profit=$3410 PA. Before tax.

(Not including DTLS)

I am wanting to fix small problems around the house and recarpet before settlement. (5 weeks for settlement)
I will get quotes by wednesday, then add this into my equation.
If this garentor thing works out there may no longer be a need for my deposit.
I will check with the broker on monday to see if the lender might let me place my 10k deposit into the revolving credit so I can use it for improvements.

Its getting late, I hope my post makes sense...

Paul, DE JA VU or what??

Sean.

[SuperDad]

Well done Sean - Pre-tax CF+ on 95% borrowings! These are not easy to find. And yes, it is De Ja Vu - ah, the excitement of the first deal. It is something I don't think I will easily forget.

The DTLS looks great - it is good to see that the govt. is doing something to look after the armed forces. $100pw is brilliant!

I bet you got a shock when you found out that confirmation date was 2 days earlier than you thought!

I'm sitting here at my computer, on another cold and frosty morning in Hamilton, and the first question that crosses my mind in respect to your situation is: Is the garage lined and insulated?

My second thought is: have you taken a close look at the IRD booklet on Rental Income ( http://www.ird.govt.nz/resources/fil...52be/ir264.pdf)?

I have quoted the bit relevant to your situation below:

If you have five or more boarders living in your home, you must keep full records of all your household expenses, and work out the proportion of the expenses relating to the boarders. You then deduct the boarders' share of the expenses from the total board payments you receive, and inclue the remaining profit as income in your tax return.

It looks like the rental income from boarders in your property will be $24000. If you don't offset any expenses against this, you will be hit with a $8K tax bill (at 33%), or a $4700 bill at 19.5%. the trick is knowing which expenses can be offset against income received from boarders. In this regard I have no special knowledge - a specialist property accountant is probably the best bet. I'm pretty sure, however, that the interest on borrowings is not deductible as an expense, as the purpose of raising finance was to get your PPOR. I'm not sure whether the same applies for depreciation, but I suspect that it does, as depreciation is a business expense.

Others might be able to help out here.

One thought: if your calculations end up showing that you will have a tax liabilty (that is, if the propery is CF-ive after tax), all is not lost. One solution is to calculate the expenses that you can claim for the property, and build these in to an inclusive rate for each room.

Suppose that you can only claim the following expenses: power, phone, rates, insurance, repairs and maintenance. (BTW, I would think that $1500 PA for maintenance is a little light.) Figure out what those ammount to per room, and add this into the board per room. So instead of charging $70 per room + expenses, you might end up charging $90 per room all up. This all inclusive price will probably be attractive to boarders - they know exactly what they are up for. It also saves you the trouble of trying to apportion expenses - for example, trying to get 1/8th of the power and phone bills from the boarders each month.

The trick will be trying to make sure that the positive cashflow you have before tax more than covers the tax liability you will have on the rental income for the property, so that you are not CF-ive after tax.

Say that you charge $90 per room - the total income (allowing 3 weeks vacancy) will be $30870. Also assume that the only expenses you can claim are the rates ($1255 (=$1400 x 7/8 ), power and phone (say $3000pa), insurance($525 (=$600 x 7/8 ), and maintenace (say $3000). ($1500 for maintenance seems a bit light.) This will reduce the income on the property to $23090 - you will need to add this to your taxable income, and pay tax on this ammount. Say that, in the worst case scenario, you have to pay 33% tax on this whole ammount - you will have an additional tax liability of around $7500, or $145 per week.

Now, let's go back and look at the actual outgoings for the property.

Income=$30870 - allows for 3 weeks vacancy per room, PA.
Expenses:
Interest:$17100 (will you have an IO loan?? If not, your actual expenses/outgoings will include principle repayments.)
Rates:$1400
Insurance:$600
Maintenance:$3400 (of which you can claim 7/8, or $3000, thus reflecting the proportion of boarders in your residence.)
Power, phone: $3400 (of which you can claim 7/8 )
Expenses: $25900

Profit= approx $5000PA. Before tax. Note that this pre-tax profit does not yet offset the $7500 tax liability. However, your income might be such that you are not paying 33% on every dollar of the $23090 of rental income after expenses) that you need to declare.

Also, my calculations do not take into account the DTLS, which will make all the difference in the world to these figures. Add the $5K per annum to the after tax figures, and you're into CF+ive territory. Well done!!!!!!

