Whether it’s a modern idea or not – a large part of the ‘Great Australian Dream’ is owning property. Having a home to call your own.
(I would argue that the new Australian dream is focused around achieving financial freedom. But that’s another conversation.)
Traditional ideas around home ownership link it to success. It’s often why buying an investment property is pretty high up on the wishlist for many people.
Some make this the next step after purchasing their own home – others choose to invest while renting in a cheaper area.
While your home may often be an emotional purchase – an investment property shouldn’t be.
It needs to be a business decision with a clear path for the future. It’s not always going to be the one that ‘speaks to your heart’.
So, if we’re looking at it from this angle – here are some of the things to consider, when looking to buy an investment property.
Creating equity in your property
First things first, create equity in your current property!
Equity is the difference between the current market value of your property and the remaining balance on your home loan.
The home that you occupy and live in rarely gives you any tax benefits. However you can leverage against your home equity to purchase an investment property – which will give you tax benefits!
You can create equity by renovating, or making other improvements that add value to your home. Or, of course, by paying off the debt as fast as possible.
Tax advantages from investment properties can differ from property to property.
The general rule of thumb here is to buy new (or buy as new as possible.) to maximise your depreciation deductions on the fit-out and construction costs.
To maximise the tax advantages associated with your loan for the property you could look at borrowing as much as possible – to cover the cost of the purchase price as well as the purchase costs like stamp duty and legal fees. Sometimes you can borrow as much as 115% of the value of the property. But the trick is to use the new investment property as security for 80% of the loan and use the equity in your own home as the security for the balance of the loan. By keeping your total debt to less than 80% of the total value of all your properties you avoid the cost of Lenders Mortgage Insurance. It also means that any spare cash you may have can be kept for paying off your non-tax deductible debt faster.
Home: $750k value
Loan Balance: $500k
Purchase price of new investment property $450k
Stamp Duty $9,700
Legals and misc $3,300
Contribution to the purchase $5,000
So, new loan = $450K+$9,700+$3,300 – $5,000 = $458,000
Overall Loan to Value Ratio 79.83% (ie $500K+$458K / $750K+$450K)
This is what is termed cross securing a purchase.
Note: IF this purchase was made in the ACT the stamp duty & legal fees would be claimable in the year paid as the land is leasehold here. In most other places eg NSW, QLD and VIC, the stamp duty & legal fees cannot be claimed upfront and are added to the cost base for when you eventually sell.
Buying new vs existing
There are many things to consider when choosing an investment property such as the different capital growth and rentability implications of different style of properties, their location and their maintenance requirements. It is therefore really important to do your research well and talk to various experts to make sure the property you buy is best suited to your needs & goals.
When looking at the tax implications, buying new usually results in better tax deductions for depreciation on the fit-out and capital allowances on the construction costs.
This is because the best depreciation on a property happens in the first five years of a property being new. Buying an older property usually means there is little left to claim.
Buying new also makes it more likely that a depreciation schedule is available from the builder/developer, saving you the expense of getting a Depreciation report done by a professional when you buy something a little older.
Turning your home into an investment property
It is common for people wanting to upgrade to a new home to want to rent out the old home as an investment property.
This can obviously be done! However, there are some things to consider here. When you buy your first home, if you think there is a good chance you will want to upgrade but keep the old home as a rental property there are some strategies you can employ when you purchase your first home to minimise your debt and maximise your tax savings in the long run when you eventually upgrade.
When you buy your “home” use a variable loan with an offset account. Make the minimum compulsory repayments off the loan but place all of your savings into the offset account. This saves you interest and gives you an immediate benefit.
When you are ready to upgrade to your next home you use the funds in the offset account to pay the deposit (and borrow the rest). Once your old property becomes available for rent, the interest on the old loan becomes tax deductible. It is important to note that if you had put all your spare cash off the original loan and then redrawn it to pay the deposit on your new home then the interest on the redrawn amount would not be tax deductible because the money wasn’t redrawn/borrowed to buy the rental property.
For example, a loan balance of $400k with $100k in redraw gives you a loan limit of $500k. If you take the $100k out of redraw to use on a new purchase the claimable interest is only on $400km. Because that was the loan balance at the time you turned it into an investment property and the redrawn amount was used to buy the new home.
So you would be missing out on $3K pa in interest claim!
Getting expert advice
If you’re looking to buy your first investment – or your tenth! – we can help.
If you want to start planning how to do this in the future, let us know We can help plan the strategy for you!
As with anything related to money or tax, your accountant is always going to give you the best advice about the do’s and don’ts when buying an investment property.
Your investments in the future should be seen as priorities. You should always speak to the professionals, rather than bumping your way through it.
We have seen most of the mistakes and pitfalls and can help you avoid them!
Get in touch if you’d like to work with us.