I am about to sell a property which will be able to pay off its loan, my current residence loan and one investment property, is it best to keep a mortgage on an investment property to be able to claim the tax or would it be better to have the investment fully paid off and keep the rent as PAYG income?

Hi Kaz,

When you pay off a tax deductible investment loan, you are essentially investing that capital in a low risk investment, with the rate of return equal to that of the loan interest rate. Because it is a tax deductible loan, it is essentially a taxable investment (because the interest you are saving would have otherwise been tax deductible).

If the loan interest rate is say 4%, and you could find a term deposit paying 4% (assuming it is invested in the same name as the loan is in), it will give you the exact same outcome.

Questions like this should be answered in 2 parts:

1. do you want/need to take on more investment risk than a low risk return of 4% (I'm using that as the example but whatever the interest rate on the loan is).
2. Is there a lower tax entity that you could invest in? i.e if the investment property and loan is in the name of someone on a high marginal tax rate, can you invest the capital that you would otherwise pay off the loan into a lower tax entity (perhaps a low income spouse or superannuation)

For example, if that loan interest rate is 4% and it is in the name of someone who is earning over $87,000, so they are on the 39% marginal tax rate (incl. medicare levy), the effective net return of paying off that loan is 2.44%, and perhaps the spouse has a very very low income, and on the 0% marginal tax rate, then they could perhaps take on some investment risk and invest in a diversified portfolio of stocks and bonds and because they will like pay no tax on the earnings, the investment only needs to produce a return above 2.44% to be better than paying off the loan - but remember, that takes on more investment risk than simply paying off the loan. If you are still 10 years from retirement (or whatever) and need to still accumulate wealth for your desired retirement lifestyle, then you may very well want to take on that extra risk and take advantage of the tax differences on offer.

Sorry for the complicated reply and the rambling. It's not as simple as saying yes you should or no you shouldn't. There's always personal factors to consider.

If you do decide on the paying down the loan, you might want to do that in the form of putting that money in an offset account so it isn't actually paid down, but gives you the same result. This gives you the flexibility of redrawing that money later and retaining the tax deductibility of that loan.

Cheers

Glenn

Hi Kaz,
As in all situations there are pros and cons of both. It really comes down to the usual financial factors, your total financial position, your current age, current taxable income, your goals and risk appetite and what you might do with that money if you didn’t pay it off.
I would recommend you speak to a great Financial Planner and lay all your cards on the table before you make the decision
Best of luck
Regards
Scott

Hi Kaz,

I ALWAYS advise clients that actively looking to create a tax deduction is a really bad idea. Let me give you an example:

If you pay tax at (say) 30%, then for every $1000 of tax deductible expense you have you get $300 back: wonderful!!!!!
$300 back in your pocket: yippee!!!!!
but the other $700 is gone, never to return!!!

lets compare that with not having a $1000 tax deduction: no claim means no tax benefit, and you pay an EXTRA $300 to the ATO: BOOOOOO!!!!!
but you get to keep the other $700!!!!!

you can see that the person with the tax deduction has $300 after spending his $1000, but the person with no tax deduction has $700 left.

who is better off do you reckon??????


To put this theory into your situation, ask yourself do I want to have a tax deduction or not??? If all other issues are ignored then you will probably say no bugger the tax deduction, I would rather keep my $700.

We dont live in utopia, and no decision can be taken in isolation of all others, because there are consequences of paying the loan down: firstly that money to do this could be used somewhere else.....which is where a good advisor comes in really handy: find yourself someone who can advise on investing and the opportunity costs (and risks) of various scenarios.........but make sure that they understand the TAX IMPLICATIONS too......and dont go looking for a tax deduction for the pure joy of having a tax deduction.

Good luck

BC

Hey Kaz,

Did I read currently that you have two properties, an owner occupied and an investment and your question was which property do you sell?

If that is correct, the simple answer is to sell the investment property and use residual funds to pay down the debt attached to your home loan.

For all of us, when it comes to wealth creation, the first step is to own your owner occupied property outright. Being debt free is a MASSIVE step towards a successful retirement.

I don't know what the numbers are but if the residual money from the sale of the investment property can be used to pay off your home loan then it is definaely something to think about.

If you want to go through things in more detail, my contacts are below.

Kind regards,

Tim Russell
Multipart Finance
0400 530 868
tim@multipartfinance.com.au