Tax Strategy: Use Capital Losses Quickly – Recycle debt + death

Some people have carried forward capital losses. These losses can usually be carried forward until the taxpayer has a capital gain which can ‘soak up’ the capital loss.

I think it is a good idea to use up these losses as soon as possible.

The main reason being that losses are ‘lost’ at death. If the taxpayer dies their loss cannot be passed on to any other person who could utilise it. Don’t lose a loss!

Example

Bart bought a property in a mining town for $1,200,000. He ended up selling it for $700,000 and has a carried forward capital loss of $500,000.

Bart dies and leaves a rental property that he owns to his sister Lisa. The property has a $500,000 capital gain.

Unfortunately, Bart’s loss will not benefit anyone. Lisa will inherit the investment property pregnant with a $500,000 gain, yet she cannot benefit from the loss.

Had Bart sold the investment property before his death he might have made $500,000 tax free and this money could have been passed onto Lisa. He might have even sold the property to Lisa – perhaps with vendor finance if she couldn’t have afforded a loan. Also, if Bart had a flexible will his estate could have sold the property and possibly used up the gain.

Another reason to use up capital losses is their benefits with debt recycling. Making capital gains without needing to pay tax will mean there is more money with which the non-deductible debt can be reduced.


Example of Debt Recycling

Lisa has a $100,000 capital loss from some bad share investments many years ago. Because of this she has a large amount of debt still outstanding on her main residence. But this has not stopped her investing in shares again. She has learnt from her mistakes and is now making some good capital gains.

If Lisa’s shares increased in value by, say $20,000 in the first year, she could sell these shares, pay no tax, and use the proceeds to pay down the non-deductible debt, and then invest in more shares and repeat.

Doing this has 2 advantages

  1. It uses up the loss, and
  2. It produces tax free capital gains which can then be used to pay off the non-deductible debt quicker.

Speak to your tax lawyer or tax agent.

Being Both Executor of a Deceased Estate and Applying for Super Death Benefits

The executor of an estate has fiduciary duties to maximise the estate of the decreased. There can be conflicts of interest where someone is both executor and they apply, in their personal capacity, for the superannuation death benefits of the deceased, and this is because they are trying to avoid having the super death benefits paid into the estate, to benefit themselves.

Example

Mum and Dad divorce many years ago, son dies without a will. Son has about $40k in assets plus about $400,000 in super death benefits. Under the intestacy laws where a person dies without a spouse and children then both parents will benefit equally from the estate.

The issue here is that $40k is in the estate and will go to each parent in the share of $20k each.

If the superfund pays the death benefits to the estate the parents will get another $200,000 each.

If the superfund pays the mum, dad will miss out on $200k and similar if the superfund pays dad.

But, by mum applying for the benefit herself she is depriving the estate the money which means she is potentially breaching her duties as executor. As executor she should be asking the superfund to pay the money into the estate – it is her legal duty to do so.

 Moral of the story – seek legal advice before accepting the position of executor, especially if the deceased

Loan Tip: Overcoming Cash out Restrictions When Buying Main Residence

This strategy is simple yet often overlooked.

Strategy: When buying a new main residence borrow 80% to acquire it, whether you need to or not.

Example

Bart has $400,000 cash and wants to buy a new main residence for $500,000. He plans to borrow $100,000 and then later set up a LOC to invest.

He borrows $100,000 and settles on the purchase. Then he asks for a $100,000 LOC and the bank starts asking questions. Eventually, after giving a DNA sample Bart is approved, but they want a statement of advice from a financial planner saying that Bart will invest in shares.

Lisa is in the exact same situation. Lisa gets some credit and tax advice and borrows $400,000 to buy her main residence. At application stage she splits the loan appropriately so that at settlement she can pay down 2 loan splits and is left with one split with $100,000 outstanding.

