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From: Mike .


Renting your own property
From: john
Date: 11/24/99
Time: 6:55:24 AM

Is there anything wrong with this scenario: Buy an investment property in the usual way. Rent the the property yourself, ie pay rent to yourself while renting your own house to somebody else. Could all deductions etc. be claimed?
 
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Les

Reply: 1
From: Mike .


Re: Renting your own property
From: Les
Date: 11/24/99
Time: 6:11:48 PM

G'day John,

When I first saw this question from you, my immediate reaction was "Where's my 40 foot pole?" On the surface, it looked like an attempt at Tax evasion - but, on re-reading it, and keeping in mind that we should Question Everything, and not just accept what is the "norm", I thought I'd take a crack at providing an answer. So here goes:-

1. I believe there is no reason why you COULDN'T do this, with a couple of caveats - one is that BOTH rents would have to be declared which would then appear that you would have TWO rental incomes to offset ONE mortgage (the new rental). It appears to me that the likely Nett effect of this would be that you would end up paying more Tax, with the only gain being that you are now living in (presumably) a newer property. So I don't see it as cost effective, so why would you do it?

2. It appears to me that it would possibly stick out like a neon sign to the Tax Office saying "Come and Audit this one" simply because of the unusual circumstances.

3. There may well be a concern whether the Tax Office "deems" that the mortgage on the Rental is a valid Tax deduction anyway - it comes down to "What was the Principal purpose of the loan?" And it appears the principal purpose is to put a roof over YOUR head, NOT purchase a rental property. And THAT could lead to NO deductions, and two mortgages (?) - frightening stuff!!!

4. Any rent you charge yourself would need to be considered (by the ATO) as a "commercial" rent - that is, charging yourself $20 a week WON'T cut it. Not a big deal, as it's a "one hand to the other" kind of deal - but the size of the rent determines the size of your Tax deductions.

A further thought - "which of these properties is now "your home?" - and that's a very important point. A book I am reading says you can only have one home, and it is CGT exempt when you sell, AND it CAN be the home you USED to live in - for a period of time, then it reverts to being "just a rental" so you lose that "no CGT" status if you sell after that time.

I'll close by repeating a warning I'd mentioned in an earlier note - "Renting out your old home is FRAUGHT WITH DANGER" - so get professional advice BEFORE doing anything. The norm appears to be "Sell your old home, and buy ANOTHER as a rental." It appears you are looking at a different approach to the same problem, John - and good for you for challenging the "norm".

My opinion is (as above) be very careful, for the reasons outlined.

I, too, would be interested to see what other forum members have to say on this one.

Regards, Les
 
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john

Reply: 1.1
From: Mike .


Re: Renting your own property
From: john
Date: 11/24/99
Time: 9:03:38 PM

Thank you Les for your comments. My motivation was two fold:

1) the adage of "once you have a property never ever sell" because you only have to pay tax (but not on your own home)

2) My son's comment on buying my first investment property was "why would you buy a better (read newer) home and have someone else live in it?"

It was not a matter of tax avoidance... from your comments I gather it would be okay as long as the new property was not used as a typical investment property ie. used to gain tax breaks. As far as tax office is concerned only one property can be principal place of residence is this correct?

From this I conclude that it is better to keep the two things separate. The personal home is good for equity in gaining investment property but if you want to upgrade your own home you have to sell and buy again since GST is not payable on your own home.
 
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Les

Reply: 1.1.1
From: Mike .


Re: Renting your own property
From: Les
Date: 11/25/99
Time: 5:07:59 PM

John,

Just checked in a book I've been reading - "Rental Property and Taxation" by Tony Compton. In it, (p 61) he mentions this ".......... by selling their rental property. It used to be their home, and they were able to MAKE AN ELECTION that meant it was exempt from CGT. That exemption carried through for the period it was rented. THIS IS BECAUSE they were away from the home for less than 6 years."

He goes on to say you ELECT it as your home in the Income Year in which the property is sold. Also, that this election must be in writing to the Tax Office. And, their NEW home (that they had already lived in for 3 years) only becomes their "principal place of residence from the date of sale of the other home."

