Getting your loan structure right is essential for building a big property portfolio, as it can prevent you from getting stuck and unable to refinance to invest further down the track.
But it’s also important to get it right for tax reasons. The correct structuring of investment property loans can mean thousands of dollars extra in your back pocket or servicing one of your debts, come tax time.
This article is not financial advice and it’s always best to consult a professional for help with a tailored strategy to suit your specific circumstances.
But here are a few morsels of food for thought if you are looking to maximise your tax potential.
Investors will have heard this term before
Diversification. It’s essential when investing not to put all your eggs in one basket, but that advice is not just for assets. It also has to do with the team of professionals you put around you, the lenders you deal with for different properties and the separation of personal and investment finances.
A dedicated bank account for your investment property income and expenses will make it easier to track deductible expenses.
Speaking of which, do you understand which investment expenses are tax deductible? For example, you can claim interest payments, property management fees, repairs and maintenance, landlord insurance and depreciation. Knowledge of these areas can assist you in the type of property you purchase and the way you structure your loans.
Now, think about how much you want to borrow. Some experts suggest borrowing the full 80% of the value of the property because the debt is tax deductible. This may work for you, but bear in mind that the lower the percentage of value you need to borrow, the better deals you might be able to unlock on interest rates and other loan features.
Interested in interest?
A popular choice for investors is an interest-only period for their loan repayments. Paying interest only for 3 or 5 years will help you achieve positive gearing and allow you to potentially put extra money into debts of your choice. The interest on an investment property loan is fully deductible, for example, but the principal isn’t. That money might be better used making repayments on your permanent place of residence, where neither principal, nor interest are tax deductible. You are also likely to owe a far greater sum of money on your home, so the extra money in an offset can significantly reduce the interest you have to pay.
What’s an offset account?
Offset accounts are linked savings accounts where the balance is offset against your loan. So, your interest is calculated on a reduced total of debt, which means you pay less.
On the surface, it seems like a redraw account in that both allow you to make extra repayments on a loan, but still be able to access the funds if you need them.
However, if you are using a redraw and taking extra money back for personal use, that money is no longer tax deductible, as redraw transactions affect the loan balance. If you took money out of an offset account for the same thing, you’d pay more interest the next month, but the full amount of the loan is still tax deductible, because the loan has remained the same, only the offset account has changed.
Whose property is it anyway?
The way you structure ownership of a property can affect your tax outcomes. Some investors might like to hold a property in the name of a trust or company, rather than face the higher tax liabilities associated with holding it as an individual.
There are pros and cons for different ownership structures, but the implications can be complex, so this is an area in which to seek expert advice.
Be wary of the double cross.
Investors with multiple properties may have had lenders try to cross-securitise different assets so that they have two loans against two separate properties. This is the type of thing that can get you in big trouble because it can prevent you from being able to refinance away for a better deal elsewhere. It can also prevent you from selling one of the properties in order to service other debt or direct the capital into a better investment. And if you are staying on top of your portfolio performance, you want to be as flexible and agile as possible so you can take up better deals as they arise and progress your wealth.