Converting your home into an investment property may seem like a quick way to grow your portfolio, but putting your home up for rent isn’t a guaranteed moneymaker.
Blogger: Jessica Darnbrough, head of corporate affairs, Mortgage Choice
Have you ever considered turning your home into an investment property?
Perhaps you have been relocated for work and can’t stand the thought of selling your home? Or, maybe you need to upgrade/downgrade and don’t wish to part with your property? Perhaps you think your current home would make a fabulous investment property?
While it often seems like turning your home into an investment property is the ideal solution, there are a few things you need to consider before you put your place up for rent.
THE FINANCIAL INCENTIVES
As with any investment property, the owner is entitled to certain tax deductions. If you have paid a significant amount of your owner-occupied property mortgage and then decide to turn it into an investment using the equity you have raised to help you buy a new home, you may find the tax deductions and financial incentives are not as good as you’d anticipated. In this circumstance, the property you are turning into an investment will have a small, tax deductible debt, while your new owner-occupied property will have a large, non-tax deductible debt. As such, the tax breaks you would usually receive with an investment property are significantly reduced.
Along with any tax deductions, it is important to consider your current loan structure. When you first bought your owner-occupied property, your home loan was structured to cater to your needs at the time. Now that you are thinking of turning that owner-occupied property into an investment, it is fair to assume your mortgage will also have to change.
For example, if your loan is a line of credit, this will no longer be beneficial to you when you convert the owner-occupied property into an investment property. The primary function of a line of credit is to offset any interest occurring on your personal owner-occupied debt rather than your tax deductible debt.
Similarly, if your current mortgage is a principal and interest loan, you may wish to convert it to an interest-only loan, especially if you are going to take out a non-tax deductible, owner-occupied loan on another property.
You will want to pay the debt down faster on your owner-occupied property than you will on your investment property.
THE RIGHT GEAR
Finally, before renting out your property it is important to consider how the investment property will work – will it be negatively geared or positively geared?
When a property is positively geared, you are not making a loss on the property – the annual rental income received from the property is higher than the annual loan repayments and costs.
Negative gearing, on the other hand, occurs when you do make a loss on the property. These losses can be claimed in your tax return, helping you to reduce your taxable income and taking you to a lower tax bracket.
Working out which way your property will be geared is particularly important if you currently own the owner-occupied property with a partner or spouse.
If the property has a negative cash flow, for example, it may be beneficial to have only one of the couple’s names appear on the title – usually the higher income earner. This allows that person to make the tax claims and, since they are paid more, get more tax back.
On the flip side, if you have paid down a significant amount of debt on the property, it may become positively geared when turned into an investment property.
If this is the case, the property should only be in the name of the lower income earner, since tax must be paid on any gain.
Regardless of your current situation, turning your owner-occupied property into an investment property is difficult and requires a lot of consideration.
To find out whether or not your home could be a suitable investment property, it is important to do your research and speak to a professional who can advise you on the best plan of attack.