A Fin24 user wants to know where he can invest his R1m from a bond to gain maximum tax advantage. He writes:
I have two townhouses that have been paid off and earn income in the form of rentals. I have applied for a housing bond of R1m on both properties. The bond will generate taxable interest against the rentals.
Where can I invest the R1m (products) and for how long in order that I should pay zero or a very small amount of tax?
First of all congratulations on your property portfolio play. This strategy has worked well for investors for a number of years and is an intelligent means of leveraging against existing assets to invest further.
There are a few things to consider when taking debt out against a rental property:
Remember also that we are currently in a low interest rate environment and whilst we do not see rates increasing this year, they are likely to climb eventually which will subsequently increase your monthly repayment. At a prime rate of 10.25% payments become R9 820 monthly; whilst at a prime rate of 11.25% payments are R10 500.
In the early years of the bond the majority of the repayment is interest and will therefore result in a higher after tax yield. However, towards the end of the bond period the principal forms the lion’s share of the repayment which will result in a smaller deduction and a higher taxable rental income.
In terms of investing the R1m received from the bank it is important to target a return that is in excess of the after tax net finance hurdle rate (breakeven rate at which the lump sum must grow in order to equal the cumulative bond repayments) in order to make this strategy viable.
In order to achieve such returns one must take on a level of market risk, as interest yielding investments typically generate returns which are both lower than this level and less tax efficient.
We would therefore recommend that a long term time horizon is considered to be able to ride out short term volatility in search of a higher return. We typically recommend a period of five to seven years for this type of investment. This ties into your query on how long you should invest.
In terms of your query about tax friendly investments you have a number of options although no investment product is entirely tax free but rather tax efficient.
I have listed a number of potential products below with basic characteristics but it is very important to fully understand the liquidity and other constraints that go hand in hand with the reduced tax.
A full explanation of which is out of the scope of this discussion.
It is difficult to point you in an exact direction, both on the product as well as the underlying investment side, without having full insight into your entire portfolio; your goals; your tax profile; your liquidity needs and your attitude towards risk.
As this cannot be construed as formal financial advice, it would be in your interests to contact a certified independent financial adviser, who will be able to conduct a full analysis on your financial position and goals and provide professional guidance with regards to your entire financial plan and risk profile.