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Property - Tax Benefits?

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Not applicable
Hi Guys

Ive heard this argument just too many times now so Ive opened this one for anyone to read.
Everyone keeps saying its a brilliant idea to have a home loan rather than paying off the property with cash because you get the tax benefits that you get to deduct.

So I thought I would put this to the test where we do 2 scenarios, one with a home loan and the other without and compare the results.
The scenario specifically deals with the situation where you can choose with or without a home loan, the discussion is void if you dont have a choice, however the resulting principles are still a good idea.

You dont need to register to read this one.

http://www.myshares.co.za/basic/blogs_view.php?p=11
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26 REPLIES 26
SimonPB
Valued Contributor
but you charging rental income so this a second home? and you haven't included running costs, empty months, advertising fees, and maintenance costs ?
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8thwonder
New Contributor
good analysis. however if your exercise is based on the premise that there's a choice between using R1m to buy an investment property cash or whether to utilise this same R1m elsewhere in lieu of taking advantage of the tax savings from the interest on the bond, then you'd need to factor in the return on the R1m invested elsewhere to have a meaningful comparison. think this would sway your outcome back in favour of the bond with 5 years compounding.
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Not applicable
Yes, this is a second home as the article deals with the situation where you buy a "buy-to-let" either through cash or through a home loan. Most opt for a home loan because they believe they are doing this through a better tax structure than buying cash as they get cash back from SARS every year.
This does not deal with the situation of your primary residence...as how would you deduct rental costs against your primary residence?

Property cost analysis is dealt in this article:
http://www.myshares.co.za/basic/blogs_view.php?p=3
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Not applicable
Thank you.
There are pros and cons to a further "what if" analysis. Your assuming that you wouldve put the money into a good investment, what if you took the extra cash and put it into Abil, or even risk-free abil prefs?

The more choices you include the more it will skew the picture, Im trying to compare as closely as possible apples with apples and the more factors go into the model the more uncertain the outcome.
Thats why I would prefer to take things step by step.
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8thwonder
New Contributor
you could just assume risk free.
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Not applicable
doing a quick back-of-that-matchbox calc I guess you would need a 5% (after tax) no risk investment minimum to break even.
So it is possible, just very complicated as the margins are very tight on things to go wrong as if there are any costs in those deals (eg brokerage, other taxes, etc) you would lose money, and thats if a find a 5% no risk investment.
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TheInvestor
Contributor
BC01, the above examples given are very simplistic and unfortunately does not give a clear picture (as one assumed you occupy the property for 5 years, then rent it out for 3 years), while both do not take into account inflationary rental and other cost escalation. I did a quick calculation, assuming you had ZAR1m and you wanted to purchase a property plus invest any surplus. I used the following assumptions: Transaction cost in Y1 = ZAR30k; Y20 = ZAR150k Rental = ZAR8k per month, increasing by 8% YoY and 92% occupancy Bond of 20 years @ 9.5% fixed interest Levies ZAR1.5k per month, increasing 6% YoY Management fee = 10% of rental Tax rate @ 40% Interest on excess funds @ 6% Excess cash = Fund not spent on property plus/minus surplus/deficit of bond and running costs Property value increases 6% YoY Model run out to 20 years No interest tax exemption considered. Conclusion: After 20 years, at 100% finance, you'd pay ZAR1.5m in tax and have assets worth ZAR5.4m (property plus cash) After 20 years, at 0% finance, you'd pay ZAR1.2m in tax and have assets worth ZAR5.0m (property plus cash) Breakeven of the 2 scenarios is at return on excess funds of 9.5%. Therefore if you confident you can achieve more than 9.5%, finance property, if not, then no finance. Please note that this is a very quick and high level calc. that may be incorrect.
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TheInvestor
Contributor
Apologies, looked a lot "neater" when I typed it. It managed to merge all my lines. Hope it makes sense :/
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Not applicable
Hi, thanks for the feedback.
I would need to spend more time on your calcs, but did you include the cost of the interest payment over 20 years...using a bond calculator thats an extra cost of R 1.2m
(Fair enough a portion of this is tax deductable)

If you are looking at a 20 year period, quite a long forecast to make, if you also factor in the potential that over 20 years you keep buying another and another property cash and each time you save that amount on those costs to spend on the next property what the benefits of that will be as well.

