Real Estate Questions Answered

Panel of experts in real estate investing answer questions from API Magazine readers in the March 2007 issue.

Using a trust structure

Question: My husband and I own an investment real estate property in Queensland and we rent a house in Sydney. We’re buying a second investment property using a company/trust structure. We’ve set up a hybrid trust for future real estate purchases. For our third property purchase, would it be legal for our company to purchase and we, as individuals, rent it at the current market rate? I’ve asked two accountants this question – one said there was nothing illegal about it but the other wouldn’t support such a move.

Answer: Most trust deeds allow the trust to rent a property to the beneficiaries of the trust. So, from a legal perspective, there’s certainly nothing to stop you from doing this. Further, there was an important legal precedent set in 1987 when the courts found in favour of the taxpayer in just such a case. For what it’s worth, this is known as the Janmor case. However, before you do this there are a couple of issues to consider:

- the home won’t be exempt from capital gains tax if you were to sell it in the future, whereas it would be if you owned the home in your own names;

- the home may attract land tax that it wouldn’t attract if the home was in your own names.

So, I would suggest that you consider whether this real estate property will be your home for a long, long time or just a short while before making your decisions. The real problem arrives if you wish to negatively gear your home using the hybrid trust features of having the loan in your own names while the trust owns the real estate home property. This is because the Tax Office has said that it will attack this. More information can be found about how the Tax Office would view y our negatively gearing your home through the trust in TR 2002/18. There are legal arguments that suggest that the Tax Office is wrong, but, of course no-one wants to be the one to test whether the Tax Office is wrong or right. As a general rule, you’re wise not to have your home in the trust and negatively gear this real estate investment.

Dale Gatherum-Goss.

Unit or House for Real Estate Investments?

Question: I’m unsure whether to purchase a unit or house. What are the positives and negatives of both? Apart from local property average prices what should I look for? And how long will the real estate buyers’ market last for?

Answer: When it comes to investment property real estate, the first thing you need to do is be clear about why you’re investing. Do you need enough rental income to replace your salary, or do you need to build equity through capital growth in real estate? Since I don’t know the particulars of your situation in investing, I’m going to assume for the purposes of this column that you’re like the majority of property investors, who need to focus on assets that will deliver strong capital growth. In this case, it doesn’t matter so much whether to buy a unit or a house. The most important thing is to identify properties that are in limited supply and have experienced consistently strong demand over a number of years, regardless of whether it is an apartment unit or home. More often than not, these are within short commuting distance of the CBDs of major capital cities, where a scarcity of available land drives up real estate property values. You should also focus on locations where there’s strong competition during negotiations, for example where there are several or more bidders vying for the same home real estate property during an auction. This is a good indication of strong demand and capital growth potential. If you’re looking at apartment units, stick to low rise developments with less than 20 properties. There are less likely to be multiple units in the same block on the real estate market at the same time, so the resale value will be higher.

In terms of research, look at recent sales results in ‘comparable’ properties, i.e. those in the area, with a similar land size, architectural style, and degree of renovation. This will help ensure you have a realistic purchase price in mind, and don’t overpay for the real estate property.

Generally speaking, the ‘right’ time to buy is when the right real estate opportunity presents itself – that is – when you find the real estate asset that’s most likely to help you achieve your objectives. However, there are indications that property investors will begin returning to the market in greater numbers during 2007. So if you find the right property, don’t procrastinate. You’ll face more competition from other real estate investors as the year goes on, which will drive up the asking price.

Mark Armstrong

Questioning a Property Valuation

Question: In September we completed building two residential properties with two different lenders. We asked for a revaluation on one and sold the other last December for $330,000. (We expected this sale price). For the other house the valuation came in at $285,000, well under the sale price of our other property next door! Both completed at the same time, similar size, same finishes etc. Our real estate agent organised sales comparisons for similar properties in the same estate, indicating $320,000 to $330,000 for two properties. Tell me what’s wrong with the facts? Can this low valuation be adjusted?

Answer: When a valuation is lower than your expectations the best approach is to supply some recent sales evidence which supports your case and simply ask the valuer to review the valuation in light of this evidence. Generally, a balanced and informed communication with the valuer will resolve any misunderstandings. If your real estate property next door hadn’t settled at the time of the valuation, there’s a chance the valuer may not have been aware of this evidence. In addition, some lenders insist that valuations be based on settled sales only – not on properties which are still under contract. Remember that valuers are totally independent and have no vested interest in your home property or the outcome of the valuation.

Phil Grahame

A Hot Real Estate Market in Darwin

Wendy Trewartha found herself in NT when her husband was transferred with work. It was here she realised a passion for real estate property and found a red-hot market. By Bronwyn Davis for the Australian Property Investor Jan 2007 magazine.

Why have you invested in Darwin real estate?

We started investing in Alice Springs because we were living there. When we moved to Darwin about four years ago, we realised we could make a better return. It’s also easier for us to own real estate investment properties where we live so my husband can do the maintenance. We looked at the returns carefully. We wanted to be able to negatively gear but didn’t want to have to make up a large shortfall.

How do you believe the real estate market is performing and what do you expect from it in the future?

