Debt Recycling Strategy: Buy and Sell Property after some Growth

Discussion in 'Property Information Resources & Tools' started by Terry_w, 24th Oct, 2016.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Debt Recycling Strategy: Buy and Sell Property after some Growth


    Selling property could be done as part of a debt recycling strategy.


    Debt Recycling is converting non-deductible debt into deductible debt. This is done by paying down the non-deductible debt and reborrowing to invest. Paying down non-deductible debt can increase tax deductions, improves cash flow and speeds up the investment journey.


    For more on debt recycling in general see my Tax Tip:

    Tax Tip 2: Debt Recycling
    https://propertychat.com.au/community/threads/tax-tip-2-debt-recycling.1472/



    Here is how it works:

    X has an owner occupied home with a bit of equity. He borrows 105% to buy an investment property, avoiding LMI. He waits about 18 months for some capital growth to kick in and then sells the property, pays the agents fees etc and then pays the CGT (delaying as long as possible). But he still has some money left over.


    He uses the profits after tax to pay down the non-deductible portion of his home loan reducing non-deductible debt. Then he repeats the process by buying another investment property. He buys and sells properties until he totally pays off the non-deductible portion of his debt.


    This can work even better with shares as the transaction costs are minimal – but more risky because of volatility. Speak to a financial advisor about this.


    Example

    Tom buys a main residence for $500,000 with a $400,000. After two years his property is worth $600,000, but he is depressed because his loan is still $400,000 and he only has saved $20,000 in his offset.


    Tom decides to set up a LOC of $80,000 against his home and uses this as deposit on a $300,000 property – borrowing $315,000 all up. This investment property increases to $350,000 in 18 months so Tom sells it. He has made a $50,000 gain – but after expenses the profit may be just $20,000.


    Tom pays this $20,000 into his home loan and then borrows to buy the property next door to his old IP and he does the same thing again.

    Doing this has enabled Tom to pay off his home loan by $20,000 extra. Sure he has incurred a lot of costs going in and out of property but he has $20,000 extra cash in his pocket. Normally he might need to earn about $40,000 to get $20,000 in his pocket.


    Keep in mind there is also a 50% reduction for capital gainst tax – meaning the max tax rate is about 25%. This makes income earned as capital gains twice as effective as income earned from a salary.


    Also note that if you are buying and selling property with the intention of a sale for profit it may be taxed as income and no 50% CGT may be available.


    Benefits of this strategy:

    - Helps give your income a boost,

    - Tax effective as capital gains are taxed at half the rate of income earned,

    - Can be even more tax effective with tax planning,

    - Can pay down non deductible debt much quicker,

    - Improves serviceability because non-deductible debt is decreasing,

    - Improves cash flow as less tax is paid and therefore more cash in your pockets,

    - You are not paying more tax, but just bringing it forward,

    - Small capital gains are easier to plan for and reduce tax (or eliminate it).




    Downsides

    - Eats up serviceability (until you sell),

    - If serviceability tightens further you may not be able to borrow to replace the property sold,

    - Make it at least 18 months to two years or the finance broker will have to give back their commission (clawback),

    - It may be better to keep holding, avoid the transaction costs, and have a larger capital base to keep growing.

    - Transaction costs can be in the range of 10% of the property value,

    - Tax is brought forward so that there is less capital compounding in the future.


    Variation on Strategy

    Tom could sell to spouse or related entity – avoids the need to pay an agent’s commission. May also be stamp duty exempt in some states


    Get taxation and legal advice before trying this.

    Please note I am not suggesting anyone implement this strategy. I am just putting it out here as a strategy which may or may not help your particular situation.
     
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  2. Cactus

    Cactus Well-Known Member

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    This is part of my plan. I am working on a triplex development that one of the townhouses will become my ppor. I plan to smash out the debt by turning over some properties and reinvesting from borrowing from ppor.
     
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  3. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    I
    I think this is going to become more and more important as lenders tighten their servicing. I've been telling all my clients that debt reduction is key and when there is an OO property in play this is the perfect way to go about it.
     