  • Lisa had no questions asked about future investment plans,
  • Lisa got the lower main residence rates for all of her splits (prob paying 1% less than Bart),
  • Lisa isn’t incurring any extra interest or costs, and won’t until she draws on the splits, and
  • Lisa has split the loans for tax purposes already.
  • Lisa has saved by not needing to pay a financial planner tosatisfy the lender.

In summary, Lisa has overcome the cash out restrictions and gotten a lower interest rate.

Tax Tip: The effect of Taking a Year off Work to Save CGT

If someone sells a property and has a large capital gain is it worthwhile taking a whole year off work to save tax? In my view it is always great to take a year off work, but it might not actually save you that much tax.

Example

Richie Rich is about to sell an investment property with a $200,000 capital gain. He is sick of it under performing and draining him with land taxand has a low yield. Richie is toying with the idea of taking a whole year off work to save CGT. Is it worth it?

Let’s assume Richie earns $100,000 in his job, and the sale will happen in the 2018-2019 financial year.

If he sells the $200,000 gain will be reduced to $100,000(due to holding it longer than 12 months) and added to his other income for the tax year. The result is an annual income of $200,000

Tax on $100,000                   $26,117          Net income   $73,883

Tax on $200,000                   $67,097          Net income   $132,903

Difference                              $40,980          Difference      $59,020

The Capital Gain will mean $40,980 in extra tax payable for the year.

This means by giving up a year’s income from work Richie would only earn $100,000 from the capital gain. Therefore, he will save $40,980 in tax by not working.

But not working means he has less income, working the full year in which the sale occurs will net him only $59,020 as opposed to his normal $73,883 (a difference of $14,863).

He would need to determine if the effort of working is worth the pay cut of $14,863 which is about $286 per week.

He should also factor in transport costs to work and other work-related costs – clothing, lunches etc.  and there are also heaps of non-financial things to consider. There would be time to do other things such as:

  • Start a business
  • Travel
  • Study
  • relax

Written by Terry Waugh of www.structuringlawyers.com.au

Offset in the name of the lower income earner

Once you have paid off your main residence you will probably want an offset account on one of your investment properties. This will be a useful place to store cash from rents and wages and also to save up a buffer for emergencies.

Where you have used the strategy of buying properties in sole names, some in the name of Spouse A and some in Spouse B, you can move money around to create tax savings.

You would generally want the cash in the name of the lower income earner as this spouse would generally be the one paying the least tax. Where there are several lenders involved (with that spouse) you would choose the lender with the highest rate as this will produce the highest return.

Money in an offset means less interest is incurred which means more income from the property.

Example

Homer is on the top marginal tax rate and his wife Marg has a taxable income of $0. They each own 2 rental properties. They have just paid off their home and old man Simpson has died and left them with $200,000 cash.

Where should they put it?

The answer, from a tax perspective, would be in an offset account attached to Marg’s loans.

Loan A is at 5% pa and Loan B at 5.5% pa. Both have offset accounts.

In this situation if $200,000 is deposited in:

Loan A the savings would be $10,000 per year. Marg would pay no tax on this

Loan B, the savings would be $11,000 per year. Marg would pay no tax on this.

There would no extra tax to pay as Marg’s income is $0 before this, and after depositing her income would be either $10,000 or $11,000 both of which are under the tax free threshold.

Let’s say Homer had 2 loans with each at 6% pa. If the $200,000 was deposited into either of Homer’s offset accounts the interest savings would be

$12,000 per year.

But as Homer’s interest decreases by $12,000 his income increases by this amount and because he is on the 47% tax rate 47% or $5,640 would be lost in extra tax.

Thus after considering tax the funds would be better placed into the offset account on Loan B belonging to Marg.

Keep in mind the legal consequences of ownership in different names too:

  • asset protection
  • estate planning on death
  • effect on spousal loan strategies

Perhaps a private loan agreement, even at nil%, can assist in legal planning.

This is also another reason to consider purchasing in sole names.

 

Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au