March 2009

Planning ahead, refinancing confusion, unique situation, capital gains tax maze and more...

Our panel of experts answers property investment questions from API readers. For more Q&As, see this month’s API magazine.

Planning ahead

Q My husband and I have three investment properties. We plan to buy another house in the next year or so on about 600 to 700 square metres. We will rent this out for five to eight years, then plan on knocking it down and building our family home. Apart from the cost of knocking down the old house and building the new house, what other costs can we expect? How do we go about making sure we’ll be able to build the house we want in the future?

A You’ve identified the major costs but there are some hidden costs that you’ll need to factor in. While you’re building your new home you won’t be receiving any rent and this cost will impact on your cash flow. In addition, if you’ve borrowed money to purchase the land and to build you’ll have a mounting interest bill that you won’t be unable to offset via negative gearing. Both these costs can vary greatly because they’re both determined by time. The longer it takes to build your home the higher the cost will be. For this reason I suggest you are well organised before you start to build.

Research is the best way to build your dream home and avoid unexpected costs. Before you buy you should check with the local council in relation to any building restrictions. Councils may restrict how big you can build, the style of building and the types of materials used.

Next step is to design your home and this can be a costly exercise. The expenses you can expect to pay include architect or draft person, local council, engineering, soil test and land surveyor fees.

Once you’ve designed your home you should get a builder to provide you with a fixed price to build it. It’s up to you to clearly specify the types of materials and fittings and fixtures you want. These include roof, insulation, appliances, door furnishings, flooring and kitchens etc. Often the cost to build a home can blow out significantly because not all materials are specified and the quote to build isn’t a fixed value. Mark Armstrong

Refinancing confusion

Q I have my home (equity approximately $100,000, bought in November 2007 – owe $300,000) and one investment property (equity approx $180,000 bought in October 2005 – owe $285,000 and rented for $350 per week). I want to buy another investment property and build a larger portfolio in the future but my broker suggested I refinance both properties to get my next one. I personally feel I only need to refinance the investment property and leave my home alone for now (and possibly refinance that one for the fourth property I buy). My wage is about $76,000 per annum and I get $3500 from Centrelink per annum. What are your thoughts?

A On the surface I agree there appears to be no necessity to refinance the loan on your home at this stage. However there may be some hidden logic behind the advice. Reasons I can see why you may consider refinancing include to get a better interest rate or to lock in some of your debt to maximise cash flow and provide you with some protection against interest rate movements. Also it may be wise to restructure the debt to ensure tax deductible and non tax deductible debt are separated from each other so you can focus on paying down only non tax deductible debt. Further, depending on the value of your next investment property the broker may need to use the equity in both properties as security. However given you have $180,000 equity in this property that is unlikely.
Mortgage brokers are paid depending on the size of the loan. The bigger the loan the more they get paid. I suggest you ask your broker to justify the value to you by refinancing your loan and if there’s none you’re probably better just to refinance the investment loan. Mark Armstrong

Unique situation

Q My partner is looking to buy a property. It will be her first and I haven’t held an interest in a property either so we qualify for the First Home Owner Grant (FHOG) in that respect. My question is this: her parents have offered to sell half of their house to her. If she buys half of the house and they become tenants in common or joint tenants etc, will she qualify for the FHOG and the first homeowner stamp duty concession? There is also the issue of not paying stamp duty if or when the second half of the house is purchased. The transaction will take place in the Northern Territory.

A The FHOG was been established to assist first homebuyers to enter the property market. Anyone who owned property prior to July 1, 2000 regardless of whether it was an investment or home was deemed ineligible for the grant. However, if you purchase an investment property after July 1, 2000 you’re still entitled to the FHOG and stamp duty concession. If your partner purchases a half share in her parents’ property as an investment she should still be entitled to the grant. Stamp duty will be payable when your partner transfers the 50 per cent of her parent’s property into her own name and will also be payable if the remaining 50 per cent is transferred at a later date if the property doesn’t form part of her parent’s estate. Your situation is out of the ordinary so the only way to be certain of your entitlements is to lodge an application with the State Revenue Office in the Northern Territory. Mark Armstrong

Capital gains tax maze

Q I bought a corner property which had two houses on it on one title with one street address and the following year I subdivided the land, resulting in two titles with one house on each title. I recently sold the property which was the subject of the subdivision and kept the one which was on the original title. How does capital gains tax (CGT) work in this situation given that I still own the original property and given that the property I sold didn't have its own title at the time I bought it? How, and when, do I calculate CGT on these properties?

