Tax Tip 232: Simple Tax Strategy to Increase Deductions

I have a friend who is on the top marginal tax rate, has several properties in NSW, and has about $2mil in cash offsetting the property loans resulting in him complaining about all the tax he is paying.

A very simple solution is to buy another property. A the slightly more complex solution is to set up a company or a discretionary trust to hold this property.

He could do this

Property purchase price $1,500,000 in NSW

Set up a discretionary trust and make an interest free loan of $1,650,000 to allow for stamp duty etc.

The money lent will come from the offset accounts linked to the investment properties. When this money is removed the interest on the loans connected to these offset accounts will jump by the following

$1,650,000 x 4% = $66,000 per year

The individual will now have $66,000 more in tax deductions per year.

This will save him about $30,000 in tax each year.


The trust, on the other hand, will have a profit because it is not paying any interest on its loan to the individual. The trust profit could be distributed to other family members, but this individual is childless and single and will remain so. So he could set up a bucket company, making sure it is a beneficiary of the trust, and any income could be diverted to this company where it will be taxed at 30%. It can later be drawn out as dividends with credits for this tax paid.

So a relatively simple strategy for him to save about $30,000 each year and to potentially get further ahead by having more capital compounding.

The alternative for him is to use a company to buy a property, not acting as a trustee, and this way the company would get an extra land tax threshold, but that needs further thinking and advice.

Related posts to this strategy are

Strategy: Don’t Keep Large Sums in Offset Accounts Strategy: Don’t Keep Large Sums in Offset Accounts


Tax Tip 82: Taking money from an offset account on an IP and Claiming Interest Tax Tip 82: Taking money from an offset account on an IP and Claiming Interest


Tax Tip 228: Break even points with Using Offset Accounts to Invest Tax Tip 228: Break even points with Using Offset Accounts to Invest


Tax Tip 108: Using Bucket Companies to Save Tax Tax Tip 108: Using Bucket Companies to Save Tax


Legal Tip 136: How to Set Up a Bucket Company as Beneficiary of an Existing Discretionary Trust Legal Tip 136: How to Set Up a Bucket Company as Beneficiary of an Existing Discretionary Trust

 

Depending on his/their age a superannuation strategy could also be more tax effective and even address some elements of asset protection in some cases. A variety of mechanisms could achieve this.

Care should always be taken since once a entity owns property it may be excluded from super forever. A strategy earlier on may address bypassing that.

 

It can be the other way around if the property falls in value. At 1% fall for a 1.5 Mil property , that's a loss of 15k a year.

 

Only if he sells at a loss. I was talking about income.

 

Tax savings can reduce the total cost of ownership allowing growth to evolve in time. We often find people who buy a "loss"making property for tax purposes. But after tax the cashflows are neutral or negligible. Perhaps even positive. They can afford to be patient and allow growth to evolve over 2, 5 or 15 years.

Terrys point is a good one -"only if he has to sell" The present state of the property market reflects this view. If you can afford the cashflows on any property you dont have to sell. People who lose tend to be impacted by external issues eg lender says sell something, forced to sell by cashflow, loss of job, divorce etc.

 

great, simple tax strategy. also outlined simple and to the point!

 

He could buy $1.65m shares of AFI, engage bonus share plan aka DSSP.

The interest is deductible (loan is against the IPs) and dividends taxed at only 30%... purchased in own name so he could save $ on setting up trust.

Currently returning approx 4% to cover the interest payments, more diversified than a single property etc.

 

Normally interest on loans used to by shares which pay bonus shares will not be deductible because there is no income - it is capital gains.

But in this situation he is not borrowing to buy, but using cash and the removal of the cash from the offset will make the interest deductible against the property.

So this strategy would work and be a good one - from a tax point of view.

 

Important to clear up some misconceptions re AFIC (AFI)

AFIC is a LIC. The company pays FF dividends. AFIC doesnt issue bonus shares and very very few companies do. I'm struggling to recall a company that has. Often a company will allow dividend reinvestment plans which allow income to be exchanged for additional shares. The income remains assessable. Its a way to reinvest the income without paying brokerage etc.

AFIC receives dividends from the companies it invests in as well as other income. AFIC then distributes its income to shareholders via fully franked dividends which are paid twice a year. Shareholders can choose to reinvest these dividends via the DRP and DSSP to grow their investment over time.
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I see no broad issue with deductibility BUT the issue is more one of capital stability v loan. ie If a sharemarket correction occurs negative net wealth could occur as the shares may fall in value v the loan.

 

However, AFI does have a Dividend Substitution Share Plan. No franking is attached to them.

 

Are these the true bonus shares?

 

Accord to this they are:
AFIC | Shareholders
The Dividend Substitution Share Plan (DSSP) is another way to accumulate shares over time. The main difference fromthe DRP is that no income tax is payable at the time of receipt of the dividend.
When Australian resident taxpayers receive DSSP shares, no income tax is payable until the shares are sold.


The DSSP may be suitable for Australian taxpaying shareholders who:

• Want to defer tax-payable until selling their AFIC shares
• Are on a high marginal income tax rate
• Shareholders that pay tax at a lower rate (e.g. SMSF) may prefer the DRP.

 

The only other company of which I am aware with a similar arrangement is WHF.

Neither plan has any provision for LIC Capital Gain I understand.

Ages since I look at them and have never participated. I prefer the income now!

Edit: I had a look. WHF web-site has a link to the ATO's ruling on WHF's plan. Link near bottom of the page.

Bonus Share Plan

 

AFIC also have an ATO product ruling which is linked on the link I quoted above.

 

The downsides to non-income related share issues under the DSSP can be CGT discount related (more CGT is paid and some may be non-discounted) and interest deductions.

A person who borrows money may likely choose not to use the DSSP but use the DRP or cash dividend options.

 

I believe the cost base of the new shares is equal to that of the "originating" shares, which means that CGT payable on sale can be prohibitive.

DSSP and similar plans are best used in a "never sell" scenario. If income is needed down the track (eg retirement), the investor can stop taking DSSP and start receiving fully franked dividends.

 

Not quiet. The cost base is apportion between original shares and the bonus shares. Selling can also be a good debt recycle strategy as CGT is half of income tax.

 

Terry, do you have a good rule to avoid running foul of a wash sale when doing this together with debt recycling?

I have read that one can do say... Sell Coke, buy Pepsi and this is not a problem. But if you go say... sell Coke, buy Pepsi, sell Pepsi, buy Coke, etc etc over many years, waiting 366 days each time, maybe the ATO will require a "please explain"?

How does one, totally above-board, implement a selling-of-gains debt recycling strategy?

 

Virtually anything can be caught by Part IVA but that would not be very risky I think

 

Hmmm okay. Maybe I will phone the ATO to make sure. Don't want to go on some sort of watch list tho :S