Building a Granny Flat and Tax Deductions

[western_sydney]

Hi All,

This is all very new to me, so some of my terminology will be off - apologies in advance. I've looked up the ATO site to get some information on tax deductions for rental properties, but there's a few things I'm not sure of.

In short my plan is to build a granny flat at my PPOR (Property A). I will be able to get this approved as a complying development through the SEPP using a private certifier.

In order to build in the preferred spot in the yard I am going to have to remove several large trees. I have already obtained council approval to do so, but my question is (Q1) Will the cost of removing these trees be deductible? I'm estimating that the cost will be in the vicinity of $4000, and the granny flat won't be completed until the next financial year.

(Q2) If it's only deductible as part of capital works deductions then am I right in thinking that no deduction can be made until the construction is complete?

The granny flat once completed will be rented out. I'm only building it to rent it out.

(Q3)I understand that any interest on a loan that I take out to build the property will be deductible, I assume this comes into effect from the moment the loan is taken?

(Q4)With this in mind then it would be best to keep the loan completely separate from the existing mortgage on the house, and to use the income from renting the property out to pay off the existing house mortgage?

The mid-terms plan is to up-size from this property in a few years time to Property B, but to keep Property A and rent both the house and the granny flat out. (Q5)From this point in time I assume that any interest on the granny flat loan and on the existing Property A mortgage would become deductible?

The rental return from both dwellings on the property would exceed the principle and interest amounts for both loans, but it would be structured so that only interest would be paid, as I'd be better off putting the additional income against the mortgage for Property B.

(Q6)Does this all sound like a sound strategy?

The expected return from a 2 bedroom granny flat is $250-$300 pw. The cost to build has not as yet been finalised, but an early estimation would have it in the region of 80k.

(Q7)Apart from information on the ATO site (including the Rental Properties 2010 Guide), is there any recommended reading for this, or can anyone recommend a good accountant in the Western Sydney area who would be able to assist?

I've bolded and numbered each of the questions here to hopefully make it easier to respond, but don't feel obliged to respond to all (or any) of them.

Any contribution is much appreciated

 

[syba]

(Q1) Will the cost of removing these trees be deductible?

No - the cost of clearing the land ready for construction is not depreciable and cannot be written off as part of the capital works allowance.

(Q2) If it's only deductible as part of capital works deductions then am I right in thinking that no deduction can be made until the construction is complete?

As Q1

(Q3)I understand that any interest on a loan that I take out to build the property will be deductible, I assume this comes into effect from the moment the loan is taken?

Yes. The current view is that interest is deductible, providing the following circumstances apply:

The interest

• expense was not incurred ‘too soon’ as to be a prelude to income earning activities;
• The interest expense is not ‘private or domestic’ in nature;
• The interest expense is not incurred ‘too remotely’ from the time of income earning activities
• The interest expense is incurred with ‘one view’…income production;
• Continuing efforts are made to realise that view

(Q4)With this in mind then it would be best to keep the loan completely separate from the existing mortgage on the house, and to use the income from renting the property out to pay off the existing house mortgage?

Yes - always need to keep investment and non-investment loans separate. Also best to keep loans for different investments separate as things may change int he future and you sell one, live in one, etc - easier to sort out and separate.

(Q5)From this point in time I assume that any interest on the granny flat loan and on the existing Property A mortgage would become deductible?

In relation to later renting out your now PPOR, interest would then be deductable.

If you were seriously considering this, I would suggest turning that loan into an interest only loan with an offset, and make sure the amount you would normally pay off your principle gets put into the offset account (or ideally all your money gets put into your offset). That way you are still effectively paying off your loan, but if/when it becomes an IP, you can pull everything out of the offset and interest on the entire loan is deductable. Eg, if you kept it as a P&I loan of say $200k, but paid off $50k before it turned an IP, interest on the $150k remaining loan is deductable, but if that $50k was in an offset, interest on $200k would be deductble.

(Q6)Does this all sound like a sound strategy?

Yes it does.

 

[western_sydney]

Thanks Syba, your response is much appreciated.

An offset is good, I think having that whilst still living in Property A will allow me to have a good deposit for Property B whilst getting the best value out of the interest deductibility when both dwellings at Property A are rented.