How I Financially Structured my Portfolio to Maximise Cash flow & Tax Deductions along the way.

Over past few weeks I've received quite a few emails asking what financial structures and strategies I've utlised to maximise my tax deductions and cash flows to build the substantial size portfolio I've attained.

I hope the following is of some help in broadening your understanding of what should not be (but often can be) a very complicated subject.

My preferred model is a structure whereby Lines of Credit (LOC), secured against equity in the existing property (PPOR and/or IP's), are first established. This can be done at the time of purchasing your investment property; however, it is far more advantageous to have had them already established ahead of making a property purchase decision! WHY? Simply because it takes the guess work out of what you can afford and simplifies the process enormously once a purchase decision is made.

There are several financial products (offsets/redraws etc) that have the similar characteristics as a LOC, but with different names. For myself as an investor, the LOC’s ought to be split into two:

1. One for personal (or non deductible) expenses.
2. One for investment (deductible) expenses.

This is necessary come Tax time so that “business” or investment expenses are kept separate from personal non deductible expenses and therefore easily identified for your tax returns.

The following is an example only and assumes one satisfies their lender’s serviceability criteria to do what is suggested:

• Your existing home is financed with Bank A.
• You establish two new lines of credit, secured against existing equity in your home.
• You decide to purchase an investment property and have Bank B finance it.
• Because you have first established your Lines of Credit with Bank A you have approved funds already available to use.
• You make application with Bank B to fund your new investment purchase.
• Bank B assess your application and agree to lend you up to 80% of the property’s valuation; without lenders mortgage insurance (LMI) and without any additional security offered (i.e. assuming that you satisfy their lending criteria).
• The balance required to settle your new investment purchase will be the difference between what Bank B lends you, and the purchase price of the property plus stamp duty and legal costs.
• This amount would come from your Bank A Investment LOC; but your family home is not used as security by Bank B.
• Assuming Bank B values your investment property at full contract price; the balance you will need to draw from your Bank A LOC is 20% (plus costs).
• Please understand, however, that Bank B will instruct the valuer to value the proposed investment property according to a set of conditions that remain confidential between those two parties. Many in the industry believe these conditions amount to a “fire sale” price; however, neither party would agree with that (nor will they disclose those conditions). Regardless, experience strongly suggests that in the majority of cases bank valuations will come in at contract price or lower.
• You need to have enough funding available from your investment Line of Credit to pay the difference between what Bank B loan you and what you need to settle.
• By repeating this strategy of only offering a lender the security of the new property you want them to partially fund, you will avoid the stereo‐typical bank approach of cross‐securing your assets.
• In each case you will draw the balance required to settle (i.e. the difference between the contract price and what they are lending you plus costs) from your investment LOC.
• Having all of your properties “stand alone” has many advantages and gives you maximum control over your investment portfolio.
• This same strategy of NOT cross‐securing your investments can still be achieved in cases where you have multiple properties with the same lender or across multiple lenders.

Capitalising expenses (adding them to the loan):

Given enough available equity (equity pool in own home) and given confidence in capital growth ‐ then negative cashflow can effectively be eliminated by borrowing against equity; using the investment LOC. Consider it “unrealised capital gains”.

Using this example the investment property (or properties) can possibly be held without any cost from your cash flow at all. It may also be possible to pay down any “bad debt” on your own home faster by using this cash flow model as posted by Terry_w.

This example assumes using an 80% loan to value ratio (LVR) but you may want to go up to 95% if you are more aggressive and can possibly work around recent changes to the lending environment.

Consider this, but purely as an example…

If purchasing an investment property was going to result in an average after tax weekly shortfall of $60 during the first two years; one would need to commit to one of following two options:

1. Set aside $6,240 from one's next two years income
2. Borrow some or all of that additional amount up front; that is assuming one has both
a. sufficient equity to borrow against.
b. the ability to service the increase in my borrowings.

Option 1:

This option is pretty straight forward; you have to find $60 a week from my budget.

