Should You Buy Assets Under $5,000?

24 July 2020

This is a recent video we have done that you might find helpful. It is a analysis of a Hamilton rental that was for sale recently and some options you could consider.  View this short video (under 9 minutes) here:  https://youtu.be/KLq2LrsI_Uc

Should you buy assets under $5,000 now to take advantage of Asset threshold change?

In the past, if you purchased an asset that cost over $500, then you would have to capitalize this asset and claim depreciation based on the rate set by IRD to reflect the assets useful lifetime.  Whereas, if it cost $500 or less (for residential property investors this includes GST and also includes any installation), then you could claim this low value asset as a repair and fully claim the cost as an expense in the year spent.

• New threshold = From 17/3/20 to 16/3/21 $5,000 or less
• Long term threshold = From 17/3/21 $1,000 or less

This creates an obvious opportunity until 16/3/21, that you could buy assets worth $5,000 or less, and get a full tax deduction on the cost in this year.

So should you do that?

 1.  Cash buffer

At the moment, it is uncertain times. So, it is really important to have a cash buffer.  Tenants might not be able to pay, or may pay late.  You could lose your job or other income.  Property prices could fall. 

So before spending money on assets, you need to consider whether you have enough cash buffer, and in most circumstances, I would wait until September or October to see how things play out over the next few months.

The cash buffer could also be for opportunities. So, if you have cash available, you might be able to take an amazing deal that comes along.

 2.  Do you really need it?

In general most people love a tax refund and hate paying tax.   Unfortunately, this logic is often wrong.

When buying an asset worth say $4,000, you are spending $4,000 to save a maximum of $1,320 in tax.  So, in Net terms, you are still spending $2,680.

So, if you don’t need the asset, it is better not to buy it!  I would look at assets that you must do, such as for Healthy Homes or insulation.

3.  Are you making a loss?

With new Ring Fencing rules in from 1/4/19, if you are already making a loss and expect to make a loss for the next few years, then extra repairs will just make your loss higher and then be Ring Fenced.  So there would be no cash benefit, so no point rushing!

4.  Difference

• If $1,000 or under, then if you do it on 17/3/21 or after, then it will make no difference.  No need to rush.
• If a repair, then threshold doesn’t matter.  See point 5, but in general new shower, roof, vanities, toilet, kitchen cupboards, kitchen bench, painting will all be repairs.
• Assets that wear out quickly like computers have high depreciation rates.  There is less benefit in having these as a repair, as they would have depreciated quickly anyway.

- Computer as repair, say $3,000 and reduce tax by $1,000 in 2021 year

- Computer as asset, 2021 approx $1,500 depreciation and reduce tax by $500, 2022 approx $1,500 depreciation and reduce tax by $500.  So, end of 2022 would give very similar result for tax.

• Assets that wear out slowly like driveways have low depreciation rates.  So, there is a big benefit in getting these as a repair if $5,000 or less, as depreciation would be extremely slow and at 4% per year.

- New Path $4,000.  If done 17/3/20 to 16/3/21, then repair so reduce tax by $1,320  max

- New Path $4,000 done in April 2021, then asset.  Year one depreciation only $160, and max tax saving $53 in year one.  LARGE DIFFERENCE!

5.  New property purchased

Anything done before tenanting is NOT a repair.  So, if you buy a rental property, paint and then tenant, the painting is not deductible as a repair.

An example with assets, if you buy a rental property today, put in a heat pump for $4,000, new carpet for $3,000 and a new stove for $1,000, and then tenant, these items are not repairs, even though they are under the $5,000.  They are a cost of buying the property. 

So if you have just purchased and not tenanted, the $5,000 threshold makes no difference.

I hope you have found this useful.

Kind regards

Ross Barnett

Starting Your Property Investment Journey

10 September 2020

Starting Your Property Investment Journey

6 Key things

1.  Don't Rush

It is important to act but that doesn't mean you have to RUSH.

It is better to buy a good property that works for you and sets a good foundation.  If you can add equity and get good cash flow, then this helps you to move forward and buy more and more properties.

