Whether to Rent or Buy a Home

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Are you still renting but would like to own your property? At times it’s necessary or practical to rent when moving around a lot. And with hot property markets and changing inflation rates it is reasonable to be concerned about mortgage risk. Buying a home is a big financial commitment but planned properly, will grow into one of your key financial assets. Let’s take a look together.

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Whether to Rent or Buy a Home
Are you still renting but would like to own your property? At times it’s necessary or practical to rent when moving around a lot. And with hot property markets and changing inflation rates it is reasonable to be concerned about mortgage risk. Buying a home is a big financial commitment but planned properly, will grow into one of your key financial assets. Let’s take a look together.

Whether to buy or not to buy?

Even with rising home prices it is still possible to use your income to buy. Every dollar paid in rent could possibly be used to pay off a mortgage. Before property hunting, consider how much you can afford to pay back and what you really need for a first home.

Don’t over extend your finances for your first home. But remember if you can afford to rent you are likely able to purchase a property instead. This is the beginning. From here you can go onto owning more than one home and have an investment property. But first, the basics!

Let’s use an example to help you to understand how you can use your finances more efficiently and achieve the goal of home ownership.

For example, if at the moment you are renting a 1 bed room apartment in Rhodes for $540 a week. But would rather purchase a similar property, let’s consider the maths.

If you would like to purchase it, it would cost you $620K including stamp duty and other expenses. Let’s assume that the strata is $650 per quarter and council rates are $250.

These are the main expenses to factor in when purchasing. As a model we will use an example of an individual who is able to borrow 100% of the property cost, with a loan interest is 4.8%.

The following is a comparison of the cash flow outgoings between buying and renting:

Yearly cash flow on rental: $540 X 52 weeks= $28,050

Yearly cash flow on buying: $38,576(1oan payment) + $2600 (strata) + $1000 (council rates) = $42,175

When you only look at the cash flow, you are not saving money on purchasing the property.

However one thing we need to remember is that while you are renting, 100% of the rental cost is paid out. However when you are paying back your home loan, a part of it is paying back the principle. Therefore the actual expenses you are paying are more like following:

One of the most financially efficient aspects of buying is that as the years grow your net outgoing expenses begin to decrease. While you continue rent your outgoing expense will stay the same or possibly increase with climbing rental. As you can see, if your rental stays the same, from year 10 you are paying less expense than renting

If the loan term is 30 years, you would be paying about $537K as interest to the bank. However if you are renting, total cost for the 30 year would be $842K if the rental remains the same. Buying the property would save you $305k over the 30 years.

Note: You can use the mortgage calculator in our website www.impacttfs.com.au to find out how much interest and principle you are paying for your home loan. Take into account the possibilities of property price movement. If the price moves up, and you have purchased the property, then any price increase will become a future profit for you as capital gain. However if you are still renting, then the renting price could be pushed up by the higher property prices.

On the other hand, if the property prices come down, you will have a future capital loss for a purchased property, while renting could be cheaper due to reduced property prices. There will always be pros and cons. However the end result of purchasing a property is for you to use your income to pay for your own home, not someone else’s.

Declaration: The Excel files and content of this website have been prepared without taking into account your personal financial situation or knowledge of your financial needs. Impact Taxation and Financial Services cannot be liable for any losses or damages arising from using the information provided. It is the user’s responsibility to seek independent advice from a professional accountant before implementing any financial plan.

10 things you should consider before buying a property

Are you considering buying a property? Do you know you could miss opportunities to save thousands, or tens of thousands of dollars if you don’t plan well before the purchase?

Below are a few key considerations:

1. How should you set up your loan structure? If you don’t have a loan offset account for a rental property, after you make extra payments directly to the loan account, you can only claim interest deduction on the remaining balance of the loan. For tax purposes, this deductible balance can’t be changed even if you redraw the overpaid amount later. A good loan structure could also help you to stabilize interest rate and speed up loan repayment by combining a standard variable loan (with an offset account) and a fix rates account.

