Unearth the value in your home!

For many home owners, the idea of being able to turn your home into an investment property and benefit from the tax deductions is certainly appealing. However, the question of renting vs buying needs to be adequately addressed beforehand.

Like most investment decisions, there is no easy way to answer the proverbial question of whether you should rent or buy. It all comes down t the individual. If you are the type of person who would rather move every couple of years due to a need for a new location, job offers etc then renting might suit you better. However, if you like to have your feet planted somewhere and be able to make changes to your residence without permission, then buying might be the way to go. There are many factors to consider when making the decision to rent or buy, from both an emotional and financial perspective.

Consider the following situation:

A young couple own their home. It is valued at $600,000 and they have equity of $300,000. They decide that they would like a change of scenery and have decided they would prefer to rent. The question here is whether they should consider using their home as an investment property or should they sell their home and buy a new rental property?

Herein the choice lies in how the original loan was structured. If the home is to be converted into a rental property and this wasn’t the original intention of the loan then the interest expense they can claim is likely to be limited.

However, if they sell the home and borrow the full amount for their next property (less 20% deposit) for an alternative investment property, they will be able to claim a deduction for the full interest expense on the entire borrowings. For example:

Scenario 1: Home becomes investment property. The home’s value is $600,000 with a mortgage of $300,000. So the maximum interest expense deduction is the interest in the $300,000.
Scenario 2: Sell home and buy new investment property. The new property’s value is $600,000 with a $480,000 loan balance (assuming 20% deposit paid to avoid LMI). The maximum deduction is the interest on %480,000.

If we assume that the interest rate is 4.8%, this equates in a difference of $8,640pa in interest expenses, something that should certainly be considered.

It should be noted however that both options are viable. If the home loan had been established as interest only and all other payments had been made into an offset account, the couple can withdraw the balance in the offset account t, leaving the original loan balance owing – the same interest expense position as if they sold and bought a different property. Under these circumstances there would be no double-up of transaction costs. Therefore good advice from the onset is essential.

There are a few different strategies the couple could follow, here is just on example based on net sales proceeds of $300,000:

  • Purchase two investment properties. The $300,000 would be ample to cover the 20% deposit, stamp duty and associated borrowing costs on two properties with a total purchase value of $1 million. They should borrow the remainder and set up the loan as interest-only with an offset account. If they have surplus cash it can be deposited in the offset account.
  • This leaves them with a balance of approximately $60,000. They could deposit $10,000 in a savings account and the other $50,000 could be used to buy a managed fund portfolio invested in line with their risk profile. They should then set up a savings plan of $500 per month for this portfolio.
  • Lastly, they could salary sacrifice, contributing 20% of their salaries to super.

If they chose to keep their home as an investment property and have access to only $180,000 to invest, they could do the following:

  • Rent out the existing property
  • Purchase an additional investment property, using some of the $180,000 to fund the 20% deposit, stamp duty and other buying costs
  • Implement all the other recommendations outlined above

Whilst these two circumstances may seem invariably similar, the main difference relates to the difference in claimable interest expenses. The couple will have adequate cash flow under either of these scenarios.

These strategies are also only appropriate for anyone in their 20s through to their 50s. A couple in their 60s or even younger but nearing retirement, the sale proceeds should go towards non-concessional super contributions and the recommended properties would be better suited being bought through a self-managed super fund.

For more information or if you are looking to buy an investment property, contact us on 02 9299 7044 or visit www.clarencestreetmortgages.com.au

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