Best investment strategy: tax deductibility vs artificially increased income

I heard a few times a tip that it is better not to deduct to much tax in order to have higher borrowing power when you just start investing and want to buy as many properties as possible.

Example.

+10K in annual income makes a borrowing power 80K more. It means that if, for example, avg property growth is 7%, then during next 10 years you can earn 10 x 80K * 7% = 56K more (we ignore compounding effects for simplicity). If we deduct that 10K each year, then we can get back, for example, 10 x 10K * 37% = 37K.

If the average growth is even higher and real tax rate is lower than 37% (e.g. when it's joint investment and spouse is not working or earn less), the difference is even higher as well.

Later, when you don't want to buy more, you can refinance to get better loan structures to have better deductibility.

Is that correct?
(sorry if that was already discussed, I'm new to this forum and could not find similar topic)

 

I think you are better to claim for tax as much as you can for now (legally).

Cash flow now is more important.

 

Unless you are self employed not claiming deductions won't boost serviceability.

If you are self employed then claiming less will mean greater profits which will help.

 

Not claiming tax deductions to increase servicing ?? The larger the omitted claim the more irrational the idea and more likely its a misleading issue for the lender.

If you choose not to claim expenses that would otherwise be deductible I get the CT effect - But based on current tax laws you lose 50% of the benefit. And if CGT laws change there is no going back. And remember you cant choose NOT to claim depreciation and capital allowances that way.... A costbase adjustment occurs even if you decide to ignore the QS report..

I would always advise a client to claim what they can today as a $1 refund today is always better than $1 (or less) in 10 years.

 

I reckon the old saying is true - "a bird in the hand is worth two in the bush"!

Claim as much as you can as soon as you can.
Marg

 

I was not really talking about not claiming tax deductions to increase the income, I meant there is a choice how to organise the loan structures to have higher/less tax income.

For example, if someone has 500K cash and existing home loan, they may pay the loan off, reborrow with loan splits, and invest by paying for %xx deposit, stamp duty, etc., so the interest will be 100% tax deductible. Another strategy is use cash to invest directly, so the property won't be 100% tax deductible, and it will increase taxable income, and eventually it will increase borrowing power. We sacrifice the tax, but we may buy more.

I meant if we don't organise tax effective loans... that's not big issue as we may buy more properties and earn the same or even more. This is like choosing between 'spend less'/'earn more' strategies.

 

so if I have two investment properties, each is positive and each earns 10K per year, it won't increase my borrowing power? Why?

 

The banks will be aware of all debts. If a debt has tax deductible interest (most) banks will factor in the lower after tax cost of servicing when looking at serviceability.

Tax deductible loans will increase your ability to borrow.

 

I know what you are saying. You would have to sit down with a broker and run the numbers. At 105% lends, you can buy x properties. At 80% lends you can buy y properties. At 40% lends you buy z properties.

I don't know which is best. You might find 80% best until you run out of servicing then switch to 40% for example. Or it might work out better if they are all at 60% for example.

 

This comment doesnt follow from my comment - they are not connected. I was talking about self employment and you are talking about rental income.

But positive cashflow property wil help serviceability compared to negative geared property because the income is greater. But it wouldn't be self sustaining unless the rent exceeded the repayments as calculated by using the banks serviceability criteria - about 7 to 8% PI. So you would need a yield of aroud 12% for a property purchase to improve serviceability.

 

Is the 12% yield based on the purchase amount or loan amount? What I mean is, can purchasing at a lower LVR help servicing?

I am thinking of someone on a low income but with a decent cash buffer.

 

12% is just a guestimate and is based on purchase price. There is a thread here somewhere where I worked it out.

A bigger cash deposit is another way to look at the same thing from a different angle

 

Thanks @Terry_w. So with a large cash pool, buying the right properties at the right LVR the strategy could be self sustaining until the cash runs out?

 

Yes in theory.

 

'cash' in general (including 'cash-->loan pay off-->reborrow for investment' chain), or only 'non-deductible cash' (direct payment from offset account not related in investment loan)

 

Cash as non borrowed funds. If you borrow the deposit serviceability is much harder because of the increased borrowings.

 

Both reduce capacity due to servicing. The tax deductible servicing MAY be less than non-deductible servicing.

 

True. If you do not pay tax it will not help.