Option 2:

This option means that one's shortfall for the next couple of years is already accounted for in advance as part of their initial loan in the form of available credit in a separate investment line of credit. The effect on one's cashflow is NOT $60 a week, rather the interest on servicing that $60 a week… or $3.30 a week (tax deductible); assuming an interest rate of 5.5%.

Capitalising Interest:

By funneling all sources of income (including wages and rent) into your personal LOC; and then paying all interest payments from this same personal LOC (i.e. interest on your investment property loans, the investment LOC and your personal LOC) you will avoid the “trap” of capitalising interest (claiming interest on interest).

All interest on your investment borrowings is tax deductible; regardless of the source you pay that interest from. If you pay your interest from you investment Line of Credit, the next months’ interest charge will be a little more as it will now include interest on last months’ interest paid.

While there is a “lot of argument out there” as to whether this capitalisation of interest is allowed by the ATO or not; the general consensus is “avoid a problem and don’t do it”.

By making any and all interest payments from your personal Line of Credit and simply claiming those individual payments at tax time, your accounting should be vastly simplified and your claims unquestionable.

Any ongoing investment/property related expenses (such as rates, body corporate and so on) can legitimately be capitalised.

As a property investor who has followed this borrowing strategy, I have been able to:

• purchase investment properties without using any of my own cash reserves.
• service the shortfall on my purchases without adversely affecting my cash flow.

Now I know the above will not suit everyone's individual circumstances and as such I strongly recommend you seek the advice from your chosen Finance Broker, Accountant and/or qualified Financial Advisor - preferably one with practical experience in creating wealth through investment property of their own.

I hope this provides some food for thought.

 

This is a great post @Rixter, and I'm fine with most of it, but I still don't quite get the part on capitalising interest. Plus, I'd always thought that PPoR LOC and IP LOC should be kept entirely separate (therefore, I shouldn't be pulling the interest payment for an IP from a personal LOC account, but instead, from the LOC associated with the IP).

I'm a 'visual learner' - I love diagrams and charts etc, as I find them much easier to decipher, than just paragraphs of texts. Do you know of any diagrams/charts, perhaps with some example calculations included, that could help explain capitalised interest to me any better?

 

Great post. You've explained it well. Thank you for sharing.

 

Thanks @Rixter for sharing, great post!

 

Thanks for an informative post rixter. Out of interest have you had an ATO private ruling on your paying interest with LOC borrowings scenario, just to be 100% sure that what you are doing isnt going to land you (or people who follow it without checking with the ATO) in hot water?

 

Its a long post and I am not sure I understand it fully, but it sounds like this:
2 LOCs
A LOC for private expense
B LOC for investment expenses

All rent and other income goes into A, and then A pays B.

Technically you would be borrowing to pay interest. This is generally ok, but if you are using it as a scheme to pay your home loan off sooner then the interest can be denied.

But in this situation the interest on A isn't being claimed, so I don't think there would be any tax issues - if I have understood it correctly.

 

Thanks TerryW - everyone loves a good summary!

 

This is exactly what I do for all my clients.

PPOR

Split 1 - P&I non deductible with 100% offset account - This is the debt we want to attack
Split 2 - I/O 60-70K deductible - to be used for NRAS 1 deposit + stamp duty + 10K buffer
Split 3 - I/O 60-70K deductible - to be used for NRAS 2 deposit + stamp duty + 10K buffer
Split 4 - I/O 60-70K deductible - to be used for NRAS 3 deposit + stamp duty + 10K buffer
Split 5 - I/O 60-70K deductible - to be used for NRAS 4 deposit + stamp duty + 10K buffer
Split 6 - I/O 60-70K deductible - to be used for NRAS 5 deposit + stamp duty + 10K buffer
etc etc etc - up to 10 splits

AMP Master Limit or STG Portfolio are the preferred products due to their flexibility, but CBA MAV or ANZ Breakfree or NAB portfolio or Westpac are all OK products - not as flexible though.