I have no doubt that you will be able to "balance the books" on this property, such that it is CF positive both before and after tax.

Awesome Sean. Using other people's money to leverage yourself into a home - well done. I hope you're doing officer training - I want smart cookies like you taking charge when the time comes to call on the armed forces to protect our country's interests.

Paul.

[waiopehu24]

Hi Paul,

Including expenses into the rent is a good idea.
Doing some ruff figures I have estimated the utility expenses as follows:

Power:$300 month
Phone:$45 month
Gas: (hot water cylander, and heater only)$100 month???
Sky digital: $70 month???

Total: $515 month
: $128 weekly
: $18.40 per person, per week (Not including me )

(Every person has their own tv, dvd player, play station, stereo, some have their own fridge and also taking into account our shocking habits of milking the power in barracks.
(A reason why im getting a sparky to check the wiring.)
In some rooms there is only one power point, so I can imagine 2 quad extensions being used in some cases!)

For those of you currently living in a house, how much for sky digital, and approximately how much for my gas??

Another dilema I have at the mo is; How will food work?
Should I have everyone pay a set amount each week specifically for groceries and take turns at cooking?
Or is it buy and cook your own food?
There is a good argument for each, most notibly,
Buy your own: You dont have to worry about not always eating/meet timings at the house, no arguments over what to buy/dislike of someones cooking.
Buy together/cook together: We eat healthier, Foods cheaper(bulk), no arguments over whos using the stove
PS. Everyone will be required to supply something for the house. ie. fridge, lawn mower, washing machine etc. It is theirs when they leave or until I can afford to buy it myself.
IO loan? Technically yes. This is my mortgage plan:

50k RC
163k IO

HOWEVER, as I only get my DTLS on a principal reducing loan, they would theoretically only pay 3.4% of the RC.
When I asked my admin guy how much principal I had to reduce PA, I soon found that it was like asking an accountant how many properties I could trade before I get taxed.
Each year I must also prove to the army that I have reduced my mortgage.
Then my mortgage broker mentioned that some lenders allow you to pay down an IO loan by a specified amount each year.
One in particular $900 PA.
I put 2 and 2 together and WHAMO, a gap in the system!
I could pay something like $10 off my IO loan each week and still claim DTLS on it!

Paul, you bring up good tax issues and after working through some numbers I find that I could actually have a tax bill.
I realise I need to talk with my accountant.

Final points:

Paul: If our deals are similar might I be liable for gst??

Cheers,
Sean.

[SuperDad]

Hi Sean,

From what I know, your deal will not attract GST. The reason for this is that 70% of the tenants will be expected to stay for 28 days or more. Also, if the tenants are on standard tenancy agreements, this apparently strengthens one's case. But remember, my information is 2nd-hand - I am just passing on what I have learnt from certain professionals.

Looking at the figures you have provided, I don't see that you will have a problem making the property CF+ve both before and after tax.

Check out the pricing options for sky here:

http://www.sky.co.nz/index.cfm?pageid=514

Regarding food, my inclination would be to let things sort themselves out. Perhaps in the first instance start with the "each man for himself" plan. I think that people will naturally start to eat together and share costs.

I still haven't been able to figure out your exact position in respect to the deal. Has the other party pulled out yet, or have they still got until wednesday to confirm?

Paul.

[BusyLizzy]

Hi Sean,

Aside from the tax issues which Paul has mentioned, the other concern that jumped out at me is that I would think that you are very light on Maintenance. You have allowed $1500. I assume it is an older-style building.. these tend to cost more to look after. And having 7 people there will add to general wear and tear of the place.. carpet, fittings, etc. There was a thread some months ago where people indicated what they typically allow for maintenance - it might be worth searching for it.

What about lawn mowing and gardening? Will you be doing this yourself? If not, more costs to factor in.

I have no answers on the food situation.. but it made me think about about general housekeeping and upkeep. Will you have a housecleaning roster (and if so.. will it work for 7-8 people?!). Or will you get a cleaner in to clean communal areas (kitchen, bathrooms, laundry, etc). If you get a cleaner... add that to your costs. I presume it would be tax deductible.. but it would pay to check.

Just some more stuff to think about...:-)

[waiopehu24]

The other people pulled out last wednesday and I have until this wed to go unconditional.

