Many money experts call ‘personal’ debt - bad debt for the simple reason that it isn’t tax deductible. On the flip side, investment or business debt can be good debt. And this is where the tax system comes into play – this time, for the reason, that it is tax-deductible.
Tax Deduction and Wealth Creation
Author of the Best Seller ‘Rich Dad, Poor Dad,’ Robert Kiyosaki explains how the rich are those who use the tax system to help out. He suggests eliminating all non-deductible or personal debt and just carry ‘good’ or tax deductible debt. And that’s the very best place to start your new plans for wealth – kill that personal debt as quickly as possible.
Going one step further… just being deductible doesn’t mean it’s a great investment either – borrowing to buy assets that provide an income is the best option. A vehicle may be a necessary asset for a business – and tax deductible, but you’re unlikely to ever recover the costs, meaning it may not be considered truly ‘good debt’ either.
Rent or Buy
More young couples are choosing to rent their own personal premises for a lower outlay, but buy properties for investment, which they in turn, rent out. This can assist in reducing tax liabilities (if negatively geared) and they get to begin an asset portfolio that can grow in value. The main catch being that if they choose to sell these properties, they would then face a capital gains tax liability, if the property had risen in value.
Many however, don’t intend to sell, but hold over the long term. As each property gains value, the equity (or growth) can be used to buy another property or other assets with the help of another loan.
You will still need to prove you have the ability to service your loans but the taxman helps to reduce this with the ability to claim the interest as a tax deduction.
Financial Flip Side
But – there’s always a flip side and each one needs to weigh what is best for them. The personal debt you have over your principal residence may be harder to pay as it’s not a tax deduction, but this property doesn’t attract a capital gains tax either.
I’m sure we all know of some clever friends who have made some good money buying run-down houses in good areas, doing them up, and selling after a few years – completely tax free.
The ability to borrow for other assets that produce income, such as shares or managed funds, is also available. And usually you can start with much lower amounts than the hundreds of thousands required for real estate.
Work the Tax Deductions
The main lesson to take away is that to get richer, it’s smart to learn all you can about the tax system. Tax deductibility should never be the sole reason for taking out an investment or deciding what to invest in but it can assist in making your investment more affordable if you know how to make the system work in your favour.
To find out what’s best for you, starting knocking over that personal debt and make an appointment with your financial adviser to discuss your own particular circumstances, goals and objectives.