Gearing all of my loan – Tax man no like

I have just taken the plunge and now have an investment property. I find myself in a bit of a situation in terms of my ability to take advantage of gearing to the full extent of the loan I have against my rental property.

I have a small terrace that I lived in for the past 5 years. It is worth about $360k and I owe about $100k. I just bought another house that I intend to use as my principal residence, with the idea of renting out my old house.

I borrowed 70% of the value of the new property. I could have reduced this significantly by selling my old place and using the capital from the sale to reduce the cost of my principal residence, but this is not in line with my desire to get a few investments under my belt.

The issue is that I could have borrowed against the equity in the investment property to purchase my new house, but the tax office assumes that this money is going to be used on my private home, therefore I can’t claim any tax relief on this portion of the loan.

On the other hand, if I was to sell the property, buy a new investment property and take out a loan for the full amount, I could offset the interest for the total loan. However, if I wanted to keep my existing rental, I’d have to (technically) sell it then buy it back with a $100% loan, which is going to involve a payment of $20k worth of stamp duty.

It understand that one could argue that the money I have borrowed against the rental property and used to buy my home is not for investment purposes, but we’re talking about a technicality here, because I’d like to transfer the lions share of my debt to the rental property, but it would appear I am unable to do this without having to find some way to sell and repurchase, which is going to cost me $20k (Damn you tax man!).

Is this just bad luck, or are there any cleaver or devious people out there? Better still, any deviously cleaver people?

Cheers, Badger.