A bad property can act like a handbrake and slow you down in the future.  Very important if you want to accumulate a lot of rentals.

AT THIS STAGE YOU SHOULDN'T BE GOING TO AN AGENT AND LOOKING AT PROPERTIES!

ACTUALLY YOU SHOULDN'T BE TRYING TO SHOP FOR A PROPERTY AT ALL JUST YET.

2.  Goals

Why do you want to invest in property?

It is important to set simple goals.  Then you can easily review if a potential property helps you achieve those goals.

If your goal is to buy one rental to help with retirement, your strategy will be very different from someone who wants to buy 10 rental properties in the next 10 years.

A great starting point is a free Financial Success Review with One50 Group.  They can help you set goals and a financial plan. If you email me (ross.barnett@one50group.co.nz), I can organise a free Financial Success Review for you.  Or you can book a free chat with me here.

3.  What do you already have?

Rather than looking for a new property:

• Is your personal house sub-dividable? Can you put a minor dwelling on the back? Can you legally convert the downstairs garage into a sleep out? Can you get a boarder, flatmate or Airbnb income?
• Or, do you have a rental that has an opportunity?
• Or, your family or friends?

Often these kind of opportunities will add value and give great cash flow.  Often they can be better than buying another rental.

4.  Know the Basics, Basic Numbers and Structure

Many rentals don't have great cash flow, and that is at 2.49% interest rates.

So, it is important to look at what your possible rental will make you in profit, or what it will cost you.  Look now, and over the next 10 years, and factor in possible interest rate rises.

Often multiple dwellings, sub-divisions or other twists can give better cash flow.

A great starting point can be to have a free telephone chat with me for 5-10 minutes, or a Property Advisory Meeting.  Click here to book a time that suits you.

5.  Pre-approval for Finance

There is no point finding an amazing property if you can't buy it.

Getting the team at One50 Group to help see what you can borrow is an important step.  They can help you save money on your current loans, plus see what you can borrow, and help set you up to buy future rentals.  For more information visit: https://one50group.co.nz/mortgages/

6.  Legal Clauses

I like to get a conditional contract on a property.  That way, it is secured before I do my due diligence, such as checking if the property is sub-dividable.

Spend some time with your lawyer early on. Establish what clauses you should put in a possible Sale & Purchase Agreement for due diligence.  That way you can put offers on properties without having to wait for your lawyer each time.

Other Simple Tips

• Always get an independent rental appraisal.  Never believe the ones from an agent or developer, get your own.
• Same with valuations, if required.  Often your bank or broker will just do an e-value that won’t cost you anything.
• Always check you can actually get insurance.
• Healthy Homes – a new heat pump in a new build doesn’t necessarily meet the Healthy Homes requirements.
• Make sure your property is insulated before renting.
• Be careful renting unconsented dwellings and look into this fully, as can cause major Tenancy Tribunal issues.
• Don’t believe cash flow reports completed by the developer or sales person.  Do your own due diligence and get independent advice.

Kind regards

Ross Barnett

FREE SEPTEMBER PROPERTY INVESTMENT SEMINARS 

Linking your Business with Property - Monday 14 September at 7.30 pm     - Click here to register

Commercial property basics, focusing on owner occupiers – Should you buy your own building? Should you rent to yourself?

Rental Property Basics - Thursday 24 September at 7.30 pm   - Click here to register

Learn the basics about residential property investment

The Next Step in Property -Tuesday 29 September at 7.30 pm  - Click here to register

This follows on from the rental basics webinar and is the next level of tips and tricks for property investors.

Common Restructure to Become More Tax Effective (Personal Home becoming a rental) Updated April 2020

Common Restructure to Become More Tax Effective (Personal Home becoming a Rental)

Updated April  2020

Are you trying to get ahead on the property ladder by converting your current personal home into a rental, and then buying a new personal house?

This is an example of poor advice that I have recently seen, followed by a common restructure that makes the overall situation more tax effective.