And Tony's final comment - "It is important to note that you can have only one principal residence."

Note also, that Tony is Brisbane based - he makes no comment re whether this 6 years thing is Federal or not. Since it is an ATO thing, I would guess that it applies across Australia.

That answers one of your questions - I couldn't remember the detail, so brought the book in today.

Now, you said "Once you have a property, never sell" - Yeah, I pretty much subscribe to that one for many reasons, but as you can see (above) it can still "work out" in some cases.

One GOOD reason for NOT selling might be if your original home was bought pre 1985 - no CGT anyway, in that case (even if used as a rental) - Note: that's how I believe it works - I COULD BE WRONG!!!!

2. Your son's a questioner, too - good!!! He says "why would you buy a newer home and put someone else in it?" - and I think several answers are spread throughout this forum (check out "TO Rent or To Buy" - that's just one I know).

But I particularly like Jan's comment (FAQ section of this web site, and in her books) - "It's a very personal thing - you might live in a tent and own 10 rental properties, or you may live in a mansion and have NO rentals! Somewhere between those extremes, you will find a happy medium."

But, John, DO watch out for that "what does the ATO deem the purpose of the loan was for" - in your case, it is FAR AWAY from being a Rental property as you are looking at using it as YOUR HOME !! So do get professional advice.

See what others have discussed in other forum entries - a number have been in the "do I rent, do I buy - should I keep my house, or sell it" categories.

One thing with moving in yourself; you would guarantee no "tenant from Hell" problems, eh?

From your answer, it sounds like you have already bought rental #1 - that right? Settled yet?

Give your son one of Jan's books - he'll find his answer ;^)

As for you, it IS unusual, so be very sure what you are doing BEFORE doing it i.e. seek professional advice - IN WRITING (just in case).

Let us all know how you went, too.

Les
 
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Les

Reply: 1.1.1.1
From: Mike .


More info re "renting out your old home"
From: Les
Date: 11/30/99
Time: 6:12:42 PM

G'day John,

A bit more reading (this time courtesy of Independent Research & Investment Service P/L (IRIS) regarding the "renting of your original home" led to a couple of VERY USEFUL points.

1. Temporary absence (up to 6 years)

"You can stop using your own home as your principal place of residence, and even rent it out for up to 6 years, WITHOUT LOSING YOUR CGT EXEMPTION. After 6 years, you do not have to return to your home, but, if you wish to preserve the CGT exemption, you must stop renting it. And you must put in writing to the ATO that you wish to have it treated as your principal place of residence during that 6 year period."

So that coincides with (and expands upon) Tony Compton's earlier words.

2. "If you wish to purchase a residence, then find you can't afford the mortgage payments, you could well consider using this exemption to your advantage by renting it out for up to 6 years and then moving back in, or selling it, WITHOUT LOSING your CGT exemption."

John, it doesn't help too much with your original question, but could well assist indirectly. "Now I'm moving out of my principal place of residence, what are the CGT implications" could be one of the off-shoot questions you may have - if you are still considering moving.

And, if (like me) you bought your "principal place of residence" before Sept 1985, this is such GOOD NEWS!!! It all helps with the "never, never sell" scenario.

Hope it helps, Les
 
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john

Reply: 1.1.1.1.1
From: Mike .


Re: More info re "renting out your old home"
From: john
Date: 11/30/99
Time: 11:58:07 PM

Gidday Les, It seems I have given you a quest. Thanks for your research ,it's all very interesting. This helps if your principal motive for living in a new house is because it is new and not because of tax advantages gained by renting. Of course why would you consider such a thing?

Thanks again for you help.
 
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leon

Reply: 1.1.1.1.1.1
From: Mike .


Re: Renting your own property
From: leon
Date: 1/26/00
Time: 9:12:44 PM

I have been reading with interest the previous articles and comments relating to the issues of renting out your own property. The most recent comments indicate that it is possible & that the interest on the loan & other associated expenses incurred are a tax deduction ( as confirmed by ATO booklet, will get copy ASAP ).

