2019 may be the last chance to invest tax effectively using negative gearing and the current CGT discount rate

I currently have a relatively modest amount of margin loan debt used to purchase a portfolio of growth assets (some direct investments in managed funds and shares, and some ETF investments in index funds), as I was forced to reduce my gearing during 2008 in order to avoid margin calls, and have taken a more conservative approach ever since.

This will probably change during 2019, as if Labor wins the Federal election (which seems highly probable at the moment) they intend to make massive changes to both the CGT concessional tax rates and the ability to use margin loans and negative gearing to reduce overall taxable income. According to their current policy website:

• Limit negative gearing to new housing from 1 January 2020. All investments made prior to this date will not be affected by the changes and will be fully grandfathered.
• Halve the capital gains tax discount for all assets purchased after 1 January 2020. This will reduce the capital gains tax discount from assets held longer than 12 months from 50 per cent to 25 per cent. All investments made prior to the 1 January 2020 will be fully grandfathered.

One positive feature for investors is that investments made during 2019 will still enjoy the current CGT and negative gearing rules going forward. So I'm in the process of transferring $50,000 of my available credit in my St George Portfolio Loan (a home equity loan) into my Commsec Margin Loan account, and I will then purchase $100,000 of growth assets (probably MVW and QUAL ETFs). The dividends from those investments should be less than then interest paid, which under the current negative gearing rules will reduce my taxable income from wage salary etc. When I sell the investments any capital gain will be discounted by 50% before being taxed at whatever marginal tax rate applies to me at the time. If Labor does win the election I'll think about doing the same again before the end of 2019.  While my taxable income will be reduced this year and next by tax deductions for my FP business and self-education costs, in a few years time (all going well) being able to reduce my taxable income may be more important.

A rough calculation shows that investing after the removal of negative gearing would cost me around $3,500 per year more in tax. And that investing next year rather than this year would mean any future capital gain on the investment would be effectively taxed at 75% of my marginal tax rate, rather than the current 50%. (Although this could be managed by only selling a small portion each year after I've retired and receiving a tax-free pension income from my SMSF, so that the CG was subject to nil or low marginal tax rates, in which case the CGT discount rate would not matter).

If nothing else, investing using my margin loan facility after 1 Jan 2020 would make my tax calculations a lot more cumbersome - I would have to keep track of what amount of the loan had been used to purchase investments prior to 1 Jan 2020, and how much afterwards. This could then be used to calculate the proportion of interest paid during the year that could be deducted against other income (eg. salary income) and how much interest was not deductible against other income, but only offset against dividend income. Additional complexities will be introduced if several investments are made after 1 Jan 2020, so the ratio of pre- and post- borrowed/invested funds changed during the financial year. Not to mention if tranches of pre_2020 investments are also sold at different times, and if interest rates have changed during the year

From a financial planning POV, the changes will make Investment Bonds a more attractive option for high income (highly taxed) individuals that are willing to invest for the long term. An investment bond pays tax on earnings at the company tax rate (30%), but benefits from any franking credits (so the effective tax rate is lower). And if held for 10 years or more, there is no tax payable on the gain made when the bond is sold.

Subscribe to Enough Wealth. Copyright 2006-2019

Windfall profit on RBS early wind-up of ETSBRK

Having previously bought US shares directly via Comsec, I had been unhappy with the costs (an annual fee from the US broker that was holding the stock certificates, plus a hefty fee for each international trade due to both Comsec and their US agent charging a large fee). So when I wanted to invest in Berkshire Hathaway in 2011 I decided the ETS (Exchange Traded Security) issued by RBS (Royal Bank of Scotland) on the ASX was the way to go. I bought 113 ETSBRK at a price of A$75.19 (total cost $8,496.47 + $10 payment transfer fee). RBS recently had a special meeting to seek to have unit holders pass a resolution to close down the various RBS ETS offerings early (the normal termination date was May 2021), as they have never been very popular and obviously were a significant cost to RBS to maintain - RBS decided to cease their equity derivatives business in 2014. In order to get the unit holders to agree to the early termination date RBS proposed a 25% premium to the normal pricing for these units. The resolution was passed on 2 May, and yesterday I received a nice cheque from RBS for the sale of my 113 ETSBRK for $27,223.79. This represents a very nice profit (capital gain) of $18,712.32, or a return of 220% over five years.