Poor advice and current situation
 
Jack and Jill own a personal house (House A), worth $500,000 with $50,000 of debt in their personal names. 
 
Jack and Jill have been advised to keep House A in their personal names.
 
They have purchased a new personal house (House B) for $600,000 with a $600,000 mortgage.
 
Outcome – Unfortunately with this structure, none of the interest on the $600,000 loan is deductible.  Only the interest on the $50,000 loan on House A will be deductible.   At say 3% interest, this would be a $1,500 deduction, reducing tax by $495 (if at 33% tax rate).
 

Restructure
 
A common restructure is to sell House A to a Look Through Company (LTC) at fair market value.  The LTC would then borrow 100% (can do with one or two banks!) being $500,000.  The interest on the $500,000 is deductible as it is being used to buy a rental property.  At say 3% interest, this would be a $15,000 deduction, reducing tax by $4,950 (if at 33% tax rate).
 
Jack and Jill would then receive the $500,000, pay off the $50,000 current debt, and use the $450,000 cash towards House B purchase.  This way there would only be $150,000 personal debt left, where the interest is not deductible.
 
This creates a tax advantage of $4,455 per year! ($4,950 new tax saved less $495 old tax saved).
 
For any restructure, it is important to look at the cost versus the benefit.  There can be catches such as depreciation recovery, tainting and the Brightline test to consider.  Also, whether there is a commercial reason for the transaction.  So it is important to get expert advice.  QB 12/11 from the IRD gives some great information on this type of transaction as well, and confirms that this type of restructure is not tax avoidance, but it does depend on the exact circumstances!
 

 Ring Fencing

Ring Fencing came in from 1 April 2019.  This means that if a property runs at a loss, that loss cannot offset your personal income and cannot give a tax refund.  But the loss can offset other property profits and reduce tax that way.

So for a restructure, if the current personal house becomes a rental and runs at a loss, there is still likely to be some tax gains, but part of the tax gains might not be in cash savings, and part might be carried forward as tax losses towards future year property profits.

What else to consider when converting your current personal house to a rental?

When trying to get ahead on the property ladder, a lot of people move to a new personal home and convert their existing house to a rental.  Unfortunately, this is often done for emotional reasons!

If you are thinking about doing this:

1)  Is your existing house a good rental?

Is there high tenant demand in the area?  Look at population figures for the area and talk to a local property manager.
Will you be able to attract a good tenant?
Is the property easy care and low maintenance?
Is there an opportunity to add value in the future?  For example, subdivide or add a minor dwelling.

2)  What is the cash flow?

As a starting point, I would work out the Gross Yield.  This is the expected rent divided by the property value *100.  For example, $400 per week * 50 = $20,000 divided by value of $400,000 would give 5% Gross Yield. The number of weeks of expected rent can vary widely depending on the type of property, condition of the property, and location, and try to be realistic.

The Gross Yield gives an indication of the cash flow:

4% or under is going to be quite negative cash flow based on 100% mortgage and a $550,000 property.

5% or better should break even or be positive cash flow for a $550,000 property.

Between 4% and 5%, it will depend on the property and it's likely costs. If buying cheaper properties, the expenses will be higher as a proportion of rent, so you will need a higher Gross Yield to break even.

Review the income less the full expenses.  The example below shows a $4,432 loss expected per year, based on current data.

3)  What happens if interest rates go up?

In 10 years time, this loss could be $10,376 per year, based on 3% increase in rent and expenses each year, and being conservative with interest rates going up to 5%.

4)  Can you afford the cash flow losses?

5)  Do you want to gamble that the property will go up more than the cash loss?

6)  Or do you have a plan to change the cash flow?

• Minor dwelling to increase rent
• Subdivide long term and sell section, or build second rental on section
• Inheritance coming that can reduce the rental debt.  NOTE:  you are likely to pay off any personal debt first.

Often I find that personal homes are not great rentals and that it is better to sell the existing personal house and buy a specific rental, with better cash flow or better long term options.

I hope you have found this topic of interest.
 

Kind regards

Ross