Cant go through the whole calc right now, but quite honestly I just cant see the logic in having more costs to get 40% of it back in a tax rebate and calling it a win. Somehow logically just doesnt sound right, and at least in this scenario the case proves it.
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TheInvestor
Contributor
The major benefit with having a bond is the leverage you get. i.e. after 5 years, the net inflow of funds you'd require to pay (after tax rebate) would be +/-ZAR136k. However, if your property increased by 6% YoY, your gain would be +/- ZAR271k (including a 5% agent commission), showing a ROI of 99%. Therefore the theory is that with ZAR1m, you could acquire more than 1 property and benefit from the leverage. This however risky as should you run into cash flow problems, you're in trouble. Anyone s welcome to correct me if I am wrong (this is the way I see it, hence I went the bond route)
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Blik
Super Contributor
I live in a small student town, where many people play the property rent game. Well so do we, and as you would have it we are looking at another property today. Simple match box calcs are:
Price: 2. Mill
Rental income - about 17K current / month
Running costs - about 14K, including interest on bond of about 1 mill (over 10 years).

The question to me, is whether we can park our one mill deposit on the back of a better truck????? The costs above are what based upon our other current costs and income.

I think to make this particular one work, we will have to squeeze the price down a little. Tax and possibly low growth in the property market make this one marginal in my mind. Still it may be better than having the money in cash.
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partridge
Super Contributor
I fell asleep reading this hoary old chestnut. Buying a second property is not diversification.( Neither is buying three houses in the same town or anywhere else in RSA -for that matter. Diversification is the only free lunch an investor can buy. High risk - low liquidity - you cannot make a market for your asset - plus you break a little considered but important rule of taxation planning. TAX rates and structures - and allowances are always outside the control of the investor. If your investment only cuts the mustard because of tax as it stands and you are self evidently going to hold this for a number of tax years - then make sure that you build in a margin of safety - and it better be generous - otherwise take a walk around the block - and think again why 5% return ( which is what you will nominally receive ) is actually not so attractive.
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prancing_horse
Super Contributor
On this forum I've stated more than once than owning a house is an evil necessity, owning another to let, in RSA(Pty)ltd is a very poor investment. Slowly but surely we are becoming more like the rest of Africa, and I can't see that changing in my life time. So capital appreciation in Rand terms is meaningless, I've done far better in purchasing foreign currency on my annual trips abroad and sticking it into the safe on my return, and no capital gain tax to pay.
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Not applicable
I believe the exercise and point of this thread was to determine the effect of leverage vs unleveraged property. The question being if you have R1m cash, is it better to rather bond yourself of pay off the investment. As pointed out by some on the thread, this is not taking all the factors into consideration - as the whole point of leverage is to free up the capital to invest in something else. So this exercise is only worth while if you factor in a) your risk free rate of return on the R1m and b) what other investment vehicles could have been considered. From an investment point of view - chucking R1m into an illiquid, slow appreciating asset with high maintenance costs is not going to get you rich. Putting R1m into a decent stock, on the other hand could have the potential to return R10m over 10 years.
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Not applicable
yes, exactly, but its to isolate the tax benefits/costs.
Thanks for the feedback, Ill do a new calculation as it seems very in demand.
Ill do a calc where I put it into one of those "around the braai" safe investment like Billies, Kumba, MTN.
Maybe also starting it in 2006? :P

I agree with you that the exercise can be taken further, but its very funny to me how everyone keeps pointing out "obvious" safe shares in hindsight....like in 2007 we had the resource bull run and the obvious safe shares to buy in the "dip" in 2008 where Biliton, Anglo, etc
When anybody speaks of hindsight trading they always seem to buy "quality" at the bottom of 2009 and yet in reality most investors dont.

I do think a new exercise will be interest to see at what point does the leveraged + costs exceed the unleveraged.
ie What rate of return do you need to exceed the costs?

What you guys also keep forgetting is the savings you have from the costs
you would use to buy the next investment and the next and so on.
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Not applicable
BIL, KIO, AGL as safe investments! That will stir the braai conversation!
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Not applicable
Those were the conversations in 2006-2007.
Remember we had a bull market in the resource sector from 2004 - 2007
I couldnt find a fund manager that wasnt bullish on resources in 2007 even up to 2012.
Today its Naspers, Sasol, Richemont, SAB, BTI and Aspen.
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partridge
Super Contributor
Suggestion: get yourself some new friends if you attend braais where people talk about stocks. I am staring to get a headache just thinking about it. ( ditto medical issues)
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AP
Regular Contributor
I've done detail property (buy to rent) calcs as well and compared the investment via investing in shares. The property investment was the superior investment (by miles), but it is important (in order to maximize the investment) to use is little cash as possible (go for max bond), keep costs low and finding investment property with good yields (aim for 10%+). The net result is after I've done the calc, I've sold some of my shares (used as deposit for investment property). However, important to point out I still have large portion in tax (property is very long term investment, not very liquid, etc.). Cash deposit for property investment was sized to get good interest rate & ensure that the property is breaking even from day 1 (I went for 80% bond). I am planning to run property at minute loss each year for tax purposes.
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