Turning my family home into an investment property

Hi Samsons,

Whilst you can transfer the security for the loans from one property to the other (which is what the bank is talking about), you can not change the principal purpose of the loans, which effects tax deductibility.

To put it another way, if you move into your investment property, then the funds you borrowed to purchase that property will become personal, and the interest you pay on those funds will not be tax deductible, you can not change the purpose for which you originally borrowed the money.

This page at the ATO explains this situation somewhat:
http://www.ato.gov.au/individuals/content.asp?doc=/content/00113233.htm
(check out the zac and lucy example)

Whilst its not an elegant solution, and possibly more effort than its worth.. you could sell the 470k property, pay out the $60k owing, purchase another rental/investment property at an LVR of 80% or 90%, and use the remainder of the proceeds of sale to reduce the current loan on the investment property you moved into. This would allow you to claim the majority of the interest your paying against your new rental property.

Hope this helps!

Sam

You can gradually improve your tax position by borrowing to pay your investment loan interest. This will help build deductions while paying off your home loan faster. It is a dangerous strategy so you will need professional advice from a tax advisor.

Thats very true..

but there wouldnt be any CGT, and the short term costs would balance with tax benefit in a few years when your talking about the tax deductibility of interest on around $400k! Still – its not a strategy I would recommend lightly..

You could 'sell' the 470k property to your wife under a 'love and affection transfer'.

The funds raised can then be used for whatever you like – ie offsetting your 600k place.

The house that becomes an IP will then have a larger amount owing (since you've borrowed against the equity of this house to 'buy' it off your wife) and be better setup for negative geating.

We're in the process of doing this.

Mr501,
In reality no money changes hands, but it does allow you to refinance your loan and redraw the equity to spend on non investment items like a new PPOR and turn your old PPOR into an IP.

The “love and affection transfer” portion is really to minimise the Stamp Duty payable, when changing the title deed.
If the point of the exercise is to maximise the tax deductibility in the future, then it will depend on the partner/wife’s ability to get a loan to refinance the property. Since we are talking about disposing a PPOR with CGT exemption, it may be best to refinance it as much as possible while minimising unnecessary transactional costs. However, it will be unlikely the bank is willing to lend >105% of the property market value. Also, remember to do a valuation (or at least 3 REA quotes) for evidence to reset the cost base when changing over from PPOR to IP.

However, do take into the consideration the tax deductibility will be transferred to the partner/wife with this scenario. Whether or not this is the best outcome, will depend on the partner’s income, objectives, the alternatives and the total cost of this exercise.

Sorry Benno,
I’m not entirely sure what you are asking: “But if you simply refinance, you are limited to purchasing investments with that refinanced amount?”
What I was trying to say – once you have changed the title, you can refinance the property with the bank under a different loan structure / name. If the intention is to use this property as an investment property to generate income, then the mortgage interest is likely to be deductible. So if the exercise is to maximise your tax deductibility, then one would maximise the amount that can be borrowed for this property (e.g. if the property is valued at 500K, then you may want to refinance the property at $500K or even $525K, if the bank is willing to). After paying off the previous loan amount, you are free to spend/invest the proceed elsewhere, and the mortgage interest on the $525K will be full deductible.
So to take your question literally, Yes. The income tax deduction is limited to the mortgage interest incurred for the loan used to refinance the property. This deductibility remains regardless of how you spend the proceed (investment or private use) in this particular instance.
To avoid confusion, i should elaborate:
In order to claim a income tax deduction on an investment property, you need to demonstrate nexus (i.e. a connection) between the income generated (i.e. rent) and the expense incurred (i.e mortgage interest). However, sometimes people do a top loan for personal reasons (e.g. to buy a car/yacht). Mortgage interest on this top up amount is normally not tax deductible, because there is no nexus on the income generated.
In the “love and affectionate transfer” scenario, the whole refinanced amount is considered used to acquire this Investment Property (previously PPoR), hence, the mortgage interest will be tax deductible, when the property becomes available for rent.

When you change the PPOR over to IP, the property is no longer CGT exempted. So when you eventually sell the property, you will be required to pay CGT. And in order to calculate the capital gain or loss, you need to determine the cost base. A bank/professional valuation or 3 REA quotes will be sufficient for the ATO. If you don’t have that as evidence of Cost Base, then the ATO will be likely to rely on Local Government estimates (on your Rates statement), but it may not be in your favour as local council usually understates the property value, hence a lower cost base and consequently a higher capital gain.

You should check with your accountant.