One of the most common ways to get involved in property investment is when you want to buy a new home and keep your existing house as a rental property.
As mortgage advisers, we are often asked to arrange finance for people, but we can also offer some basic general advice on how to structure things, always with the proviso that they speak to an accountant to ensure that everything is done properly.
Here is how we helped a couple turn their Auckland home into a rental, buy a larger home, and minimise tax in the process.
Our clients outgrew their 2 bedroom KiwiBuild property and wanted to buy a larger home. This is a common scenario in New Zealand, but all too often loans are not structured correctly, and everyday Kiwis miss out on the advantages available to them.
In this case study, we look at how a simple restructuring will save our clients thousands of dollars each year, and also comply with the brightline property rule.
Our clients bought a 2 Bed KiwiBuild property in Papakura, Auckland for $575,000 3 Years ago. But now they have two kids and it’s too small!
Now it’s worth approximately $700,000, and still has a home loan of about $380,000. They had a property manager suggest they could get $700 per week in rent.
They have the option to purchase mum and dad’s $800,000 much larger property for just $400,000 on the basis they look after them in their retirement. A win-win.
Therefore, they need to borrow an additional $400,000, which means in total, they will now need to borrow $780,000.
Here is how this looks without investment advice:
| Papakura House | New Purchase | Owner Occupied | |
|---|---|---|---|
| Mortgage 6.65% | $380,000 | Mortgage 6.65% | $400,000 |
| Value | $700,000 | Value | $800,000 |
| Income | Income | ||
| Rent (annual) | $36,400 | Rent (annual) | N/A |
| Expenses | |||
| Interest Cost (annual) | $25,270 | ||
| Rates | $2,200 | ||
| Insurance | $1,800 | ||
| Total | $29,270 | ||
| Profit | $7,130 | ||
| Tax Payable (33%) | $2,352.90 |
In the table and scenario above, there was no restructure or professional advice sought.
In essence only $380,000 lending could be claimed back when filing end of year reports to the IRD. This results in a taxable profit of around $7,130 every year.
At a 33% tax rate this is about a $2,352.90 tax bill every year.
To maximise the tax benefits available, the existing home needs to be sold and purchased by a new entity. In this case, it was suggested (and confirmed through a Chartered Accountant) that they use a company known as an LTC (Look Through Company), which allows any tax losses (or profits) to be allocated to the company shareholders.
Here’s how the figures look when structured this way:
| Papakura House | New Purchase | Owner Occupied | |
|---|---|---|---|
| Mortgage 6.65% | $700,000 | Mortgage 6.65% | $80,000 |
| Value | $700,000 | Value | $800,000 |
| Income | Income | ||
| Rent (annual) | $36,400 | Rent (annual) | N/A |
| Expenses | |||
| Interest Cost (annual) | $46,550 | ||
| Rates | $2,200 | ||
| Insurance | $1,800 | ||
| Total | $50,550 | ||
| Profit (loss) | -$14,150 | ||
| Tax Payable (33%) | -$4669.50 |
Ahhh, here we go much better. Tax efficiency achieved!
Please note that in both situations they are borrowing exactly the same $780,000. It’s just where that debt is sitting and the tax rules associated that have changed.
In essence, we have $700,000 of investment debt that is now a legitimate claimable expense, meaning a ‘paper’ loss of roughly $14,150.00 per year. These losses can be carried over to subsequent years to offset any profits made.
Notes and Disclosure:
With the right setup, our clients maximised tax benefits and minimised their tax bill. Are you ready to optimise your property investments and unlock financial freedom? Talk to an investment mortgage broker today and make your money work smarter for you!
