Rent + purchase IP vs PPoR for tax purposes

Hypothetical scenario:

Let's assume you're not desperate to live in your own PPoR for emotional reasons or whatever

Instead of buying a PPoR, you buy an IP instead and rent that out. Then you just rent somewhere else to live. Could be another state or it could be next door, but the income from your IP is approximately the same as the rent you pay, or maybe you live somewhere your rent is less than the IP income.

In this scenario the interest payment on the loan becomes a tax deduction. The holding costs are irrelevant because you have to pay that anyway if you were living in a PPoR and they also become deductions on the IP. Other costs/expenses to factor in I can think of would be property management fees and CGT if you decided to sell at some point in the future. You could move into the IP later on to either reduce the CGT or remove it from the equation entirely (ie: not sell).

Are there any other reasons from a tax or investment perspective that make this strategy a bad idea?

 

Combine it with the 6 year rule to potentially get the best of both.

 

Yep good idea, I'm already making use of that 6 yr rule on one property purchased just prior to heading o/s. At the time there was no rule about minimum duration you needed to live in a "PPoR" before moving out turning it into and IP. Do you know if there have been any changes to this rule in past 5 yrs or so though?

 

I am currently rent-vesting and it is working out well for me. Keeping the portfolio positively geared so far so serviceable.

 

Over time you would be at a disadvantage as the rents you pay will generally rise while the amount of loan associated with the properties will decrease so there will come a point, soon, where your serviceability will work out better by living in one of your properties.

 

I suppose that would be true if the loans were P&I however they are interest only. That at least allows for more cash flow given I can write more off on tax and also better given I don't plan on ever living in any of my investment properties.

Also, wouldn't the increase in rents on my properties offset the increase in rent in the property i'm living in?

 

Think about it. Rents go up and even if the cost of holding your investment property never changed you would be soon paying more for your living place rent than the cost of your rental properties, You will also be paying tax when they become positve income. And by not living in one you are refraining from paying it off so that affects serviceability too. Factor in the main residence CGT exemption and land tax and it gets worse!

 

Yes. Past main residence exemptions can be lost if you sell while non-resident or sell within six months of recommending tax residency. And after 6 years there is no CGT discount at all until you return and recommence tax residency.

Your proposed ideas on IPs may also be affected by stamp duty and land tax surcharges depending on citizenship and more. Seek advice prior to acting. Each state varies.

 

Well I live in Sydney so my rent is already significantly higher than the rents in my investment properties and again my properties are already positively geared and the tax from the income is offset by the tax breaks. But i'm not sure how my serviceability is affected by not paying down the principal given my income not even factoring in the passive income the properties are generating is good enough to service the debt comfortably, and i'm sure positively geared assets couldn't hurt that equation surely? ¯\_(ツ)_/¯

However back on the topic from a tax perspective, I don't feel overtime rent-vesting is a disadvantage. PPOR is non-deductible debt. I don't feel you are ever at a tax disadvantage having all deductible debt and no non-deductible debt (given you can service the debt). ¯\_(ツ)_/¯ However I would love your thoughts on that as you are the tax professional.

 

Just because a debt is deductible it doesnt affect it value and its growth. Serviceability is always affected by borrowing whether its +ve geared or -ve geared. Servicing calcs can include non factual calculations which disregard reality rather than real actual cashflows. And will always include personal income and outgoings. Lenders have different ways to calculate these things but its always a matter they include in some way. And its more likley that in the past 6 years borrowers with larger debt have seen their capacity to borrow shrink despite lower interest or higher rent. Many talk about hitting the service ceiling. Some even now complain they cant buy a better main residence due to this debt trap. They have no further capacity to borrow.

From a purely financial perspective rent vesting can by hype created by people to oversell tax benefits to help them sell property. A bad cashflow property is a bad choice whether CGT is exempt or not. Negative gearing is always regressive. But importantly its the cashflows to consider, not the tax return. Even at the highest tax rate of 47% each dollar of neg gearing produces a refund of perhaps $47c in the dollar. Add a negative cashflow property and this reduces negative cashflow by 47cents in the dollar. So its still 53% negative.

From a personal perspective rentvesting that means you and the family live in a small 3 bed apartment where they dont want to live while a tenant lives in a better property in a better suburb is also not able to be measured. I couldnt sell my wife on the concept in a million years.

 

Funny you say that because we were in a small 3 bedroom apartment! We decided however to rent a 4 bedroom house in the inner west. Exactly where want to live and raise our kids. The rent was more expensive granted, but it was only 15% of our income including other additional holding costs so we still had a comfortable surplus to invest.

So for us on the contrary, rent-vesting didn't mean live where you don't want to live just because you have to make financial sacrifices. It actually meant renting where you want to live because if you bought there instead your serviceability would really be screwed. Rent is expensive, but median house price where want to live is over 2 million. If we managed to borrow enough for a house here our serviceability would be shot. However now we have 4 investment properties all cashflow positive and hopefully going to get approval for 2 more this week (fingers crossed we'll see if i'm still serviceable ).

Furthermore from a financial perspective, rent-vesting makes sense to me because it could help you leverage into a PPOR by building a portfolio of income generating assets while keeping expenses low without killing your living standards. I suppose it would be different depending on the area you are attempting to purchase in.

It's interesting to hear about what's happening behind the scenes as the finance gods go through our numbers but I am told by the majority of financial experts that I deal with that a positively geared property is better than a negatively geared property when considering serviceability.

 

How is this feeling possible???

