Around Australia, house prices have risen by more than 500% in the last 20 years. How will your kids be able to buy their home?

What’s more, the world of work is changing, and it’s not a good idea to assume your children will enjoy safe employment with just one or two employers during their working lives.

More probably, as the sociologists tell us, they will have a “patchwork” of part-time and casual engagements, with nothing like the secure tenure that typified their fathers’ and mothers’ employment experiences.

I am sure your kids are bright, and bright people tend to do well financially. But it is still not a safe bet that they will blitz their way in and out of university or trade school and then into the top echelons of the work-force. The competition is tough, and is going to get tougher.

What’s more, the competition is not just here in Australia. The global economy means our kids are competing against the brightest minds from anywhere in the world.

Given all this, you can understand why children stay home well into their mid-twenties. They have no choice: they cannot afford to leave. The entry price in the most popular suburbs in all our major cities is becoming too high for most people under age 40. And even then, you would be amazed how often the new home is only afforded with a bit of discrete help from grandma and grandpa. It’s just not possible otherwise, particular if there are kids in the kitchen or on the horizon.

What can you do to help? Here is one simple solution. “Buy” your child a home now. It does not have to be something they will live in when they are 50. But it should be in a part of the world that has good growth prospects. Buying another home in effect insulates your family against future home price increases – and helps to protect the next generation against the risk of home prices running away even further.

If your own home is paid off or nearly paid off, and you are still earning at a reasonable clip, most of the banks will lend you a similar amount at home loan rates without too much fuss or bother. Make sure the interest rate is the same as the home loan rate: the banks will often try to squeeze an extra percentage point or two here, and have been known to tell clients that they have no choice but to charge that bit extra. “It’s the ‘investment loan rate,’” they say.

Space does not allow us to explain the tax maths of all this. But we will explain it in our next ebook The User’s Guide to Negative Gearing, which will be published in March. The ebook will show that a relatively small after tax cost to mum and dad in the early years spares your child a large before tax cost in the later years. This gives your child a real economic head start in life and, with a bit of luck, the child’s own efforts will amplify this head start many times over.

The bottom line is that, for higher income earners, it’s almost cash-flow neutral to 100% gear a rental property if the interest rate is 5%, the rental yield is 3.5% and depreciation can be thrown in as well. The tenant (with a little help from the tax office) basically pays the place off for you.

Sometimes, the second and subsequent homes are owned through a family trust and the children just live in them later on while saving for their own homes and investments. This has the added advantage of protecting the children against the risk of losing assets in divorce or a bad business experience. Residential property can be a great investment for a trust (and everyone else for that matter).

This strategy works with one, two or even three children. Maybe the maths become a bit daunting with four or more children, but the idea can of course be modified by buying the homes a few years apart or buying lower priced homes and letting the children up-grade them later under their own steam.

Or maybe just aim for half a home for each child.

Call us old-fashioned, but we think this concept is even more important for your daughters. It might be 100 years since the suffragettes, but women still do not have equal incomes or workplace opportunities. Most women have less than $40,000 in superannuation when they retire. That won’t go far.

Virginia Woolf thought it took a room of one’s own to achieve gender equality. We’d change that to a home of her own – for each of your daughters.

There is a saying in business that the best time to plant a tree was always ten years ago. But there is an even better saying in philosophy: the meaning of life is to plant trees that someone else will sit under in the future.

These sayings are relevant here. This strategy was a great one to implement ten years ago. The return on residential property was 8% per year for the ten years to December 2015 (source: ASX/Russell Long Term Investing Report. You can read this report here).

An investment returning 8% per annum for ten years provides a total return of 116% for the period. A $400,000 home purchased in 2005 was worth $864,000 in 2015 (including the rent received). If only you had read this in 2007, you would now be sitting pretty!

But ten years ago was ten years ago. The key is to not be having the same regret in 2027. So, get in touch with us now and let us talk you through how you too can help your kids have a home of their own.

If you would like more information on home loans contact MartinCo today >

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This is especially important when it comes to the interest you pay on your debt. Minimising the real after tax cost of debt is necessary to maximise the real after tax return on your investments – including the investment you are making in your business or practice.

When is interest deductible?

Interest is deductible where the purpose of the borrowing is to generate assessable income.

The critical word is “purpose”. How do you prove purpose? Paper proves purposes. In the case of interest on debt, purpose is proved by looking at the detail of the borrowing and what it was actually used for. The courts have often looked at the question of purpose, in the context of whether interest on a loan is tax deductible against business or investment income. You can get an idea of the scope of their enquiries by reading ATO Taxation Ruling TR 95/25, which can be accessed here: ATO Income Tax Ruling TR 95/25.

When you use borrowed money to generate income, it’s always a good idea to create and retain a clear paper trail showing the deductible purpose. This paper trail should be long and detailed, including for example the original e-mail to your bank manager to get the ball rolling, the formal loan application, the loan documents and all other documents created in connection with and as a result of the loan. This includes things like bank statements reconciled to actual receipts, etc.

Tax deductible debt is cheap money

• At present some people are borrowing money for as little as 4% a year.
• If a business owner is in the 37% tax bracket, this means the after tax interest rate is just 2.5% a year
• Inflation is running at about this level, which means the real interest rate is virtually nil.
• In other words, once you consider tax and inflation, tax deductible debt is very cheap money.

Once you have debt, everything you buy is borrowed

I was chatting with Adam, a fellow financial adviser. We were discussing Eve, a new client Adam met while holidaying in Eden (NSW – and yes, the names have been changed). Adam said Eve was quite well off and had just paid $200,000 cash for a new parcel of shares. But when he looked at Eve’s financial statement he noticed she also had a $200,000 home loan. It was not much. And her home was worth well over $600,000. But it was still a loan.

This means that Eve had in effect borrowed to buy the shares. This is because she could have used the cash she used to buy the shares to pay off debt instead. When Adam pointed this out, Eve tried to disagree. She told him she would never do that. She would never borrow money for investments.

The point is that, whenever someone has any debt, that person in effect borrows every time they spend any money at all. It does not matter whether they buy a litre of milk, a new shirt, a new car or a parcel of shares. They have in effect borrowed because they could have used the cash involved to pay off the loan. But they did not. This means they have more debt than they would have had if they had not bought the milk, the shirt, the car or the shares. So, they have ‘borrowed’ money to buy the milk.

What’s more, because Eve’s debt was a home loan, the interest was not tax deductible.  If she was paying 4% to her lender, then this was the after-tax cost.

A simple thing for Eve to have done would have been to use the $200,000 to repay her loan, then borrow $200,000 specifically to buy shares. Shares generate taxable income, in the form of dividends. Because tax is paid on dividends, interest on money borrowed to buy shares is deductible. If Eve is in the 37% tax bracket, then the after-tax cost of the debt falls to just 2.5%.

On a $200,000 loan, this equates to a saving of $3,000 per year. Every year.

The golden rule

This brings us to the golden rule of debt management, which is to:

1. Use cash to pay for private costs, including loan repayments on private debt such as home loans; and
2. Use debt to pay business and investment costs.  Your business and your investments generate taxable income. So debt used to finance these activities is usually deductible.

Following this simple rule means you will pay off your expensive non-deductible debt as fast as possible. This minimises the after-tax cost of your debt. And when you minimise a cost – any cost – you increase your profits.

The golden rule does require you manage cash flow in the right way. If you don’t, then you can fall foul of the tax laws. So, please contact us and we can show you how to manage your debts to legally and legitimately minimise your tax and therefore maximise your profits.

If you would like more information about tax deductible debt please contact MartinCo today here >

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