Ultimately I prefer AMP though- because of the Master Limit flexibility and no cash out restrictions, AND the I/O debt is the same rate as P&I O/occ rates. Everyone else loads the I/O rates.

This structure is established before any purchases are made- and in the example above, the borrowing capacity/budget for all 6 purchases has been mapped out at 7.5% assessment rates in advance. Purchases are then made with different lenders.

And there is always, always always - a 10K buffer in place

 

All good except AMP are not doing any lending to investors atm and St.George have been so slow at processing its not funny! (2 months and counting)
What is the difference between STG and AMP with cash out?

 

You have understood it correctly Terry_w.

There is no scheme of claiming of interest on capitalised interest in order to pay down non-deductible PPOR debt.

Capitalising interest is when you use a loan (in this case an LOC) to pay the interest component on another IP loan. Where an issue may arise is IF one claims the interest component on the loan from where an IP's loan interest was paid from. With the above mentioned structure I've illustrated there is no claiming of interest on interest as Terry_w & I have pointed out - the capitalising of interest (claiming interest on interest) has been avoided.

The following flow chart I've attached below may be easier for you to decipher.

I hope this helps.

 

Incorrect - if you are using a PPOR they will happily lend for INV purposes and I/O and at the same rates you get for P&I ... they never ceased this. I think many people failed to understand that they only ever ceased lending against INV securities, rather than for INV purposes.


AMP has no restrictions whatsoever on cash out to 85% LVR - no restrictions

For example - if you had an unencumbered $1 Million PPOR and wanted to pull 850K out for INV purposes - as long as you were not using the INV property as security - no problem at all. Although I would advise you didnt do that. You could simply pull 20% + stamp duty against the PPOR and borrow the other 80% elsewhere using the INV as security and avoid LMI. But you take my point

 

So once you cash out your PPOR and have used all the cash investing then your done, cant cash out the investment properties any further with AMP?

What are STG cash out limits and/or restrictions?

 

Why would you cash the IPs out with AMP since they're not with AMP?

 

DT is right - you use AMP for cash out against your PPOR security. You use other lenders to purchase your INV properties. Although - AMP are re-entering INV lending very very soon, I keep hearing.

 

STG are easy to release equity with at 80%, no questions asked from my recent half dozen deals with them.

Haven't tried above 80% of late, but they don't lend to Investment securities above 80 anyway. ANZ all the way above 80% if you can service, they're better than most.

Re AMP, they've forced plenty of investment refinances from borrowers - not exactly a great business model (regardless of their reasons). They're rate on PPOR P/I is pretty attractive though for 90% lends.

P.s. great post Rick!

Cheers,
Redom

 

Thanks so much for this @Rixter. This makes sense, but now has me very worried that my finances for my IP have not been set up correctly. I think I might need to see a financial planner, as I may now be in the predicament that you and Terry are both saying can cause problems.

I'm wondering if it is worth making an appointment to speak with a lending specialist where I have my IP mortgage, with the attached offset account.

 

For both the above paragraphs, I think the word you're looking for is mortgage broker.

 

Yep - its why they should be used only for pulling equity from PPOR securitites and INV purchases should go elsewhere.

 

They could be with AMP! (prior to their stop on IP lending) i.e. if you cash out you 1mill PPOR then spend that 850 on say 2 IP's then will they cash those 2 IP's out again (with AMP) will current lending practices allow this at this moment?

I understand that is it a different strategy to the one mentioned, but using the cash out to buy IP's outright then cash out again with AMP rather than using the cash out to pay the deposit and costs to buy and borrow with another bank... Does it make any difference besides having all your lending with one lender in this case AMP? It would be less loans/banks to contend with, just one log in and multiple sub accounts...

 

@Rixter interested to hear what you think the main benefit is to using borrowed funds to pay interest if you're not claiming the interest on those same borrowed funds? Is it just OPM? Leaving cash for PPOR? But then if you're not capitalising interest you're generating more non deductible debt? Is that right?