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  4. Gockie

    Gockie Life is good ☺️ Premium Member

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    Love it. As always "when the student is ready, the master will appear"
    I plan to use this. :)
     
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  5. kierank

    kierank Well-Known Member

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    If all you filthy rich capitalist pigs do this and pay your CGT, our Budget will be in surplus in no time :) :).
     
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  6. Gockie

    Gockie Life is good ☺️ Premium Member

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    Will pay taxes... but as late as possible without attracting the wrath of the ATO. It will be paid though!
     
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  7. bob shovel

    bob shovel Well-Known Member

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    Is it the total amount of debt they are not liking and that is playing a bigger part in the way calculations are done for someone to keep buying.
    Are borrowers seen as more risky the higher the money borrowed is, even if the lvr is low? (Say <70%? ?)
     
  8. wombat777

    wombat777 Well-Known Member

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  9. Gockie

    Gockie Life is good ☺️ Premium Member

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    I'd say every dollar of non deductible debt takes away from your borrowing capacity for IPs - your borrowings all counts against your serviceability. PPOR debt is bad because it's not tax deductible and it doesn't earn any income either. So destroy the non deductible debt (if you have any), and this will allow you to buy more IPs. My thought is that IP debt is better to have than PPOR debt because with IPs there are income and tax benefits.
    That's my plan anyway.

    Of course, by all means, own a great PPOR if you can afford it - love how there's no CGT on PPORs and it can be used as a wealth store for when you are old - doesn't matter if your PPOR is worth 5 mill - value of PPOR doesn't matter in terms of getting a pension if you were thinking of getting government benefits or leaving it to someone in your will (at this point in time).
     
    Last edited: 26th Oct, 2016
  10. Gockie

    Gockie Life is good ☺️ Premium Member

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  11. bob shovel

    bob shovel Well-Known Member

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    Oh yeah. I was talking about the ip debt, ignoring the ppor debt.

    Selling the IP's after growth seems like the way to get ahead now.
    Sydney investors should be looking at this strategy if they haven't already
     
  12. Gockie

    Gockie Life is good ☺️ Premium Member

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    ;) I should have some news this Friday..... then I'm back to buying up big :)
     
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  13. kierank

    kierank Well-Known Member

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  14. Jess Peletier

    Jess Peletier Mortgage Broker & Finance Strategy, Aus Wide! Business Member

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    Yep - they don't care much what the LVR is unless the debt is with them, but care very much how much debt you have in total.
     
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  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Depends on how the tax legislation is drafted. Trust assets do not pass via you will so when you die the trust will keep on going as is but under new control.
     
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  16. Spoony

    Spoony Well-Known Member

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    Quite an interesting strategy I hadn't thought of, cheers. I'm currently refinancing and extracting equity, and a 2-3 year play like this, done twice, may work well for future relocation plans and getting the PPOR loan finished. With an average income I'm reading more and more on here that trying to grow an IP portfolio in the current lending market will be a substantial challenge.

    I feel it would also change the initial IP selection too, I was initially thinking a better yield play and hold, but this would be adjusted as growth is key. A bonus is it also has one reconsidering stock assets as an option.
     
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  17. L3ha7

    L3ha7 Well-Known Member

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    I am still confused -will read again after having coffee :)
     
  18. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It is just realising capital gains, using the profits from the sale to pay down non-deductible debt and borrowing to repeat.
     
  19. L3ha7

    L3ha7 Well-Known Member

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    Thanks @Terry_w , so in simple words it is the same cycle of buying and selling IP's and profit goes in to PPOR's offset? But one has to repeat this cycle every 18 months to 2 years to make it more effective?

    All up $315K for $300K property because stamp duty etc.?

    Why only half the CG tax?

    Sorry for these questions Terry.
     
  20. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    it depends. You might sell a property you have held for many years, pay off the home loan on your PPOR, reborrow and buy another property again.

    The capital gain is reduced by 50% if you have held more than 12 months.