To mitigate some of the capital gains tax implications I've decided to fix $75,000 of my Comsec margin loan balance for 12 months at 6.49% (the current variable loan interest rate is 7.13%), which will allow me to claim a tax deduction for the $4,867.50 prepaid interest this financial year.

Subscribe to Enough Wealth. Copyright 2006-2016

Spending the holidays at home

I'm spending the Christmas/New Year holiday break at home this year. My parents are in the last stages of clearing out their Sydney house and moving permanently up to their rural property near Inverell, so we didn't get to take the kids for a farm-stay this year. DS1 will be going up to their farm in the new year to stay with my parents until the 2010 school year commences at the end of January. I have a long list of home improvement projects I'm not getting done. I had planned on first completing my 2008/9 tax return and lodge it using eTax before the end of the year, but the capital gains tax calculations were even more cumbersome than I had expected.

I'd sold off all of my smaller share holdings in March 2009 (as the market dipped below the level where I would start getting margin calls if I didn't raise some cash) and in order to calculate the relevant capital gains figures I had to trawl through 15 years worth of tax pack files to find the relevant dividend reinvestment plan amounts in order to calculate the cost basis for the shares that had been sold. Where the shares had come into my account via a distribution due to a take-over or demerger I also had to work through the paperwork for several different share holdings to calculate the cost base relating to a particular share sale. Some added complications arose where I couldn't find the DRP paperwork in the relevant tax pack file (apparently I had the bright idea of filing the papers that would be needed for future CGT calculations in a different place at some point in time - now I can't find those dividend statements at all!). In those cases I had to look up the dividend payment details online (via computershare), but the online records only went back five years. For my Commonwealth Diversified Share Fund CGT calculation I had even more trouble getting information as the company had delisted when the fund closed down last June, so I couldn't even look up the historical share price information to calculate an approximate cost basis for the DRP shares that had been issued more than five years ago. In the end I had to download the historical price data for XAO (the all ordinaries index) and use a spreadsheet to calculate the approximate ratio of CDF share price to XAO index price, and estimate the CDF share price that would have been used for each DRP allocation. The final cost base amount for my CDF should be a reasonable estimate (within $50 or so), so it won't have a material impact on my CGT calculation. In any case, it looks like I'll have made a small capital loss overall for the 08/09 tax year which will carry forward until I eventually sell some shares for a net profit.

If the ATO ever does a desk audit of this tax return (I haven't been audited yet), it will be interesting to see if they decide to accept my estimation methodology, or want to spend time working out the exact cost base figures. From all the capital gains calculation information I've seen on the ATO website, they tend to prefer the most long-winded methods possible (for example, totalling all the purchase amounts and broker fees separately and then deducting total brokerage cost from total purchase cost, rather than just adding up the net cost amounts. The two methods are mathematically equivalent). At the end of the day, there's a 50:50 chance that I've underestimated the cost base and would be due a refund.

Diversification, dollar cost averaging and use of dividend reinvestment plans seemed like a good idea at the time, but since I stopped recording all my share transaction details in Quicken in 1999 the GCT paperwork has turned into a headache. That's one of the reasons I tend to invest in index funds these days, rather than investing in individual stocks.

Subscribe to Enough Wealth. Copyright 2006-2010

Margin lending dilemma

The end of the financial year is nigh, so it's once again time to decide whether or not to pre-pay the next twelve months interest. The main benefit of doing so is that if it's paid before 30 June the entire amount is deductible in this year's tax return. The other potential benefit of pre-paying the interest is that the interest rate is fixed, rather than being variable if you are paying monthly. There appears to be little chance of an interest rate cut in the next twelve months, but some possibility that the interest rate might increase another 0.25% or 0.50%.