Take the extreme 30 year approach. If you were living in a property you owned and borrowed 100% for you might be slightly disadvantaged initially, but in 30 years you will have no loan to pay and no rent. Imagine had you kept renting instead. Your investment property loan might be paid off or very low so you are paying a high tax on the rent. You would also be paying market rate rent yourself which might be a few thousand per week, if not more.
Furthermore when you sell your investment property you lose 25% of the profit in tax, which you wouldn't had you been living in the property instead.

 

And over 30 years its very difficulty to rent-vest. Just the fact a property will be positive geared seems a problem over the long run. Rent vesting is a temporary strategy. I hate using the term as its a sruiker term to sell tax benefits to help sell more property and loans.

 

Its actually trademarked so be careful using it.
I am actually renting and investing because I want to live in the CBD at the moment, but I don't think it is a good place to own property in a CBD high rise. I am also using the 6 year rule so not missing out on any Capital Gains Tax free growth.

 

There are some interesting assumptions there. Sounds like you are assuming that rent-vesting means you won't ever buy your own house. I'm actually using rent-vesting as a mechanism that will allow me to leverage into my own home. Rather than saving up $400k to take up non-deductible debt (20% deposit for a house in the area im living in) that I will have to work for 30 years to pay off, I instead saved $200k purchased 2 positively geared investment properties, a year later I bought another property and I am in the middle of refinancing the first two of them to buy two more investment properties. Next year I plan to leverage all of them to buy my own house. The equity from the investment properties will help with my downpayment plus savings, the income generated from the investment properties will pay the repayments on my own home. That all happened in 2 years. It took me 5 years to save that 200k (granted income is higher now). I would still be saving for a house right now and not on my way to purchasing my 6th investment property. Again i'm sure it makes more sense in other areas where housing is more affordable to just buy a house however inner west Sydney is a different beast. Not to mention I have other goals in my strategy as well including financial freedom, more houses abroad etc. It was better for my situation to rent-vest than it was to buy a house at the start.

Theres another assumption there that If I just rented for 30 yaers, I would have only purchased 1 property. Had I rented for 30 years without planning to buy a PPOR, I wouldn't own just one investment property. I would own at least 20 as that is our target number (and who knows we may keep going!). So the tax hit on the property I purchased 30 years ago would be offset by the tax benefits from all the other properties I purchased within the last 10-20 years. Those properties by the way would be generating way more than enough passive income to pay my market rate rent wherever the hell I wanted to live. Give me the penthouse in darling harbour at that point! Probably not an opportunity I would've had If I had purchased a house in the area I want to live instead 30 years ago which would've landed me with a monthly repayment of at least $7200 compared to my rent of $3200 completely bashing my serviceability to crap. I wouldn't have been able to buy a single investment property let alone build a portfolio of properties.

Theres also an assumption that I plan on selling and I don't plan on selling anything. I plan on getting rid of all non-deductible debt I acquire over the years and keeping my deductible debt to manageable levels, living off the income and passing it on to the kids when we're gone. So that eliminates the CGT issue.

 

That's an interesting take. I've never heard of rent-vesting from a spruiker as I don't deal with any spruikers so the term doesn't have any negative connotations for me. I don't see any difficulty to investing over a 30 year period while not owning your own home and it seems really weird to me that this is a weird concept. As if like "if you're going to invest, you must buy a house!" like.. what??

I don't quite understand the concept of a temporary strategy. A strategy is used to accomplish a task. I rent-vested so I could build out my portfolio quicker, so I could own my own home sooner. If it's known as a 'temporary strategy' because I plan on eventually owning my own home then you may as well call every strategy that has a defined start and end a 'temporary strategy'.

 

Wait...... you're rent-vesting like me for the same reasons as I am. You are renting where you want to live. That's exactly what I'm doing except my reason for not buying a house is because I can't afford it. I am now thoroughly cross-eyed.

 

Well I guess that one comes down to mindset. I personally couldn't possibly have no context other than "a positively geared property over 30 years" and my first thought is "problem". I got into investing because I like to find out ways to make doors open, not find ways to make them close. A positively geared property over 30 years to me is anything but a problem.

 

I am not saying don't rent and invest, but to plan carefully - which you might be doing.
But if you haven't lived into any then you have no property being used that is eligible for the main residence exemption, you are probably not getting owner occupied rates and buy paying cash deposits for the first or subsequent investment properties you are causing yourself to have higher non-deductible debt down the track.

If you can't afford to get the property you want straight away you might have no alternative, but every property you buy ties up borrowing capacity, even if they are positive geared, so the more you get the harder it will be to qualify for the dream main residence.

Selling is a good strategy, but even if you never intend to sell you are setting up your heirs with a higher CGT bill down the track potentially.

 

Wouldn't the only way I would be setting up my heirs for a CGT bill is if the heirs decide to sell? Not sure if there is a tax on transferring assets to beneficiaries (I know they're trying to implement that in the states) Either way that's far from a terrible thing in my opinion for them because that only means access to (presumably) a mountain of wealth which was part of the plan of building this portfolio.

Anyway like all forms of investing, its all a money-raising play at the end of the day. If i'm presented with the affordability problem, and on one hand I raise money via rent-vesting and I go to get my dream main residence and I get knocked back because I have too many positively geared properties, I can solve that problem by selling what I need to sell, resulting in me acquiring the dream home. Sorted. On the other hand, I raise money by working hard for years to finally get enough for a downpayment. I'm serviceable no problem there, but I'm now working for at least the next 30 years paying the loan off when I planned to retire in 10