Borrowing against your rentals to reduce tax liability?

[Bearded Man]

I recently read that "the rich" borrow against their wealth and live off the money from the loan on their capital, because it does not incur a tax penalty, whereas selling an asset does.

I could see this playing out well with rental properties, and being quite advantageous. As the value of the house and the rents go up, to reduce your taxed income from the rental, you refinance and have a higher mortgage payment while still being cash flow positive enough to live off. Meanwhile you are flush with cash from the refinance to invest again and keep repeating. Or you could live off it, do whatever with it.

[beltim]

People certainly do this, but the reason is rarely because of taxes.  Paying 4% to save 1.5% never makes sense: it's a classic case of the tail wagging the dog.

The actual reason is leverage: they believe the underlying asset will appreciate faster than the cost of the loan.  This reason certainly applies to real-estate secured debt: if you take out a loan secured by the value of the house and invest it elsewhere (real estate or stocks or something else entirely), then you'll make money if the return on the invested funds exceeds the cost of funds.

[marty998]

Yeah it's called Living off Equity.

Allows you to keep your assets instead of selling them and triggering CGT to fund your retirement expenses.

You just need to prove to the bank you can service the loans, and you need to feel comfortable that you won't hit LVR limits before you die.

[Bearded Man]

People certainly do this, but the reason is rarely because of taxes.  Paying 4% to save 1.5% never makes sense: it's a classic case of the tail wagging the dog.

The actual reason is leverage: they believe the underlying asset will appreciate faster than the cost of the loan.  This reason certainly applies to real-estate secured debt: if you take out a loan secured by the value of the house and invest it elsewhere (real estate or stocks or something else entirely), then you'll make money if the return on the invested funds exceeds the cost of funds.

Paying 4% to save 1.5%? I take it 4% is the loan amount interest rate, what is the 1.5% savings you speak of? Savings on taxes are certainly greater than 1.5%

Also, keep in mind these are rentals. I'm not paying the loans, my tenants are, and increasing the mortgage payment by withdrawing enough money to have just enough money to live off reduces the amount of tax I pay on the cash flow. And I don't pay capital gains taxes or earned income taxes on money I withdraw from the house. These are huge savings.

[beltim]

People certainly do this, but the reason is rarely because of taxes.  Paying 4% to save 1.5% never makes sense: it's a classic case of the tail wagging the dog.

The actual reason is leverage: they believe the underlying asset will appreciate faster than the cost of the loan.  This reason certainly applies to real-estate secured debt: if you take out a loan secured by the value of the house and invest it elsewhere (real estate or stocks or something else entirely), then you'll make money if the return on the invested funds exceeds the cost of funds.

Paying 4% to save 1.5%? I take it 4% is the loan amount interest rate, what is the 1.5% savings you speak of? Savings on taxes are certainly greater than 1.5%

Also, keep in mind these are rentals. I'm not paying the loans, my tenants are, and increasing the mortgage payment by withdrawing enough money to have just enough money to live off reduces the amount of tax I pay on the cash flow. And I don't pay capital gains taxes or earned income taxes on money I withdraw from the house. These are huge savings.

Yes, I used 4% as an example interest rate. The 1.5% is the tax savings that would be realized if you paid a 37.% tax rate - possible but unlikely. And it can't get much higher than this.

Your tenants would be paying you either way, so it's not relevant to calculating the cost of a loan.

[mr_orange]

Borrowing is not a taxable event and it is a good way to access liquidity when you find projects worth pursuing.  Property makes nice collateral for a line of credit as well to give you the speed needed when there are opportunities worth pursuing. 

If you keep 1031 exchanging up and doing like-kind exchanges your basis steps up at your death too and you never pay taxes.  Pretty nice ;-)