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Tax Tip 60: Never use cash to invest

Discussion in 'Accounting & Tax' started by Terry_w, 18th Oct, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I was speaking to someone the other day who didn’t really understand the concept of borrowing to invest and it seems this is fairly common. Then today the topic came up at this thread https://propertychat.com.au/community/threads/deposit-for-loan.4878/

    Using cash to invest means you are throwing away money! Its that simple

    Imagine a Mr I.P Freely has a $400,000 home loan and has saved up $50,000 cash in a savings account. With the $50k sitting around most people would go out and use this to invest. They would use it as deposit on an investment property for example.

    This is the same as throwing money away because they are giving up tax deductions.

    $50,000 x 5% = $2500 per year.

    If they use cash instead of borrowing then they will pay $2,500 more interest on their home loan and $2,500 less interest on their investment loan.

    At 37% tax rate that would be about $925 less money in their pockets each year. Imagine how much quicker you could pay off your home loan if you could pay another $1000 off the principle each year.


    Same applies whether the $50,000 is in the offset or a separate savings account. See same concept with a offset account here
    Tax Tip 9: Don’t use Cash in Offset account to Invest
    https://propertychat.com.au/communi...nt-use-cash-in-offset-account-to-invest.2355/

    How to avoid the use of cash?
    Simple borrow 105% of the cost of the investment property. This can be done by borrowing teh deposit and costs in one loan secured against the main residence and the remainder secured against the new investment property - 25% and 80% for example.

    Even if you do not have any non deductible debt it would still be a good idea to borrow 105% because you may want to use your cash in the future for some other private expense - main residence upgrade, children’s school fees, kidney on the black market etc

    Even for the first property you should ideally borrow 105% where it will be an investment. This may be possible using a few strategies such as related party loans, family pledge loans etc.
     
  2. bonanzawealth

    bonanzawealth Well-Known Member

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  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Cash can be used as security to achieve 105% borrowings. Once the property increases in value you can have the cash released from being used as security. Achieves 105% LVR on initial purchase price without having any other property as security.

    A good option for the first home buyer. the only downside is a loss of interest until the cash can be released. Receive say 2% but pay out 5% sort of thing.
     
  4. Bayview

    Bayview Well-Known Member

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    Sorry to be the contrarian, but this is what we did for 5 IP's, and it kept us in a very ordinary to downright terrible cashflow situation after you add all the unforseen rubbish that happens with Resi IP's and Land Tax...and that included trying to decrease debt along the way by reinvesting the tax returns, in order to improve cashflows.

    Got up to a decent level of equity at one stage, but after selling and paying all the associated costs, CGT - not much left over.

    What fun. How fab it is to be an "on paper" equity millionaire.

    Unless the joints you buy enjoy a massive and quick CG, and you can then sell them and plonk the profits into another IP/s and make it/them CFP from day one, or you are on more than 6 figures per year from PAYE and can live a lifestyle on the remainder...it's got fur on it..
     
    Last edited: 19th Oct, 2015
  5. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Bayview - this seems to be because of the properties. If you borrowed 80% for each it would have been the same. The only difference is the tax effect which would have been better if you did the 105% borrow.
     
  6. Ed Barton

    Ed Barton Well-Known Member

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    I only ever use cash to invest
     
  7. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    I'm not sure this is consistent with good lending practices or a strategy that suits all people.

    There are many people who borrow to invest who also have a goal of adding equity not just through increased asset prices but also through debt reduction. These people are debt averse or have increased cashflow later in life etc and their strategy is to eliminate the debt so that the yield reflects a solid return.

    I have clients with share portfolio's build on borrowing who now owe nothing. The 2,000 CBA shares they originally bought using borrowed funds ($11,200) are now worth $144,000 and pay a annual yield of 75%+

    Many people buy property to OWN it. The strategy of borrowing endlessly until the lender says stop is a strategy many use but its a strategy without a solution if prices stabilise or fall and there isn't 20% equity +.

    I use a analogy - Its like the old greeks and Italians who built this country after the war. They hate debt and think the only strategy is to pay it off and live off the income.

    Just two different strategies. Obviously with leverage its far easier to use borrowed $. Some must question whether this strategy will be popular/safe/prudent if prices fall. APRA is one of them.
     
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  8. Bayview

    Bayview Well-Known Member

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    True. The diff in cashflow between an 80% loan and a 105% loan is bugger-all after tax consideration.

    Based on yer average suburban properties that most PI's will go for to try and maximise CG - which usually hover around the 5% range for rent yields - without the terrifically low interest rates we are currently enjoying; the cashflow is often k-rap.
     
  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    BTW, I am not suggesting that people borrow more overall - just don't use cash, borrow and park the cash in the offset. same interest amounts in the end but tax deductions much better going forward.
     
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  10. benk

    benk Member

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    Sorry I'm very new to this so I don't really understand. How are tax deductions better if the interest amounts are the same?

    Say for your example,
    $400,000 loan, you pay 100k and borrow the rest so you pay interest on 300k and can make deductions on 300k
    $400,000 loan, 100k in offset, you still pay interest on the remaining 300k

    What am I missing?
    Thanks!
     
  11. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    You are preserving cash for future private expenses = more deductions.
     
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  12. bonanzawealth

    bonanzawealth Well-Known Member

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    Please help me out with my math.. say I have $100k cash but I don't want to use it, instead I put it in term deposit earning 2% and borrow it at 5%.
    That means I will be taxed on my 2% or $2000 earning and get tax deduction on my 5% or $5000 pa.

    In average joe situation where one earn $60k on salary, property yield 5%; will these scenario be beneficial mathematically for deduction purpose after taking into account property maintenance costs, depreciation etc?
     
  13. neK

    neK Well-Known Member

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    No. Losing money is never a winning proposition.

    Look at it another way, if you gave me $1 and I gave you back 30 cents, would that be a good deal for you?

    If you think yes, then I'll message you my bank account details and you can transfer money to me.
     
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  14. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Not immediately. But longer term it could be.
     
  15. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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  16. LaoBan

    LaoBan Active Member

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    Do banks (or any bank) allow lending based on offset account amount as security (rather than having to put the money in term deposit ) ?

    Got some money in my offset linked to PPOR, which can be used to invest but as people pointed out here not to use the cash but rather borrow the money.

    I dont want to use the money to pay down my PPOR because the plan is to convert it to IP in 10 years time, but that means I cannot increase my equity quicker (will be solely depend on market valuation) and cannot convert non tax deductible debt to deductible debt.
    My money 'stuck' in offset account..

    How can I use the money in the offset to the max benefit?
     
  17. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    No they don't because you could just use your offset money without restriction.

    10 years is a long time to wait. I would consider paying down the loan now and moving forward with borrowing further.
     
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  18. Ben_j

    Ben_j Member

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    @Terry_w I currently own a PPOR and am looking to purchase an investment property with the view to move into it within 2-3 years and then converting current PPOR to an investment property.

    Would you still recommend borrowing ~105% for the new property given that this will turn into non-deductible debt in 2-3 years?

    Thanks
     
  19. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Why not?

    No harm done if you are borrowing money and putting the cash you would have used in your offset account.

    But if the plan to live in the property doesn't eventuate you will be much better off. You would be better off during the 2 to 3 years also with higher deductible debt and lower non deductible debt.
     
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  20. Ben_j

    Ben_j Member

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    Probably should have provided more information on this, my thinking around not borrowing 105% is the current PPOR we'all definitely be moving out of and borrowing against this further will reduce diductibility on this property in future.