CHAPTER 4
Other Practical Aspects of Home Ownership
4.1
Who should own the home?
This is often a key question for self-employed clients. To them, the worst aspect of falling into financial 'trouble' in their business is losing the home. This causes the most angst and pain. It can even destroy marriages. Ask yourself how your partner would feel if you lost the family home as a result of your business or investment activities. It would probably rank after the death of a close relative as the worst thing that could happen to you, and the most stressful.
As a result, the question of whose name the family home should be owned in is one that all business owners or others who may be sued (health professionals, lawyers, etc) need to resolve.
4.2
Should a spouse own the family home?
If you do not own something you cannot lose it. So, for people in 'risky' professions who become involved in some sort of litigation, if their spouse owns the home it will typically be safe and beyond the reach of the courts in the event that professional indemnity insurance does not cover any damages claim.
The Family Law Act generally ignores nominal ownership between spouses (with some few exceptions). It generally does not matter whose name the home is in if the marriage breaks down. This applies to all the marriage assets.
So if clients are married and are considering buying a home they should think hard about whose name the house should be owned in. If one member of the couple is engaged in a risky occupation and is litigation prone, most likely it will not be in their name - unless their spouse is even more litigation prone than they are.
How do you tell who is more litigation prone? Simple. If one spouse pays more professional indemnity insurance than the other it means the actuaries think that spouse is the more vulnerable to litigation.
Our practice has access to a team of lawyers who can provide assistance on issues to do with nominal ownership of the family home. If you have any questions, please let us know.
4.3
Family trusts, family homes and the Family Law Act ("FLA")
The Federal Court, which oversees the FLA, has sweeping powers to ignore any legal arrangements put in place to defeat the purpose of the Family Law Act. Transferring the home to a trust controlled by one party will almost certainly have no effect for FLA purposes. The Federal Court will simply ignore it. It is a powerful Court.
But owning a home in a family trust can still make sense, especially where asset protection (that is, the risk of losing valuable assets in a litigation) is an issue. Owning a home in a family trust does negate some of the tax advantages that apply to the family home. These include that a family trust cannot access the principal residence exemption, meaning that CGT is payable on 50% of any capital gain that the home enjoys. In addition, land tax can apply to family trusts.
That said, there can still be advantages for owning a home in a trust. These include:
- That the trust will outlive the current tenants of the house, allowing for inter-generational transfer of the property. Remember, the principal residence exemption is only an advantage when the property is sold;
- CGT is only paid on half the capital gain if the home is actually sold (assuming it is held for more than a year). There is an argument that homes should be owned for a minimum of 10 years, and should not be sold even if the client upgrades, but instead retained as an investment property;
- Family trusts are CGT efficient for owning appreciating assets. Beneficiaries with little or no other taxable income can receive a capital gain and pay little or no tax;
- Even if some CGT is paid, this is a small price for the security of the home being beyond the reach of litigious client, and for the tax benefits enjoyed in earlier years.
In summary, for clients who face the risk of losing the family home in litigation, family trusts are well worth considering.
As we say above, our practice has access to a team of lawyers who can provide assistance on issues to do with nominal ownership of the family home. If you have any questions, please let us know.
4.4
When should homes be sold?
In our experience, many clients are too quick to sell their homes, particularly when upgrading to a new home. If you are living in your second or subsequent owner-occupied home, ask yourself a question: do you wish you had kept the first home you bought? For most people, the answer is a resounding yes.
Homes have, on average, returned 9.5% per annum over the last two decades. When people upgrade, it's usually not long before the sale of the old home is regretted.
People should consider never selling their old home when they up-grade, and should instead consider retaining it, renting it out and letting time do the rest. The first few months, or even years, may be tight, but before long the value of the new home and the old home will rise and the decision will be validated.
As a helpful hint, we recommend interest offset accounts as much as possible: buyers can withdraw their equity and transfer it to the new home, reducing non-deductible debt, while the old home becomes a negatively-geared investment property. If you think this could be relevant for you, please let us know.
4.5
What if your home is not expected to appreciate?
Clients in capital cities think home prices always go up. This is optimistic, but that optimism has a solid base: in most capital cities they almost always do go up. At least eventually.
But outside capital cities the position is more complex. In some places prices do not rise at all. In other places prices fall. Rural or regional clients should always consider owning at least one residential property in a capital city.
It is clients living outside of major cities who might pay the most attention to Phil Ruthven (see above). Living away from the city is often a lifestyle decision. In such cases, it makes sense to separate the lifestyle and the investment decision as Ruthven recommends. Live in the bush - but own in the city.
4.6
Homes for children
Whenever we meet with clients who are parents (and over 85% of women end up being mothers - the same proportion of men probably do as well), those children are very much in our mind.
Simply put, clients with children over the age of 18 - or at least, children now earning taxable income - should encourage those children to buy a first home, with a 20 year time frame in mind (as we say this, we are fully aware that there may be some better investments for time periods of less than ten years).
A loan, or a bank guarantee, from mum and dad means the next generation enters the property market much earlier than otherwise. This lets them buy properties at 2017 prices, rather than 2035 ones. And if the children stay at home and rent the property the tenant and the tax benefits pay much of the costs. This further accelerates the wealth creation process.
It's a great way for clients to create a permanent financial advantage for their children. Property is an inter-generational asset. Parents and grandparents should be thinking that far ahead.
The only real down side is the risk that the property may fall in value and the parents become exposed under the guarantee. This is a manageable risk, and one most clients who are parents can easily prepare to take on.
Exercise some basic common sense and this strategy can be very low risk.
4.7
Apartments
Generally, clients should not invest in an apartment unless it is on the secondary market (ie not off the plan). We also like the apartment to have perpetual views that can never be built out, and to be one of a relatively small group. High rise is high risk.
There is an over-supply of apartments - especially high-rise ones - in most capital cities so the capital gain prospects just aren't there. Sure, some apartments will be OK investments. But many won't be. It's generally better to be safe than sorry.
In 2018, the ABC reported on substantial falls in apartment prices in Brisbane, while Business Insider was reporting that this was a common experience in all capital cities.
4.8
Tourist accommodation
We are not very happy with investments in 'tourist accommodation' either. There is an over-supply and the capital gain prospects just aren't there.
Think about this real-life example. It was reported that in 2011 a client made the classic mistake of not getting advice before they bought a Gold Coast apartment for $400,000. They bought it while they were on holidays. It seemed a good idea at the time. The rent was good, $30,000 a year, which meant the interest of $22,000 a year looked like it would be more than covered. The problem was management fees of $15,000 a year and cleaning costs of $6,000 a year. Throw in rates and water and the total outgoings became more than $45,000 a year. The cash shortfall was $15,000 a year.
The apartment is worth less now than it was in 2011. Brand new apartment blocks are springing up all the time. This apartment is not new anymore and so it struggles to compete with those that are new. What's more, holiday renters can treat a property roughly. Any capital gain is decades away.
Holding costs of $15,000 a year means the family's own week in Surfers Paradise each May costs more than $2,000 a day. That's what we call an expensive holiday.
In summary, tourist accommodation is too risky. There are too many apartments and too few genuine buyers, and 'owners' are at the mercy of the apartment managers.