181 - Buying an investment property? Here are some numbers to crunch

Question

I need some financial advice regarding an investment property. I intend selling my existing property for R2m.  I will use R1m as a deposit on a new property and invest R1million in a 5 yr fixed deposit. The interest earned per month is estimated at 10K per month. This I will use to pay for the bond, levy etc.

How can I structure my tax package so that I pay the minimum tax due to SARS?

Answer

Without knowing the rates on offer and your personal details, I cannot give you a definitive answer. I can, however, share some principles that may help you make an informed decision.

Look at after tax interest rates

The interest on your fixed deposit is fully taxable so you must take this into account when you do the numbers.  You need to calculate the after-tax interest rate.  To do this, you must do the following: 

• Calculate the amount of interest you will get in a year
• Subtract the tax free amount you qualify for. If you're under 65, the first R23 800 in interest will not be taxable.  If you are over 65, this amount increases to R34 500.
• Divide this number by your investment amount

This will give you the after tax interest rate that your investment is providing.  You would use this number to compare with the bond rate 

Regard your bond rate as a tax free investment

As you are taking out a loan to buy the property while having sufficient cash to fund it, you need to ensure that the after tax returns that you get on those investments are better than the interest rate that you are paying on your bond.

For example, if your home loan rate is 11.5%, then any investment that you invest in must give you an after-tax return that is higher than 11.5%.  In your instance, the after tax fixed deposit return would need to be greater than 11.5%

Rental income is fully taxable

Your rental income will be fully taxable. However, you will be able to offset the interest payments on the bond against this rental income for as long as you have the bond.

Once you have all these numbers, you should have a good idea on what would be the most effective way to fund your investment property.

Should you do this?

Before you make any investment, it is always worthwhile to look at all options and see if there is not a better option open to you.

If you invested the full R2m into a well-constructed investment portfolio instead of buying an investment property, you would have the following: 

• you could draw an ongoing stream of income from the investment while the capital grew
• the tax on the income would be lower than that you would pay on rental income and fixed deposit interest as it would be charged at the CGT rate which is less than half of your tax rate
• the capital is easily accessible without any charges like estate agent fees and transfer costs
• There is no schlep of dealing with tenants who may require repairs or are unable to pay their rent.

There will be times when a property investment is best but there will also be times when an investment in a unit trust portfolio will be the way to go.  It is therefore important to follow a structured approach when comparing investments.