It is most people’s dream to own their own house but the issue for property investors is often whether to own one property or more.
Having paid off or built up a considerable amount of equity in one property, it is often not long before they are on to the next and then the next.
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In theory that may seem a good way to build up assets. In practice, however, it is not a strategy that suits everybody.
Some people will shun the thought of taking on more debt and will be much better suited to selling first and trading up to another home.
As with any asset class, property has its pros and cons as an investment. A major criticism is that it is a very “lumpy” asset that can’t always be sold quickly or in part if you need access to money. Often the biggest attraction to buying an investment property is the tax benefits that come with it, including the much-lauded ability to negatively gear, or claim as a tax deduction, the excess costs.
That automatically implies there will be a cash-flow shortfall between the outgoings and the incoming rent that has to be funded.
An alternative is to own property that is positively geared, or where the income received is greater than the total amount of the expenses. In this case, tax must be paid on the net income.
Capital gains tax is the other big tax consideration. While a person’s principal place of residence is CGT-free when they sell it, investment properties are subject to CGT. Whether a person negatively or positively gears property, there will be a need for some careful tax planning, says Adrian Raftery, of Stature ARW Accounting.
“A lot of people hold investment properties until they retire before they sell them or they may wait until they have capital losses from other investments to offset against the capital gains,” he says.
If it is a positively geared property and you are in a couple then it makes sense for the lower income earner to hold the property in their name and pay tax on the income at a lower rate, Raftery says.
Negative v positive
Raftery is not a big fan of negative gearing – although he recognises that there are tax benefits for the higher income earners and it is still the most common way for most people to pay off an investment property.
“Negative gearing means that your expenses exceed your revenue so automatically your cash flow is negative. The tax benefit is still only a percentage of that loss,” he says.
Negative gearing deductions are most beneficial to people in high-income brackets who pay tax at the top marginal rate.
Over the years as tax brackets have changed and tax rates have been reduced there are actually fewer people in the top tax bracket who can take full advantage of negative gearing tax benefits. “The only reason you would negatively gear a property is if the capital growth of your property has grown faster than the negative cash outlay,” Raftery says. Of course there are no guarantees that this is going to happen.
For those who do proceed down the negative-gearing track, a big part of the tax deduction available is the interest portion of the mortgage. Other costs that can be claimed include property management fees, rates, loan costs and maintenance and repairs.
Raftery says it is not uncommon to see people investing in several properties to struggle to pay for them out of their cash flow.
“They are generally asset rich but cash poor,” he says.
While most PAYG taxpayers wait until the end of the year for a tax refund to pay off large chunks of a loan, if people are having cash-flow issues, it is possible to smooth the flow during the year, Raftery says.
By submitting a PAYG income tax withholding variation application to the Australian Tax Office you can apply for all of those investment deductions to be refunded during the year.
What happens, in effect, is that the amount of tax being withheld by your employer is reduced and you get a bigger payslip.
Raftery says anyone using this strategy to help with cash flow needs to be disciplined enough to use the extra money to meet the shortfall rather than using it for everyday living expenses.
Remember, if you apply for advanced refunds in this way, there will be no end of year tax deduction.
CASE STUDY
Joshua Ruttyn, 25, bought his first property in Dee Why, NSW, almost two years ago with a view to buying more in the future.
After living in it for several months he moved back home to live with his parents to save money and secure a loan for a second property on Sydney’s northern beaches.
“It was a big help being at home,” says Joshua, the business manager for a marketing company. “I was able to save and the rent I was able to get from Dee Why helped to secure the loan for a two-bedroom place in Avalon.”
With the Avalon property rented he is happy to live in Dee Why but plans to move to Avalon later this year.
“The rent I collected on Dee Why covered the mortgage on that place but, unfortunately, living at Avalon it won’t be quite as easy,” Joshua says.
His longer-term aim is to use equity in his two existing places to buy a third and possibly fourth property.
“There may come a time when I sell some of the apartments to buy a house but I always want to have at least two places,” Joshua says.
The high costs associated with selling and buying property mean that most investors do everything they can to hold on to a property and use the equity in one to upgrade, says a mortgage broker with Mortgage Choice in Hornsby, Ryan Ewart.
“We run scenarios where we look at their ability to service a loan with the rent and their income and then whether they have enough equity in the property to be able to buy again,” he says.
