What would Ryan do? How would he get his deposit money back whilst maximising tax deductions?
Hey guys and welcome to another episode of WWRD or What Would Ryan Do, the segment of On Property where you send in your questions and I give you my opinion about what I would do if it was me in your situation; and I try and leave you with some thoughts that you can think about yourself.
We are not taking ourselves too seriously here, but we are trying to help you guys to assess your situation and get some outside thought on it because sometimes you are so deep in the jungle, you cannot see the forest for the trees because you are just looking at your own situation. It can really help to get an outsider’s perspective. We also like to have a little fun here, as you can see by the photo; if you have any questions that you want answered, you can submit them. Just email me, Ryan@OnProperty.com.au.
So the question today comes from Vicki who asked, “How do you structure a loan when you want to buy an investment property to maximize tax deductions when you do eventually buy your own first place?”
The thought process here is Vicki is going out, she is investing in property while she is renting – so she is rentvesting, as some people like to call it. And basically, she wants to use her money wisely so when she does buy her own place, she gets the maximum tax deductions on her property portfolio. So she is using an example: if I buy an investment property for – let us say $100,000, I would need $10,000 deposit and $5,000 closing cost. How do I get that $15,000 back with tax deductions?
The ATO will not let me refinance and take $15,000 out and claim the interest on the $15,000 as a deduction. I have to have an initial loan balance of $105,000 and they have not reduced the balance of the loan at all. How can I do this?
Well, let me first say, this is WWRD. This is What Would Ryan do; this is not what a mortgage broker do or what would an accountant do because I am neither of those things, so this is my disclaimer that I cannot give taxation advice or mortgage advice. However, I will talk about this a bit and some things. If it was me in the situation, what are some things that I would consider and what would I do?
And so we have a $100,000 property, we are putting in $15,000 of our own money. We are talking small figure, which is probably unrealistic for most people, so let us bump it up a bit to make it more understandable for people. Let us say I am investing in a house, an investment property for $400,000, and I am putting down a 10% deposit of $40,000 plus let us call it a $10,000 closing cost. So I am putting in $50,000 into this $400,000 property. How can I get that $50,000 back and get tax deductions for it as well?
Now, this is a big ass because you are actually saying, “How do I get my own money back from my investments and how do I also get tax deductions for my money?” It is kind of the equivalent of saying, “Okay, I have $50,000 in the bank. How can I get tax deductions and tax benefits for having $50,000 in cash and for earning money on that $50,000?” It is just not really the way that tax system works. The tax system is there to like, if you are making a loss, if you have legitimate expenses against your property, you can claim them against the income.
It is not there to create these tax deductions from money that you have yourself. So, even though we are not saying, “How do I take my money and get a tax deduction on it,” that is effectively what we are trying to say because you are saying, “I am taking this $50,000. I am going to invest it. I want it back. And now I want tax deductions on that $50,000 even though I have it back into my account.” And so it is not something that you can really do if you want that $50,000, to be able to spend on personal stuff.
Now, when it comes to drawing equity from a property from my understanding – again, I am not an accountant, they will look at what is the purpose of this loan; so they are equity loans, what is the purpose of it? If you are drawing $50,000 in equity to go on a holiday, is that for investment purposes or for income generating purposes?
Well, no. I am going on a holiday to have fun with my family.
It is a personal thing, so I should not get a tax deduction on that because it is a personal thing. I should not get a tax deduction every time I go to Krispy Kreme’s and buy a donut because I am buying a donut, it is not good for me but man, it tastes good. That is not something that the Australian government, that Australia as a whole, need to deduct like, I should start to pay tax on that $3. Just because I spent it on a donut does not mean that I get to cut that out.
And so same with any personal expenses, any holidays that you have and things like that. As you guys can see, we are not taking it too seriously here. We are trying to keep a bit of fun so it is interesting for everyone. But Vicki, please do not take offence. I am not saying what you are asking is unreasonable.
It is a good question but I am just trying to align what you are trying to achieve with like what the government thinks in terms of taxation and bring some realism there. So, I hope you appreciate that; I hope I am not being offensive because I can come across brash sometimes. I am not the most empathetic person. Anyway, I am trying to help. I really like helping people. I am hoping this is good for you Vicki and for everyone else.
And so, in thinking that if we want to take out $50,000 for Krispy Kreme donuts, we are probably not going to get a tax deduction on that and we will probably be dead because that is a lot of donuts. But what if we want to get that $50,000 out and we want to reinvest it in property? Now, we know that that $50,000 is money that is being used for investment and for income generating purposes. So, obviously we need to see our accountant but there is a good chance that we are going to get our money back and it is going to be tax deductible.
Now, that money will need to be spent on another investment. You cannot say, “I am going to get that money out for an investment property and then go and spend that on your Krispy Kreme donuts because that is probably fraud. I am not 100% sure but it sounds like fraud to me, and we do not like fraud; we do not want to end up in jail. So, we can get our money out and we can use it to reinvest and we can kind of repeat that process but I do not think we will ever get to the point where we can borrow that money as equity from any of our properties and have it as tax deductible and use it to buy our house.
Now, I am not sure – I am hesitant in saying this, but I am not sure of the situation. Say I was to get the $50,000 out, buy an investment property; it was an investment property for 5 years, and then I decide I want to go on and live in that property. How does that affect things? I do not know. Definitely get professional advice on that, but that maybe something to look into because I guess it would be a tax deduction and it will be tax deductible as debt until you moved into it. And then once you moved into it, it becomes a personal loan and that will not be tax deductible. That is my reasoning behind it but I am not 100% sure.
