Are you borrowing from the govt to support your IP?

[Gerrard]

I mentioned (in another post that of course can't find it now) that I've been having an ongoing debate with a friend who has a negatively geared property in Wellington about whether to keep it or sell it.

Talking about it again tonight I said "Do you realise you are borrowing from the governmet to support your property".

Now I've either read that phrase somewhere before and it's stuck in my mind, or I have just come up with a new way of looking at it. I wonder how I could make money out of it...

Anyway, I digress.

The point I was trying to get across was that by relying on tax breaks to make a property break even (or better), you are in fact borrowing money from the government (in the form of depreciation) of which you will have to pay some back in the future when you sell the property*.

I bet there's not many people who would be happy about getting more into debt every year with a bank, so why treat the government any differently?

We came to the conclusion that there are only 3 options in the situation:

• 1) reduce the mortgage so the return is better (either by switching to P&I, or paying off a lump sum)
  
  2) sell the property
  
  3) stay as is and wait for future capital gain

Option 1 isn't preferable as he still has a fairly big mortgage so it makes sense to pay that off first.

Option 2 would result in being in a of equity (even if the property was sold for valuation there would be agent and laywers fees, and depreciation recovered).

Option 3 is a complete gamble.

My friend (and no it's not me!) is by no means skint so he can afford any of the 3 options. What would you do?

Oh yeah, and there was a reason to this rant too. Lots of people with positive cashflow properties are in the same situation of relying on the tax breaks as the main source of income from their properties. Scary to think they are in fact getting into more debt without realising it.

Gerrard

* there's not many people who own property for generation after generation so you should assume you will have to sell it at some point in your lifetime.

[Monid]

Well we would sell sell sell
I just don't like losing money to have the possibility to make more especially given the uncertainty in the market these days.

On the borrowing money from the government point, this is exactly how we concieve of this (I even account for it as a loan form the government) Nonetheless we are still claiming for it. Why?
Because it is an interest free loan and due to inflation the amount we have to repay devalues every year. In the mean time it saves us interest, basically it is like an ongoing refinancing of your property. (also if your property did actually lose value, when you sold it it would effectively be that the government had covered your losses )



I am still a student and I am doing the same thing with both student loans and my interest free overdraft, both are maxed out and paying off our house because I am swapping interest bearing debt for interest free debt, and I know what I prefer!

So by all means don't percieve depreciation as profit, but still bring it on...


Cheers David

[murray-spi-investments]

Gerrard with out knowing
1. Any other properties your friend owns
2.What kind of tax holding he has on his presonal family home
3. What excess cash/income you friend has
then it is difficult to say keep or sell

For example I have clients who are negativley geared but by having effective planning in place they are on paper mortgage free on their family home. Thus they have transferred the non deductable mortgage on the family home into a tax deductable mortgage on an investment property.

Another possibility is say you have $100k to invest you could buy 1 property for say $200k and be positively geared or perhaps buy 2 properties for $200 each , thus borrow $300k and possibly be negativley
geared. Now I think most of us buy property for the long term capital gains and are aware that rent increases over time. So for a given sum of money why not buy two properties and thus double you potential for long term capital gains and in time the rents will increase and pay off more of the mortgage. ie negative gearing can be affective to gain entry into a market for a period of time until it becomes cash positive

Of course this does not suit all investors some want to buy for income only and thus lower leverage suits them. People on lower tax brackets will not receive the same tax benefit as higher (over $60k pa) income earners and of course some folk are just more risk adverse. However assuming you are not buying a property with a 4 or 5 % return and really hoping for capital gains to make money for you (don't count on it ) then depending on your circumstances and planning then yes negative gearing may be a worthwhile option.

On the matter of "borrowing from the government to support your property" I do not view it as a loan but as an accountant I view the time value of money benefit as very usefull. Depreciation of couse needs to be repaid if the purchase price is lower than the selling price when you exit the property. But as an example I brought a property in 1996 and to date have claimed $75k in depreciation as I am in the top tax bracket that means I have had a tax refund of $29250 over that time (not quite correct as 39c rate was not in effect in 1996). I am saving 7.5% on my mortgage at present on that amount as I paid it off my mortgage and until I sell the property I do not have to pay it back.

Owning property is a busness and we as property investors as entitled to depreciate and claim all allowable expences incurred in runnning our business, so I am satisified to claim depreciation on the expectation that one day I will repay it.

Having said all that assuming your friend has no other investments and are mortgage free on the family home then I agree with you Negative gearing should be a short term only as although you may get 39c in the dollar back from the tax man it has cost you 61c to do so.

So the answer to your friends is ..... it depends

[cashed4crash]

Because it is an interest free loan and due to inflation the amount we have to repay devalues every year.

I claimed my depreciation at the then top tax rate of 33%. When I came to sell the govt had put the tax rate up to 39%.

What a bummer

[Warren]

Cashed4crash,

Like everything in this world there is 2 sides to every story.

If you had sold the property, and at the time of the sale, your income was in the lowest tax bracket you would have paid the tax at 19.5%.

A couple of other points seems to have been missed in the general discussion.

It is possible to minimise the amount of clawback tax. So for example, if you have claimed $20,000 in depreciation over the period you have owned the IP you do not have to pay $20,000 back in clawback tax.

Also, another way of looking at this issue of paying it back is, even if you do have to pay the clawback tax to the IRD, you will have the funds to do so having just sold the IP and repaid (any) outstanding mortgage and (hopefully) having made a capital gain.

Plus there is the issue of time value of money already discussed.

Depreciation is your hottest tax reduction tool for property.

regards

[cashed4crash]

Like everything in this world there is 2 sides to every story.

If you had sold the property, and at the time of the sale, your income was in the lowest tax bracket you would have paid the tax at 19.5%.

Whoopty Do. if I had bought the correct lotto ticket last Saturday I would have won too.....so what, the fact was I claimed at 33% and paid back at 39%. Depreciation to me was a big yawn and waste of time.

[Tucker]

Maybe you should have learnt abit more about it before selling cashed4crash.

[cashed4crash]

Hey Tucker.

Who pulled your chain?

What was there to learn about? I bought some houses, they went up and I sold them. Who cares about a lousy 6% extra depreciation to pay back. All I was saying was the depreciation thing was a waste of time. No one knew that Labour were going to get in and put up the tax rate.