A To calculate the CGT on the sale of the subdivided property you must make a land/building apportionment at the time you made the original purchase. If the split between the two parts was 60/40 future sold property/property kept then CGT would be payable on the sale price less 60 per cent of the original purchase price of the total property bought. Any joint costs of splitting the titles would also be apportioned to the properties based on that original 60/40 break-up. If you occupy the remaining property this can remain CGT free. Pat Mannix

Which bit is deductible?

Q My question is, we purchased a rental property and borrowed the full 100 per cent plus set-up fees and charges, as well as some money for a managed fund. Come tax return time which part of the borrowings are we able to claim against? The property is negatively geared.

A Any interest paid on loan monies accessed for the rental property, rental property costs and a managed fund will be 100 per cent deductible. These loan monies are for investment purposes, not private purposes, therefore they’re fully deductible. Pat Mannix

Main residence exemption

Q I have a new property in Darwin which is my principal place of residence (PPR). I will be renting it out for $1400 per fortnight from May. I’ll need to provide a further $700 per fortnight to service the mortgage which provides about $180,000 equity. I intend to rent this PPR out for five years, then move back into it prior to expiration of the six-year rule so that I don’t have to pay capital gains tax when I sell. I will be working overseas for five years but my wife will remain in Australia in a rental property yet to be established. I intend to purchase land in Brisbane and construct a duplex development for rental investment. My question is, in relation to the best possible strategy for us considering the following:

• my wife residing in one of the constructed duplexes,
• the other being rented to other tenants,
• maintaining the Darwin property as a PPR but renting it out for five years, and
• intending to sell one of the duplexes after five years,
• how can I go about renting one of the duplexes to myself without affecting the PPR ruling for the Darwin property? Our combined income during the five-year period will be about $200,000 per annum.

A Firstly, your strategy regarding the Darwin property is a sound one providing you believe it will yield the most capital growth in the next five years. If this isn’t the case and you feel the duplexes would have a higher capital growth rate then you may consider nominating the duplex that your wife will live in as your PPR. Essentially, you can only ever have one capital gains tax free property per couple at any one time.

I wouldn’t advise renting the duplex that your wife is in to yourself even as a commercial transaction. The ATO doesn’t look favourably on this strategy as it sees it mainly as private expenditure and will likely disallow it if tested.
Remember it’s time in the property market that matters so buy and hold as long as you can and minimise the transaction costs of selling property. Pat Mannix

Financial consequences

Q My wife and I own a property (Property A) for which we are $55,000 ahead on the mortgage repayments. In a few months we intend to move to another property that we're building (Property B), live there for a year, then move to our other rental property (Property C). So our principal place of residence (PPR) will move from Property A to B to C. Property A will be retained as a rental and Property B will be either sold or rented, depending on our analysis of the market at the time. If we redraw the $55,000 available from Property A and put it towards the loan of Property B (our new PPOR), can we claim the interest on the Property A redrawn loan as a deduction? If not, can we claim the redrawn amount of Property A if the $55,000 goes towards Property C, which is currently a rental? This being allowed, what will be the consequences when we finally move into Property C?

A The redraw of the $55,000 available on Property A and switched to the loan on Property B while you live in Property B will not be deductible. The ATO will look at the purpose of the redraw to see if any interest attributable is deductible or not. As the redraw is for a private purpose loan the interest isn’t deductible. However, if that $55,000 amount was taken from an offset account set up for Property A then the interest would be deductible because the offset is seen as a savings account against the original loan and any redraw from the offset is seen as an amount coming from a separate account.

If the redrawn amount goes to Property C’s loan then the interest would be deductible, so long as Property C remains a rental property. Once it becomes your PPR then the interest will not be deductible. Pat Mannix

For more Q&As, see API magazine.

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