Each of my three margin lenders is offering different interest rates for prepaying twelve months interest. St George margin lending is offering 10.25%, but because we have our home and residential investment property loans with them we are "gold" clients, so I get a 0.25% discount on the interest rate, bringing it down to 10.00%. Yesterday I faxed in the paperwork to fix and prepay the interest on $70,000, which is almost the entire loan balance on this account.

I'll probably also fix and prepay most of the loan balance on my leveraged equities account, but I'll leave about $8,000 at the variable rate so I can reduce the loan balance at any time if I sell off some odd stock lots that were left sitting in this account after some takeover activity. Leveraged Equities usually mails me a prepayment form in early June, so I don't yet know what interest rate is on offer. Hopefully it will also be 10% or less.

My third Australian stock account on margin is with Commonwealth Securities (ComSec). They sent out a prepayment offer last week, but the interest rate on offer is an exorbitant 10.35%! This account has my largest margin loan balance (just over $150,000), so I'll have to phone them and try to negotiate a better rate. If they won't come to the party I'll consider transferring the holdings to my St George margin loan account. I'd rather not have to do so, as it might trigger a capital gains tax liability. It might also be a hassle arranging for the Comsec loan to be paid out if the shares on that account are transferred to my St George margin account.

The higher interest rate charged by ComSec seems even more excessive considering that they don't pay any trailing fees to brokers (as I found out from YourShare when I arranged to get a 50% rebate of trails on my various investment and loan accounts by making them my nominated broker). If I borrow funds from St George rather than ComSec I would get a rebate of trailing fees worth around 0.15% in addition to the interest rate being 10.00% rather than 10.35%

The interest rates on my margin loans have increased from around 8% a year ago, to around 10% today. There's considerable risk that the overall ROI of my stock investments won't exceed 10%pa in the medium term, which would make the use of gearing an ineffective investment strategy. However, most of my Australian stock holdings include considerable unrealised capital gains, so I'm not keen on selling stocks in order to reduce my margin loan balances at this time.

If interest rates drop and margin lending remains a useful investment strategy, I'm hoping to be able to liquidate these holdings gradually during my retirement. Under the current superannuation rules my SMSF pension income won't be taxable and doesn't even have to be included on tax returns. This would (I think) mean that it wouldn't be counted as income when working out the marginal tax rate to be applied to any capital gains realised during retirement. On the other hand, the Rudd government has indicated that they want to include such retirement pension income in some social security calculations, so presumably the data would then be available to the ATO and might end up also affecting capital gains tax calculations.

It's a bit hard trying to make sensible decisions about taxation planning when the rules can change at any time. In fact, some Labor politicians have expressed a desire to do away with the current 50% CGT concession for "long term" capital gains, so holding on to my stocks could end up costing me a lot extra tax in the long run. Perhaps I should hedge my bets by selling off a portion of my Australian stock portfolio and use the proceeds to reduce my margin loan balances. Of course, if I want to do that during the next financial year I can't fix and prepay the entire loan balance. Decisions, decisions...

Subscribe to Enough Wealth. Copyright 2006-2008

Alternative/Passive Income Week

Last week was a good one for 'passive' income. A cheque from Primary Healthcare arrived for the takeover of my Symbion shares ($11,664) and the half-yearly dividend payment season was in full swing, so I received $4,298.71 by direct deposit into my credit union savings account:

26/03/2008 LLC $ 206.83
26/03/2008 QBE $ 394.55
28/03/2008 APA $ 12.76 
28/03/2008 APA $ 679.33
31/03/2008 AEO $ 56.20
31/03/2008 WPL $ 121.00
01/04/2008 SYM $ 144.00
01/04/2008 BSL $ 171.82
01/04/2008 SUN $ 500.76
01/04/2008 BBI $ 4.62
01/04/2008 BBI $ 9.82
02/04/2008 FGL $ 450.12
02/04/2008 CBA $ 146.90
04/04/2008 TLS $1,120.00
04/04/2008 TLS $ 280.00

However I don't count this as disposable income as it all needs to be reinvested (the takeover payment) or used towards the interest payments on my margin loans (the dividends).
Copyright Enough Wealth 2008