I am trying to determine the best course of action based on our current scenario. Own property valued at $400K (Inner West Syd) Mortgage $152K 25yrs at 6.55% P&I Estimated rental return $410/week Combined incomes $95,000 We have 2 children & require a larger house. This would mean purchasing for at least $550K ie sell with net profit$215K and new loan $335K. However I don't want to sell our current property & want an alternative to committing to $2,500 mortgage repayment each month.

1.Is it best to rent out current property and find larger property & rent it for ourselves( even at $350-$400/wk) and use current equity of $248,000 to purchase 1 or more investment properties?

My calculations (rough estimates) show that renting new house would be equivalent to interest charged on $335k loan! Is this still an advantage?

2.Our cashflow appears to better ie $1400-1600 rent v's $2500 mortgage = $1100-$900 better off. Does this appear to be correct & does this put us in a better situation?

3.I have taken on board comments re Temporary absence up to 6 years. Does this mean you can relocate to a suburb 5Km's away?

4.Will the PIA software help me calculate all of this? I have already booked an appointment to see an accountant & want the facts before I go because it sounds like not all accountants understand the principles we are discussing-would that be a correct assumption?

My gut feeling is that by keeping our current home & renting it out & renting out new house to live in & investing in more property is the best possible avenue for wealth creation, but I need to convince my wife who still has her mind set on 'owning our own home' and wants to see the figures & is concerned about the legality of it all. Comments appreciated
 
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Les

Reply: 1.1.1.1.1.1.1
From: Mike .


Re: Renting your own property
From: Les
Date: 1/26/00
Time: 11:18:24 PM

G'day Leon,

I LOVE a bunch of numbers - you have been very thorough in providing detail. And in so doing, you should find that the answer following checks out. Try this:-

Refinance your current P&I loan to IO and/or borrow up to 80% (or slightly less to save Mortgage Insurance) and you can release $165k, thus allowing 2 x $70k deposits for 2 Investment properties up to $350k each, with $25k left for expenses. Based on my observation of Sydney rentals, these $350k properties should rent for $360/week or better.

So, you now own 3 properties (all Investment) and own $1,100,000 worth of properties, with total mortgages of $880,000 costing (IO of 7%) approx. $63000 per year - with rental Incomes totalling approx. $60,000 per year.

Most authors (Jan, et al) recommend allowing 25% of rent to cover other costs (Insurances, Maintenance, Rates, etc.) so you are down by approx. $18,000 or $360 per week.

But, now comes the good part. Your Tax deductions on these 3 properties will come to over $300 per week at 47% Marginal Tax rate. These consist of Building Allowance (assuming all 3 are built after 1985 - if not, check with your accountant), Borrowing Costs, your rental costs, and depreciation of fittings.

Be aware, this latter figure will vary MARKEDLY depending on the various costs you ACTUALLY have, but I calculated them on the following (with all 3 included):-

Building Allowance $300k

Fittings $40k

Borrowing Costs $15k

Maintenance, Rates, etc $15k

I believe these would likely be conservative, thus you could likely get more of a Tax deduction than quoted.

There may be a small requirement for you to input to these 3 (my calculations say LESS than $50 per week NETT, as long as you are using 221D and putting all of the extra Tax into the equation too).

So, you now need to house your family with your quoted $350/$400 per week rent. So what are you gaining? Well, that depends on the current cost of the existing mortgage on your current home - I didn't see it quoted, but you won't be paying that now (it's been replaced, above) so that should cut down the amount you need to find for rent.

And, I've saved THE BEST for last - if property grows at 4% (how's THAT for conservative) your new portfolio of properties will be gaining equity at the rate of approx. $850 PER WEEK .... If Sydney sticks to its usual figures, 9 or 10% would be more like the true figure.

As far as "legal" the Govt. has determined that it will support anyone who is investing far more than it will support a home buyer. Check all of this with your accountant, of course, after you have verified that they seem to fit your scenario.

Hope that helps, Leon. If any queries, do come back - it is certainly more than a little "involved" ......

Regards, Les
 
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