2. Timing of renovation. You might want to do a renovation right after you have bought the rental property. But do you know for any genuine repair & maintenance included in the renovation, you can claim an outright deduction against the rental income when the property is available for rental? If the work is done before the date when the property is available for rental, you can only claim the deduction against future capital gain when the property is sold. Depend on when you are going to sell, it could take years or up to decades before you can claim the deduction.

3. How should you split ownership? You might want to share the property ownership with a family member. For tax purposes, the percentage of ownership is based on the legal title, regardless of who is paying more on the mortgage. If the property will give you a tax profit, you might want to allocate more
ownership to the low-income earner to utilize the lower marginal tax rate. If it is giving you a tax loss, you might want to allocate more ownership to the high-income earner to utilize the loss. The goal is for the family to pay minimum tax together.

4. Should you use a family trust to purchase the property? There are many pros and cons related to a family trust. The advantages include tax savings on rental profit or capital gain, asset protection and succession planning on family wealth. However, family trust can’t distribute losses. All losses are trapped in the trust to be used to offset future trust profit. Therefore, you can’t utilize any rental loss in a trust to offset other income such as salary & wages. Family trusts also attract high accounting fees on initial setup and annual fees on financial statements and tax returns. State governments also charge much higher land tax on family trusts.

5. Will the income level change in future years for different owners? You might want to forecast the possible income for different owners to understand total tax payment / savings related to the property. This could also impact on your decision making on point 3 and 4 above.

6. Understand when you can treat your property as main residence to receive an exemption on capital gains tax. When eligible, even if you have received rental income, you could still treat your rental property as main residence and receive the exemption. To be eligible, you will need to treat it as your main residence at the beginning. Please check out this ATO link: Treating former home as main residence.

7. Decide whether you need to purchase a depreciation report. Most taxpayers don’t know that the depreciation on the building will need to be added back to calculate capital gains tax when the property is sold. When the property is held for more than 12 months, after applying the capital gains tax discount of 50%, it will effectively cut the tax rate by half at the time of sales. This makes depreciation deductions desirable for high income earners. However, for low-income earners it might not be ideal to claim depreciation as a rental deduction since they could be paying more on capital gains tax in the future. It could get more complicated if the property is under joint ownership between high and low income earners.

8. You might want to consider Centrelink payments for future or existing owners. Most Centrelink payments are income and asset tested. Before attaching a rental property to a family member who is receiving, or plan to receive government benefits, you might want to check the testing thresholds first to see if the Centrelink payment will be impacted. This is also applicable when you are making distributions from a family trust to different family members.

9. Have you considered using your SMSF (selfmanaged super fund) to make the purchase of a rental property? There are a lot of tax saving opportunities with a SMSF since the income tax rate is only 15%. And the capital gains tax rate is effectively only 10% after factoring in the 1/3 discount. The major downside with a SMSF is normally you can’t get the money out until you retire or on compassionate grounds (SMSF does have more flexibilities compared to normal retail super fund. But the choices are still very limited). It could be expensive to set up and operate a SMSF too. There are also strict legal requirements on the trustees. Penalties on incompliance could be severe. Tax law around SMSF is very complicated too. You will need to find a good tax accountant specialized in SMSF to help you to understand the structure, also do a cost-benefit analysis before setting it up.

10. Consider internal ownership changes. For your existing rental properties, you can also consider whether you should transfer the ownership between family members, or between different business structures (this is not applicable for SMSF). You might want to do this when the income level changes with family members, or rental property changes between tax profit and loss. Before the change, you need to consider the cost of transfer including capital gains tax, stamp duty, conveyancer fees, etc. Again, a cost-benefit analysis is a must before the change.

Last but not the least, did you combine all the above strategies and compare your choices? If you haven’t yet, how would you know that you have picked the best strategy to minimize your taxes? We can help you to factor in all considerations, compare different scenarios, also present you with a Property Prepurchase Report with all our findings to help you to make a decision. Contact us today to book in a consultation with an experienced tax accountant!

This is general advice only and does not consider your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from your financial adviser and seek tax advice from your accountant.

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