Today im visiting my mortgage broker and accountant.
After this im going to get quotes for improvements.
Then finally ill get some more of my potential boarders through to check the house.

Lisa; We will all be responcible for general maintenance of the place ie. cleaning, mowing etc.
It is up to me to set rules and make sure they are followed.
Any tips on what rules to make and how to enforce them, would be appreciated.

The valuer has confirmed the price at $225500, how convenient.
Ill be talking to my accountant about how the tenency agreement with my boarders will work.
As for maintenance, I will look into it further...
Im not including my pre settlement repairs on the property into my maintenance budget.
Instead I will proberly include these as part of the purchase price (yes may have been a good idea to negotiate the deal that much lower).
This brings up a 2nd challenge: Money for the improvements!?
I have 10k deposit and a garentor to get my loan.
Today I will talk to the broker about the possibility of using this for improvements...
I sure hope so as the garage is not lined or insulated, and I want to at least gib the walls in it.

PS. Paul if I became an officer I would have little time to do this stuff!! Ill just stick to my job and enjoy my free time!

[revdev]

The valuer has confirmed the price at $225500, how convenient.

Hi Sean,

Quite a common occurance for first time buyers I think, especially when it has been ordered by the bank as a condition of finance (at cost to you of course).

In fact I know of one valuer, his nickname amoung mortgage brokers is "500 buck John", for his uncanny ability to value everything $500 above what the purchaser paid for it.

Keep it up Sean!

G

[waiopehu24]

Well guys this is what happened today:

I talked to my accountant and I will claim 100% of all expenses.
How?
I will own the property under my own name so as to get DTLS, and pay rent to myself from my personal account into my rent account.
I understand this is frowned upon by the IRD but it suits my situation.
I will have a definate seperate automatic payment for my rent. Also the fact was brought up: DONT MIX MY RENT ACCOUNT WITH MY PERSONAL ACCOUNT!

Also in regards to the tenent; they will be flatmates and I will have a flatmate agreement with each of them.
This agreement is not subject to the residential tenencies act but any problems can be resolved through the disputes tribunal.
This means I can take a bond as large as I want and not have to lodge it.
It also means I can include all my house rules in there that will bind my flatmates by law.

Everything seems set to go...
Except one problem: I am having trouble getting flatmates.
I have taken people round to see it and what starts out as 'yeah were in!!' turns out to be: My girlfriends mate pays $40 per room, its not that cheap.
One even had the cheek to say they want to see my mortgage costs so they know how much im paying in interest vs rent recieved!!
I think they believe that im ripping them off, and they dont like the idea that they are paying my mortgage!
I am trying to stress that it is a buisiness im running not a flippin soup kitchen.
The worst thing is, when put on the spot they ALMOST make me feel like I am taking their money for nothing. I have to remind myself that even though I may not be able to get through to them, I know what im doing, what im providing and what I stand for
I need to know by wednesday whether or not people will actually live there at my specified price.
The 4 outside rooms have less appeal than the inside rooms,
may mean a rent review here.
I have been searching for this deal for a while and I would hate to see it fall over because of the flatmate issue.
A note: I was targeting responcible people, from a management point of view.
One more rekless friend I was looking at taking on says that he doesnt want to live with 'responcible' people and never would the people he had in mind.
Stuff manageing a houseful like that!!
I realise however, that I really need to select people who all get along and dont need to be told to put the toilet seat up when urinating!
Tomorrow I am getting a property manager I know to view the property and give me a rental appraisal realistically telling me how much I can expect to rent the rooms for.
Students drive the city and given the type of property it is, they would be my target tenent outside of the army.
There are many pros and cons of living out of barracks, but I think it is more a fear of breaking out of their comfort zone.
I need to somehow counter this fear...
At least students dont have a super cheap barrack environment they arent afraid of leaving!

[revdev]

Students drive the city and given the type of property it is, they would be my target tenent outside of the army.

Personally, i think the student market would allow you to keep a degree of separation, and therefore your sanity..

G

[Dean@Massiveaction]

Just be aware waiopehu that your renting to yourself is not just frowned upon, IRD won't let you do it. And as you have publicly stated your intentions here in this forum if IRD ever get hold of it you will get prosecuted, potentially have all the deductions disallowed, pay penalties on the money you have claimed and be an IRD target for years to come etc. etc. etc. I suggest you get a more honest professional accountant.

