April 12 2022
"In regards to an investment property, tax can be one of the more confusing areas to wrap your head around, yet it's one of the most important purposes for the property." - Marco Zande, Strategy Executive.
Q: I bought my first home in late 2011 and lived in it until December 2018, when I moved out of town. This property had a valuation done in June 2018, which showed a decrease in value compared to when I purchased the property. Since January 2019, the house has been available for rent.
I’m currently renting with the aim of buying another house to live in in late 2020, using the equity in the mortgage along with some additional savings to avoid paying lenders mortgage insurance.
How does using equity in an investment property to purchase my main place of residence affect the investment property with regard to tax purposes? I’m looking at both in the present situation and also down the track if I decide to sell the rental property with capital gains tax.
Regards, Jason
A: If you borrow money to buy your family home, the interest on that loan is not tax deductible. If you use your investment property as bank security to help you buy your family home, the tax outcome is the same. The purpose of your borrowing from the bank (supported by the rental property) is to buy a family home. And that family home does not generate taxable income. So the interest expenses and the other costs you incur in buying your new family home are not tax deductible.
If your family home begins to generate rental income, then things will change. The purpose of the interest incurred would then be to generate rental income from your new rental property (former family home). So that interest would be deductible.
If you are using the equity on the rental property to buy a family home, make sure you structure the loans properly
The changing nature of a home creates tax opportunities if you have a mortgage offset account. With a mortgage off set account, the bank charges you less interest on a loan as you have bank deposits in another account. If you have a bank loan with an equal amount in a mortgage off set account, you might not pay interest at all.
If you close the mortgage offset bank account, the bank will then start to charge you the ordinary loan interest rate on the original loan. And that original loan was for the purpose of acquiring what is now a rental property. So the loan interest will become tax deductible. The correct use of mortgage off set accounts can potentially allow smart investors some tax opportunities – they can move their private home deposit around to the home they live in.
The fall in the value of your home while you lived in it is unfortunate. When your former home started to generate income, you would have been given the deemed tax purchase price (cost base) of that home. The cost base is the market value of the home at that time.
The loss in value from when you bought the home to when it generated rental income is a private loss. It is not tax deductible for income tax or capital gains tax.
If you are using the equity in the rental property to buy a family home, make sure you structure the loans properly. As the new loan portion will be a private cost, you will want to make a separate loan to track the private costs. Do not mix two loan purposes into one loan.
Need to know
- If you borrow money to buy your family home, the interest on that loan is not tax deductible.
- Property ownership costs are only tax deductible when the property generates an income.
- The loss in value from when you bought the home to when it generated rental income is not tax deductible for income tax or CGT
Source: Your Investment Property
Forrester, R. (2020, June 10). Tax Q&A: How does equity affect an investment property? Property Investment Magazine find Australia's best investment suburbs. https://www.yourinvestmentpropertymag.com.au/tax-questions/tax-qanda-how-does-equity-affect-an-investment-property-271818.aspx