Moving forward. Prioritising my loans...

Moving forward

Q We currently rent a property but have two investment properties and we wish to move into one so we can reduce our costs and look at buying another investment property. What information will the Tax Office require from us? Is this the best option so we don't have to pay rent any more? Both loans are low doc which is also holding us back, so what do we do to move forward?

A From your question I'm assuming that both of your investment properties are costing you money each week from your own pocket, and that you have already assessed that the costs of supporting the property you move into without getting the tax breaks is going to be less than the rent you pay on the house you live in now. Sometimes, due to the high cost of living where we choose to live, it can be more financially viable to rent where you wish to live and continue to buy property purely as an investment in areas which display strong growth drivers.

There are two main things which the Tax Office is going to be concerned with - that you only make tax claims to which you're entitled, and that you suitably account for your capital gain and pay the relative tax.

In terms of the deductions, you must keep record of the date that the asset ceases to earn an income (not the date you move in) and then, when you submit your tax returns, ensure that your claims for tax deductions on your expenses relate only to the exact period that it was available for rent.

As for the capital gain, once you eventually sell the property, you must account for the gain which occurred while the asset was income producing. You should have the original contracts and a date when the property started being rented. I'd suggest that you obtain an independent valuation as soon as possible after the tenants move out, as this will establish with no doubt its value and hence the gain you've made. The Tax Office won't need these documents until you sell the property however.

As a final observation, make sure the debts on the two properties aren't tied up with each other. One of them will become a personal debt when you move in, and accounting can be difficult if both debts aren't separated before this time. Margaret Lomas

Which path to take?

Q I'm a 40-year-old permanent resident. In February I finished paying off my personal debts amounting to $25,000 and currently have savings of $15,000. I'm looking at buying a property, but I'm in a dilemma as to whether I should buy a new home ($380,000 as a first homebuyer, about 45 kilometres from Perth CBD - construction finishes in a year's time) or a cash flow positive investment property ($200,000 in a regional town). I'm not sure which one would create more equity faster by debt reduction rather than growth to enable myself to get to a second property. My annual gross salary is $113,300. Living in small mining town renting at $150 a month, I'm able to save about $2400 a month towards a deposit. In the next three years I'd like to scale back from full-time employment.

AI'm glad you've asked this question, as so many people wouldn't think through the financial implications of their investment goals before plunging in.

The first thing for you to consider is the bottom line financial terms of each opportunity. If you moved into your owner-occupied property, what would it cost you in real terms? If you instead continued to rent (and it sounds like you have a good deal on the rent) what would owning an investment property cost you, after you claim your tax deductions?

Often, it's so much cheaper for us to rent where we need to live and use our funds to purchase investment properties. You can still get the First Home Owner Grant at a later date as long as you never live in any of your investments.

Next you have to research both options in terms of their investment potential. You must establish what growth drivers exist in both areas you're considering to establish the likelihood of growth for each. This is then considered alongside the financial information. So, for example, if the owner-occupied option has less chance of growth but costs less, you then have to work out if the commitment to the investment would result in a suitable gain to have made it worthwhile. In your case, it's likely that your personal cash flow (due to the very low rent you pay) and the fact that you're looking in Perth, where I don't expect great growth for the next few years, would mean that a tax deductible investment elsewhere will probably win out for you on all fronts.

While you're considering all of this I want you to remember that for you, positive cash flow isn't the most important thing given your favourable financial circumstances. You want to get the best growth you can while you're working, since you have a good personal cash flow and you can afford to contribute some funds to your investment plan. This is not to say that you can't have both cash flow and growth as I believe you can, and have proven this with my own considerable portfolio. Just take care that you don't choose positive cash flow in an area where you won't also get growth. If you can get a cash flow which you can afford, some growth and also can undertake debt reduction, then the choice comes down to which option gives you the best available growth for the lowest weekly cost to you. Margaret Lomas

What should I do?

Q I currently have a rental property and am getting plans to put a unit in the backyard on a separate title. I live in a rental myself and have no main residence nominated. I intend to keep the development and rent it out. For tax purposes, what is the best way to structure this? Am I best to move in myself for a while and claim this as my main residence, or just rent it out from day one? Am I liable for GST?

A This property has always been an investment, so moving in won't completely exempt you from capital gains tax (CGT). If you genuinely move into one of the properties for a minimum of 12 to 18 months and make it your principal place of residence then it will begin to be CGT-free from the date you move in and will remain exempt if you subsequently move out for another six years from the time you leave, as long as you nominate this property as your principal place of residence after you've left. If the reason you've moved into the property for the minimum amount of time is only to avoid tax you may find yourself in some hot water with the Australian Tax Office. Finally, GST may be applicable should you sell the property within five years of construction but some factors can affect this including your intention for the property at the time it is built, and your involvement in any other developments. Pat Mannix

Prioritising my loans

Q I own an investment property worth approximately $220,000. The loan against this property is also $220,000. I wish to subdivide the property, sell the portion with the house, and then build a new house on the retained lot. The value of the new lot would be approximately $90,000. Assuming the selling price is $220,000, how much of the loan would I need to pay down? Would it be wise to split the loan into two components - one for the house and one for the lot - prior to the sale? Could I transfer the entire loan balance of $220,000 to the lot, and then use the proceeds from the sale to pay down my home mortgage? Would lenders mortgage insurance become payable if the loan-to-value ratio increased to over 80 per cent? Could you provide any additional insights into how the Tax Office and the banks would view this treatment?

A Tax Ruling 2000/2 is the relevant ruling on mixed purpose loans. It requires you to track the portion of the loan that's relevant to each property. You'd do this by apportioning the $220,000 you originally paid between the market value of the house on a smaller block of land and the market value of a small block of vacant land at the time you originally purchased the property. When the small block with the house on it is sold you're only allowed to pay down the portion of the loan that represents its share of the original purchase price. You can't shift all of the loan to the vacant block and continue to claim all the interest as a cost of buying just that block. So the loan-to-value ratio (LVR) issue isnt going to come up. The LVR should be the same or better, providing the bank reduces the cap of the loan to the market value of the vacant land when you purchased it. The change you have from the $220,000 after paying down the house's share of the original loan can be used to pay down your home mortgage. I expect the bank is using the security on your home already to allow you a 100 per cent lend on the investment loan so all up the bank should be very happy with you. Julia Hartman

What should I do?

Q I currently have a rental property and am getting plans to put a unit in the backyard on a separate title. I live in a rental myself and have no main residence nominated. I intend to keep the development and rent it out. For tax purposes, what is the best way to structure this? Am I best to move in myself for a while and claim this as my main residence, or just rent it out from day one? Am I liable for GST?

A You'll need to get a market appraisal from a real estate agent or a registered valuer to apportion a value to each of the residences. You'll then pay transfer duty on the one you're going to live in at the home rate, and on the one you intend to rent out at the investment rate. If you're taking out a mortgage to purchase the duplex then you can deduct the interest on that portion of the loan that bears the same percentage as the value of the residence that's to be rented. You may wish to take out a loan that allows it to be split into two sub-accounts, one for the home loan and one for the deductible investment loan. This would make life much easier for you and your accountant.

Of course, if your previous home is to be rented, then any loan that was originally taken out to purchase that property would become tax deductible as well. Make sure you get a valuation on this property at the time of changeover as you'll need it to correctly calculate any capital gains tax in the event that you sell the property. Terry Holliday

 

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