Ever thought about turning your home into an investment property? There are many implications that need to be considered before you take the leap.
Blogger: Bob Korver, owner, Mortgage Choice
Plenty of people turn their home into their investment property – and for good reason. They may have been relocated for work or they may need to upgrade into a bigger premise and can’t bear the thought of selling their abode.
Whatever the reason for turning your home into an investment property, you will be pleased to know that doing so can be a sound financial decision – provided it's done correctly.
There are implications that need to be considered before you take the leap and make your home your investment property.
1. The six-year rule
If you are thinking of leaving your main place of residence and returning to it sometime in the future, the six-year rule will allow you to rent out the property for up to six years, make claims for expenses, and avoid capital gains tax once you sell the property.
If you rent the property out for longer than six years and then try to sell it, you will attract capital gains tax at the current discounted rate, on a pro rata basis for the amount of time the property was a rental.
2. The financial incentives
As with any investment property, the owner is entitled to certain tax deductions. Of course, if you have paid a significant amount off your owner-occupied property mortgage and then turn it into an investment dwelling, you may be negatively affecting your hip pocket.
Say, for example, you had an $800,000 mortgage when you first bought the property and you have now paid it down to $200,000. When you turn that property into an investment dwelling, that $200,000 you now owe becomes your tax deductible debt – not the $800,000 mortgage you started with.
3. Loan considerations
When you first bought your owner-occupied property, your home loan was no doubt set up to cater to your needs at the time. Now that you are thinking of turning that owner-occupied property into an investment property, your mortgage may 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.
4. Gearing – positive or negative?
Finally, you will need to consider how the investment property will work – will it be negatively or positively geared?
When a property is positively geared, you are not making a loss on the property as 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 make a loss on the property. These losses can be claimed in your tax return, helping you to reduce your income and taking you to a lower tax bracket.
Working out which way your property will be geared is particularly important if you own the owner-occupied property with a partner or spouse.
If the property has a negative cash flow, for example, it may benefit to have only one of the couple’s names appearing 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.
To find out whether or not your home could be a suitable investment property, it pays to speak with a professional.