Prices are still on the rise, but things seem to have slowed down a bit. A couple of months ago a real estate property would be in the paper once before it was sold; now it might be advertised for a couple of weeks. A house around the corner from us went up for action recently and I asked a few real estate agents what they thought it would go for. They all thought about $450,000 but it ended up selling to an interstate investor in real estate for $493,000. I think this real estate market will continue to increase in value. They’re doing a new 700-block development of property near us at the moment. They’ve just done the first stage, with land priced at $217,000 to $250,000 for blocks from 500 to 900 square metres.

How is this affecting your real estate portfolio?

This new real estate development should increase the land value on my own home, which is good because I’ve been using it to buy other real estate properties. I’ve found it easy to borrow against my own home because each time I get a valuation done, it’s gone up. I bought this house four years ago and had a valuation done when I first purchased my first condo unit investment in 2004, then another when I bought the last two real estate units about a month and a half ago.

Do you intend to invest further in Darwin real estate? Why?

We’ll have a break for a little while because we only just bought the last two. The next one will probably be something we can rent out now and retire to later. We thought about buying and building in the new estate, but I think they’ll be priced out of the rental market so we wouldn’t get enough of a return. Half of them are going to be defence houses though, so we might consider one of those.

What advice would you give about buying real estate property in Darwin?

Probably the same advice I gave my daughter – she’s just buying her first real estate property. I told her that as soon as she gets enough equity in that one to try to buy her next real estate property and keep going from there.

In hindsight, what would you have done differently?

I would have got into it earlier. We procrastinated for a fair while before we bought that first unit.

Your best real estate investment?

The house I’m living in at the moment. That’s more than doubled in value in the four years we’ve been here. I’d say the same thing about the home I owned in Alice Springs. I bought that for $78,000 fully furnished and sold it 10 years later for $200,000. The difference being that this one has doubled in value in only four years.

Why real estate property?

I was working with the bank and I could see other people making real estate property work for them. At the time there were a lot of programs on TV about property investment too. They had a lot of millionaire experts talking about making money from real estate property and that really opened our eyes. I’m not the sort of person who likes to put all of my money into super. Now when I retire I can either cash in and use the funds from my real estate properties, or have them paid off and collect the rent from them. It’s a forced way of saving.

For more Australia real estate and pre-construction condos including waterfront and lakefront homes, please click here.

Real Estate Tax Straight Up Questions and Answers

Resident tax expert Julia Hartman answers questions from API readers in the January 2007 magazine.

Timing the real estate renovation

Question: We are about to purchase an apartment on a first homebuyers grant and plan to live in it for the required time, and then lease it out and move into something a bit bigger. We were wondering if it would be worthwhile doing the upgrades to the real estate property while we are residing in it or rather when it becomes an investment property.

Answer: It’s probably more cost effective for you to do them while you’re living there and the tax consequences for any upgrades, as opposed to repairs, will be the same. If you replace the bathroom or kitchen most of y our expenses will only qualify for the special building write-off of 2.5 per cent a year for the next 40 years, so you’ll still benefit from that when you move out. Replacing equipment such as air conditioners, vinyl, carpets, stoves, and the hot water system is best done just before the tenant moves in, as they’re depreciated over 10 to 12 years. Initial repairs, i.e. things that needed fixing when you bought the real estate property, wouldn’t be tax deductible anyway. It’s only later repairs that are better done once the tenant has moved in but these repairs can’t improve it beyond the state it was in when you bout it.

Interestingly, the ATO states in TR97/23 that you can claim a tax deduction for real estate repairs carried out while the unit is rented, even though they became necessary while you were previously living there. For example, if the walls don’t need painting at the moment but by the time you move out they’re starting to look a bit shabby, providing you put tenants in there first you can claim the cost of a repaint of the apartment real estate property. If possible avoid buying depreciable items that cost under $300 until the real estate tenants move in as these can be completely written off in the year of purchase. Examples of these include curtains, light fittings, and fans. But all like items must be grouped together to be under the $300 limit for the year. So if you’re going to replace all the curtains, wait until the tenants are in there and then only do $300 worth per year.

Finance Confusion

Question: I own my own real estate home, have an investment loan of $200,000 and savings of $80,000. I would like your advice on how I can utilise my savings in the best possible way over the short term, as I will need access to this money in the future. I was recently advised that if I put the $80,000 onto the investment loan (and reduced the balance to $120,000), if I was to later redraw this money back out for non-investment purposes only the interest on $120,000 would not be tax deductible. However, if I was to deposit the money into a 100 per cent offset account (which is separate from the loan) I could later withdraw my savings and not affect the tax deductibility of the interest on the full $200,000, even though the total amount of interest actually charged in both scenarios is the same. Is this information correct?

Answer: Yes it is correct. Couldn’t have put it better myself.

Consequences of Payment

Question: My real estate investment property was leased to the Defence Housing Authority for nine years. The real estate lease had a contition that on the end of the lease the property would be repainted outside and inside and new carpet put in. The real estate property was painted inside but I chose cash compensation instead of outside painting and new carpet. How will this payment be treated in my tax return?

Answer: This would be assessable income.

If you have tax questions you’d like answered, please email it to: editor@apimagazine.com.au. Julia Hartman is a CPA, registered tax agent and founder of BAN TACS Accountants Pty. Ltd.