So, if we cannot borrow to get our money back, what is another way we could get it back?
Well, we could potentially get it back through positive cash flow in the property. So let us say our property spins off positive cash flow of $100 a week or $5,000 a year. In 3 years, then I would have my $15,000 back but I would still have my tax deductibility. I would get my $15,000 back; I would still have effectively that money that I spent. I am going back to $15,000.
I meant $50,000 that would take a lot longer. So if I was getting $100 a week; $5,000 a year, it would take me 10 years to get it back. But then I would have my $50,000 back. You could potentially do it faster if you do things to improve the cash flow. I would have it back, but you would kind of have $50,000 in your pocket. But you would still have that original $50,000 in the property as equity and as we already discussed, there is probably nothing you can do about that.
So, if you want it back then maybe you can do it from the profits of your property; so it could be the profits from positive cash flow, it could be profits from selling the property. Potentially, the property might go up in value; you could potentially do a renovation to increase the value of the property, and you could then go ahead and sell that property and get the money out. That is another way to do it. Obviously, you have to pay fees and that.
But I think really, like when we get into the core of it, the best way to think about this is that, I have, let us say, $50,000 in my bank right now. I am not getting a tax deduction on that as it is. If I go ahead and invest in property, that $50,000 is now a deposit. It is not a loan, so this $50,000, I am not getting a tax deduction there. If I was to draw that $50,000 out and to get an equity loan from that for personal reasons, I now have a $50,000 loan that is not tax deductible and I have my $50,000 back. So, the whole time it has not really been tax deductible so having the $50,000 in the property as equity, not tax deductible because it is equity.
You do not have a loan that is tax deductible on that so as you draw it out, it is still not tax deductible. In all this period of time, the $50,000 or $15,000 or $30,000 or whatever it may be, has really never become tax deductible because it is value that you have. It is money that you have and having money and earning money is not a tax deductible expense because that is what you want.
You want to have money; you want to earn money which means paying tax. Not getting a tax deduction on it. So, I think the whole time, looking at it, as the $50,000 moves around, it is always your money so it is never becoming tax deductible. Unless of course, you may have loss on the property and then maybe you could offset that loss or something.
I do not know how that works. But even still, that is not your $50,000. Your $50,000 is lost and you now have an extra loss that you could have tax deductibility on. I think, coming back to your original question, how would you structure a loan to buy an investment property to maximize tax deductions; basically, like what you have already said, I would consider obviously, get professional advice about this. Interest-only loans, because it means you are not reducing your tax-deductible debt, and so when I purchase a property – if I had positive cash flow, if I wanted to pay down debt, I would spend all my effort paying down my home loan first and then I would focus paying down my investment loans after that.
Really, when it comes down to it, probably the best way to maximize your tax deductions, is likely going to be interest-only loans but I want you to go and get a professional advice from an accountant and a mortgage broker about that because I cannot give that advice. But the theory says that if you do not pay down your tax deductible debt, it is still maintains its tax deductibility.
So, yeah. That is my thing. I guess the answer would be to not pay down your tax deductible debt, and when you do purchase a property, focus on paying that down because that is not tax deductible debt.
I hope we covered it in What Would Ryan Do and in this situation, what would Ryan do? He would probably take that money, try and get an equity loan, reinvest it, grow my portfolio, and then eventually, maybe get an equity loan to buy my own property and just accept the fact that it is not tax deductible; or get enough profit from the passive income that the property is generating that I can go ahead and purchase my property as well.
So, Vicki, I hope that this segment of WWRD was helpful to you. Unfortunately, there is no way to buy $50,000 worth of Krispy Kreme donuts and call it a tax deduction. Though, I bet you there are companies out there that have done that over the course of time; bought it for their employees and things like that and claimed it. But we are getting off topic. It sounds very difficult, what you are trying to do. I do not know if it is possible or legal. I would definitely seek legal advice as my disclaimer.
If you guys have a question that you want to know, WWRD – What Would Ryan Do, submit your questions to Ryan@OnProperty.com.au, and I will try and get to all those questions. We will do this as a weekly segment thing. If I get enough questions, we will do it on the weekend when you are just cruising, looking for something fun to listen to on the weekend. You will have your WWRD segments.
So I hope that this has been interesting for you guys. If you want legitimate help, someone who is actually going to sit down, do a strategy session with you. work out your goals, how are you going to achieve it with property, help you find a good property in a good area; if you want a legitimate help like that, not fun like what would Ryan do, but legitimate help, you might want to consider a buyer’s agent. And I do recommend a lot of people to my friend Ben Everingham over at PumpedOnProperty. If you are interested in meeting up with him, he is offering On Property listeners a free strategy session. And so, just go ahead and write down the link.
It is on OnProperty.com.au/session, and you can get a free strategy session with Ben over there. Ben is a buyer’s agent who is financially free himself and is now helping other people purchase great properties in great areas and you can talk to him about it. And if it is a good fit, you can hire his services. Otherwise, he will point you in the right direction for investing yourself. Again, that is OnProperty.com.au/session, if you are interested in that free strategy session and you want legitimate help from someone, not just a WWRD segment.
Thank you guys for listening and until next time, stay positive!