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February 08 newsletter

The Ghost of Blue Chip

About a month ago, a friend (letís call him David) asked me to review some numbers that had been put together for him on a potential residential investment property.

The crux of Davidís investment opportunity was the projected tax deduction of the (considerable) loss on the investment property against Davidís income. Essentially, the ability to offset the cash outflow with a tax rebate was compelling.

Without looking too closely at the overall investment proposition, the numbers around the tax write off were a little optimistic.

I thought I would use this newsletter to touch on a few of those numbers in case you were to consider a similar investment opportunity.

Residential Property Investment Variables

A value of $5,000 was nominated for the set-up costs. While it was unclear what the set-up costs represented, the real problem for the purposes of this newsletter was that the $5,000 was assumed to be deductible on an annual basis. So David was seeing an annual tax rebate of $1,950 ($5,000 x 39%). That is the one result which wonít happen. Depending on the nature of the set-up costs, one of the following may apply:

  • No deduction,
  • It is capitalised with the building cost, or
  • A one-off deduction is allowable.

Another glaring problem with the annual deductions was to assume that the high level of depreciation on the chattels would be maintained. Using a diminishing value, this deduction would quickly fall after year one.

There were other blatant mistakes such as assuming the property would be tenanted for 52 weeks of each and every year.

An Investment Lesson

The lesson for us is not to accept any number or assumption at face value. Investors need to assess and understand each variable in any sort of investment.

The advantage for property investors is that, unlike managed funds, you can control the destiny of the investment. The disadvantage is that in a worse case scenario, you could lose the investment property and the family home.

It is important that you assess the merits of all investment opportunities. In particular, I always recommend that you engage the services of a qualified, independent adviser.

Random page of the month

Check out some information on the many variables in residential property investment.