[drelly]

Wai, it has been pointed out in the past that your accountant was giving you bad advice. Did you get another one or is this the same one?

[SuperDad]

Sean,

I just read your post again in light of Pooomba's comment. When you say your accountant told you that you could claim "all costs", did this mean the interest on your loan and depreciation on building and chattels? If so, then you'll end up in big big trouble.

Have a look again at my posting on this thread regarding the IR264. Those are the expenses you'll be able to claim - I'm pretty certain of this. (And remember, you'll only be able to claim those costs in proportion to the number of boarders you have.) If you are in doubt, I'd recommend you talk to a specialist property accountant. Try Peter Meads, of Property and Business Accounting Ltd - (09)4899455. From memory, he does the books for around 1500 rental properties.

You should still be able to make the property CF+ive pre- and post-tax, IF the market will sustain $90 per week per room (or there abouts).

When you get the rental appraisal, be sure to ask the property manager what he or she thinks the demand for the property, and what the likely occupancy rate will be. Its no good getting a rental appraisal of $90 per room (incl. costs), if there won't be much demand at that level, or if you wil only occupy 4 of the 7 rooms at any one time. Also, remember that the student market is seasonal - roughly late Feb to Oct. Unless you get them signed up on year-long tenancies, you might have cashflow problems over summer. Also, how far is it in to the city? Students generally like to be within walking distance of campus, or of public transport that will get one to campus pretty quickly.

Last, but not least, don't be afraid to walk away.

Good luck,

Paul.

[spaceman]

Ird

I think Dean is wrong about the IRD when he says the IRD won’t let you rent to yourself.

Just be aware waiopehu that your renting to yourself is not just frowned upon, IRD won't let you do it. And as you have publicly stated your intentions here in this forum if IRD ever get hold of it you will get prosecuted, potentially have all the deductions disallowed, pay penalties on the money you have claimed and be an IRD target for years to come etc. etc. etc. I suggest you get a more honest professional accountant.

Below is a press release from the IRD. It isn’t exactly the situation our young AJ friend is in, but it’s pretty close.

Regarding if it IS tax avoidance, I think the IRD chose their words very carefully when they state; "may", "some" and "will often". To me this means that there are situations where it will be tax avoidance and time when it won’t be. Otherwise surely the words used would be "will", "all" and "will always". It goes on to state that they are considering several cases, what’s to consider if it’s always tax avoidance.

I would bang off an email to Ms Cotton (or her 2006 equivalent) and request her advice as to what you need to do to be sure that you are in the clear. Though I really doubt that you will get any sort of reply back
2004 media releases

Tax avoidance involving LAQCs and the family home

19 July 2004

Inland Revenue has noted with concern that a group of taxpayers are selling their private home to a loss attributing qualifying company (LAQC), and then claiming tax deductions.

Selling your private home to a LAQC in order to claim a tax deduction for what are really private expenses, may be tax avoidance in some cases, says Margaret Cotton, of Inland Revenue.

"Unfortunately, some investment advisors are telling their customers that they can claim a tax deduction by selling their residential property to a loss attributing qualifying company, renting the property back from that company and claiming a tax loss," said Ms Cotton, National Manager of Technical Standards.

"Inland Revenue considers that such arrangements will often be tax avoidance for the purposes of income tax," she said.

Ms Cotton explained that Inland Revenue is currently considering several cases where a LAQC has been used to buy a residential property that the shareholders will rent as their residence. Even where a market rental is paid to the LAQC, a tax loss can still be generated to the advantage of the shareholders.

Where tax avoidance is proven, the taxpayer must pay the tax avoided as well as a penalty of 100% of the tax avoided. Use of money interest will also apply.

Ms Cotton says that if taxpayers are concerned about their position in respect of these arrangements then they should contact their local Inland Revenue office or seek professional advice.[/i]

Good luck

Cheers
Spaceman

[Dean@Massiveaction]

You are quite right Spaceman but Waiopehu has made it quite clear that the primary motive is tax avoidance and that will end them up in large amounts of bovine eschatology

[rustica]

I have been searching for this deal for a while and I would hate to see it fall over because of the flatmate issue.[/quote]

Flatmate or tenant issue, these are your 'customers' and you need them to make your business work. Irrespective of the deal, no customers= very bad deal.

Good luck with the search and the deal