SHARES OR PROPERTY
SESSION 2
In session 6 we will see that pensioners affected under the income test should look for capital gain as $1 in capital gain is worth $3.15 of ordinary income and that $1of depreciation is $3.88 of ordinary income. (see below)
Depreciation is primarily available for property which brings us to the question whether property is a good investment and particularly whether it is a good investment for pensioners.
The good old question of property against shares
Shares Growth 7% Income 4%
Property Growth 7% Income 4%
Depreciation 4.25% of building 5 years
There is very little difference in Capital Gain and income of shares and property in the long term apart from the fact that shares could be volatile and property is more stable.
If the property is an existing property the question is still unresolved.
There is a consideration to be taken into account with property if we split up property in land and buildings. Capital growth for land in the future will be greater than capital growth for buildings.
A standard clause in a Development Application (DA) is that the developer is responsible for any upgrade of infrastructure ( roads, sewer, stormwater and water). Most infrastructure in capital cities has reached it’s capacity and existing sewer and stormwater pipes will have to be increased.
Any new road reserve under Town Planning rules must be 17.5m wide, footpaths must be 1.5m wide and regional areas have the same strict demands as capital cities areas.
All this will result that property development becomes very expensive and the developer must pass this on to the public. This will also increase the value of existing property.
It is therefore likely that land will have a greater Capital Gain in the future.
Some argue that shares are liquid and property is not. This is not true because if you need money you can always borrow it with the property as security.
I was in a seminar together with 500 other advisers and a presentation of “Property against Shares” was given.
Lots of jargon, graphs , history but in the end it boiled down to the fact that the presenter considered income and capital of both investment but then finally compared the Accumulation Index of Shares (Capital Growth + dividends re-invested) with Capital Gain of property without the rent being re-invested.
And low and behold shares came out ahead.
Not one of the 500 advisers in the room stood up and said
“you are comparing apples with bananas and your argument is absolute rubbish”.
Investment advisers have a very vested interest. When you recommend a share-trust to your client you get a commission of 5%. If you recommend residential property you get nothing. Investment advisers use property trusts which are mostly commercial property.
Most investment adviser are controlled by a bank or financial institution. They can only pick from a recommended list and I have never seen a list of recommendations that includes residential property.
Most investment advisers will recommend a diversified portfolio but they argue that the client already owns their residence so why do we need further property.
So, shares and established property are probably 50/50 but new property is a different kettle of fish and new property is superior because of depreciation allowances.
There are 2 types of depreciation and the following is very rough and you should always get a Quantity Surveyor’s Report to prepare a proper depreciation schedule. Depreciation can be divided in Division 40 and Division 43.
Division 40
This is carpet , air conditioners etc which roughly amounts to 10% of the building. Depreciation is over a short period using the diminishing value method, say 5 years. This means that for the first 5 years 2% of the building cost can be used as depreciation.
Division 43
For the remaining 90% of the building. This is depreciated over a 40 years or 2.25% of the building cost.
So for new buildings for the first 5 year there is a tax deduction of 4.25%
Sell the building after 5 years or carry out Division 40 renovations and increase the rent
We are interested whether Shares or Property are a good investment for pensioners
Share Investment
Centrelink assesses shares under the income and asset test.
Under the asset test, shares are an asset. If registered on the stockmarket the value and number of shares has to be declared to Centrelink after which they will monitor the shares. Any fluctuation in share prices will automatically result in variations in your pension.
Under the income test, the actual income from shares is ignored . Instead the income from shares is deemed under Centrelink’s deeming rules.
Franked dividends and franking credits are ignored by Centrelink but are taking into account by the ATO.
Tax rules and Centrelink rules are different and franked dividends and Franking Credits may be beneficial to Self funded Retirees as they will reduce tax .
Centrelink still monitors the value of the shares and the deemed income from the shares may vary and therefore also affect your income under the income test.
Property Investment
Centrelink and the Taxation Dept have different rules. There is for instance no negative gearing for Centrelink ( losses cannot be offset against other income). Building allowances on property (Division 43) are not allowed but Centrelink will still allow depreciation for plant and equipment (Division 40) . Taxation department still allows both types of depreciation.
There is however one Centrelink concession left for retirees and that is Capital Gains . This means that a dollar of Capital Gains is worth a lot of money to a retiree.
Capital Gains is not regarded as income for Centrelink.
It is regarded as an asset but this will normally not affect the pension.
This makes property a very good investment for retirees on a part pension affected under the income test
Using the example above , a dollar of Capital Gain is worth the following,
Pay Capital Gain after 1 year @ ½ x 30 cents = 15 cents
Therefore a retiree will have 27 cents left for every dollar earned but 85 cents left for every dollar of Capital Gain after paying Capital Gains Tax.
This is a 315% increase
Or in other words;
$1 Capital Gain is the equivalent of $3.15 of normal income
The second strategy is to create depreciation allowance as every dollar of depreciation equals $3.88 of ordinary income.
These strategies will be discussed in Session 6
In summary
Long term income and capital gain in shares and property are roughly equal.
Under the asset test there is very little difference between shares or property. Shares have advantages if franking credits are used but property has the advantage of depreciation allowances.
Under the income test it may be beneficial using our strategies to change property income to capital gain or borrow money against investment property to invest in shares.
In both cases borrowing money will enhance the performance of the investments
In further sessions we will show that if you invest in property you should borrow against that property to invest shares.
Disclaimer
I have a vested interest in property being a director of a property development company building affordable rental accommodation for pensioners