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One key part of investing in property – in fact, it’s a good habit to practice in nearly every part of our lives – is the idea of having an exit strategy should things fail to go according to plan (the “Murphy’s Law” scenario)!
The exit strategy you choose will depend, in some part, on the phase of property investing you’re going through.
Create an exit strategy before you even put down a deposit. Know what you plan to do with the property (buy and hold, flip, renovate) and be open to last minute changes to your plan if necessary.
3 Stages of Wealth Creation
Essentially, a property investor will go through each of the following three-wealth creation phases numerous times before they’re ready to stop actively investing:
- Acquisition phase
- Consolidation phase
- Lifestyle/Legacy phase
During this period of your property-investing career, you are in the process of showing lenders that you are a safe risk. They’ll want to be assured that your income is secure and that you have the capacity to service your debt.
You will need to understand how to use tax deductions to your advantage and make the most of leverage – even if it means lender’s mortgage insurance (LMI) is part of the deal.
During this phase, you are “streamlining” your investment portfolio, selling properties to reduce your debts and to maximise your cash flow. You also want to be certain that your ownership structures are compatible with your strategies.
For example, your capital tax obligations will be different depending upon whether you own property as an individual, in a company trust structure or your SMSF.
This stage is reached once you’ve begun nearing retirement. The plans you set when you first began investing in property may change at this point because let’s face it – “life” happens.
You may decide that you want to start a new venture after retiring from your chosen profession rather than sit back and enjoy your retirement.
As you may already have realised, these phases aren’t cut and dried, and you may find yourself going through each of them a number of times before you can call your wealth creation journey complete.
As suggested earlier, the exit strategy you choose will be dependent upon the phase you are in.
There are a number of strategies you can employ as a property investor to mitigate any losses and make the best use of your finances.
This is more like a “no-exit” strategy.
Your properties have delivered some great capital growth. You tap into your equity by opening a line of credit (if permissible) that you use to pay off your loan balance and for your living expenses.
You live off of your properties’ rents – assuming you’ve paid off your mortgages.
This strategy can be used during all three phases of wealth creation.
Sell properties that aren’t performing then use the proceeds to pay off the mortgages on your prime investment properties. The idea is to have a continuous stream of passive income once you’ve finished building your portfolio.
You can spot the losers in your portfolio pretty easily. If it’s been five years or more and the capital growth on your investment property hasn’t beaten out inflation during that time, there’s your candidate!
If you don’t plan to leave anything behind and you have determined that you can live off the sales proceeds for the remainder of your life, sell all of your properties and live it up!
Use this strategy at any time to “fine-tune” the capital growth and cash flow of your portfolio. Don’t forget to factor in sales costs when doing your analysis.
Buy and flip
Buy a property in need of a few minor renovations, have it revalued and then sell it – within a short time frame. This means you’ll obviously buy at a deep discount and avoid becoming overleveraged by keeping a tight eye on your costings.
Use this exit strategy during the acquisition or consolidation phases of your portfolio development. It’s a risk to do this kind of deal right before you plan to retire – just in case the market doesn’t perform.
Time your strategies
Watch supply and demand. If you see a shrinking demand for property or the land supply is opening up consider selling because your capital growth and yields may take a hit for some time.
Don’t wait until everyone’s in a rush to sell because the market is tanking. Better to give up a little capital growth than risk losing all of what you gained when the market was growing!
Put a plan in place for how you’ll deal with the “worst case scenario”. For example, let’s say your property is vacant for two months. If you have planned for such an event you won’t panic because you’ll have set aside buffers to deal with such a situation.
But let’s say it’s now been three months and not a tenant in sight. You already decided – before this event even happened – that you would have a valuation done to determine if selling would be the best option.
Decide before even purchasing the property how low you will allow your reserves to fall before you take action. Be prepared to cut your losses before you wipe out your buffers entirely.
So you’ve sold your property and are now on the lookout for a better yield, but have you forgotten about the ATO? I can guarantee they have not forgotten about you!
Capital gains tax issues
What is capital gains tax (CGT) and when do I pay it?
Capital gains tax is a tax on profits you make from an investment. It’s paid at the time you realise those gains.
Just some of the assets that are subject to CGT include:
- Managed funds
- Personal property (e.g. cars)
- Real estate purchase
Other situations where CGT may be applied include:
- If one of your assets is destroyed or lost
- If you leave Australia for good (or longer than 6 years) and you have assets
- If you purchased your property before 20 September 1985, rest easy; you won’t have to pay capital gains tax.
- Your personal residence is exempt from CGT.
How much is it?
There is no set figure for the capital gains tax. It varies depending upon the tax rate of the individual paying it. The capital gains your investment makes are added to your income and then taxed at your marginal tax rate.
Here’s an example:
$100,000 – capital gains (annual)
- 25,000 – capital losses (can add previous years’ losses to this figure)
- 5,000 – CGT discount/concession that may apply
$70,000 = Amount of capital gain which can be taxed (at your individual tax rate)
If you own your own small business this can reduce your capital gain tax even more.
How can I minimise it?
Contributor to Your Investment Property, Michael Quinn of The Quinn Group, describes how investors who choose to rent out their personal residences as an investment strategy can avoid paying capital gains tax:
“The following simple rules apply:
- Only your main place of dwelling will be exempt from CGT. Thus, you can’t own two properties, live in one for a couple of years and then alternate between that property and your main residence while avoiding paying CGT on both houses.
- Usually, if you purchased a house after 7.30pm on 20 August 1996 you have to have lived in it when it was first bought (i.e., not rented it out) to be entitled to a full exemption. This is because by renting the property straight away, the ATO deems you to have acquired the property purely as an investment to produce income.
- Provided the above terms are met, you are exempt from CGT if you rent out your home for less than six years.
- If you’ve held a property for more than 12 months and the ATO has deemed you subject to CGT, you are entitled to a 50% discount.”
As each situation is highly variable, I highly recommend you seek advice from a reputable accountant or tax professional before choosing this strategy.
To learn more about exit strategies or how you can use property as an income stream, register for our free Positive Real Estate membership. You’ll receive a treasure trove of fantastic investment information including how to create your own strategies! Click the button below to gain access.