Investment vs PPOR tax dilemma

[Goddess K]

I have lived in my apartment for six years. I originally borrowed $190K as a mortgage and $22K as a personal loan. My my credit union made a bit of a stuff up with the original loan and could not lend me the entire amount as a mortgage. Long story.

Consequently I repaid the $22K within 6 months. This left $190K owing. Almost two years ago I refinanced (as my property value had increased) and the new amount was $300K, of which $285K is still owing. The $100K was for a private use.

If I decide to move out of this property and rent it out for a year I know that I can only claim deductions against a portion of the loan however I am a little confused as to which amount, and what deductions can be claimed - i.e. interest, ongoing costs etc and if so, what percentage thereof? I also assume that I will pay a certain amount of capital gains.

I am considering just selling this property and using the capital I make to invest in other property that is fully deductable. Does anyone have any comments on this and advice as to what I should do?

Thanks,
Goddess K

 

[Simon]

You will be able to claim interest on each part of the loan that you took out for the property. Even paying the purchase costs etc.

You will not be able to claim the $100K for personal use.

If it is all mixed in the same loan then you will have to pay it all down equally - ie you cannot pay off the $100K personal bit first then the deductible portion.

This is why splits are useful as they keep the two components from being "mixed or contaminated"

Cheers,

 

[goddessk]

Thanks Simon. I thought there may have been a catch with the paying off piece. When I bought it 6 years ago I had no idea I would consider renting it or even that I would be looking at buying property. My partner and I are moving in together and this has prompted the decision to sell or to rent out.

So what you are saying is that I will only be able to claim against the original part of the loan less whatever payments are apportioned to that part of the loan. i.e. I have obviously paid off a small amount of principal (plus purchase costs) over the years and they will deduct some of that from the original loan before we work out the tax deduction. Is that right?

It sounds like I may be better off selling the property and buying other fully deductable properties with the cash I will receive. Especially given that my suburb has not gone through a growth period for a while, in fact it went down by 3% YOY. I think its realised it maximum potential for a while.

 

[Simon]

You will incur additional costs if you choose to sell.

Why not consider keeping it and buying additional properties.

I am sure your accountant and broker can tidy the loan and tax deductions for you.

Cheers,

 

[Rolf Latham]

Hi GoddessK

When I bought it 6 years ago I had no idea I would consider renting it or even that I would be looking at buying property. My partner and I are moving in together and this has prompted the decision to sell or to rent out.

Gawd I wish people would listen to,,,,,,,, or read your story.

Weekly i find people in the same position, many having been given poor advice by their lender/broker/accountant.

So simple and painless to avoid by using the right borrowing structures and savings/offset accts. Unfortunately one too many people just have troubke fore seeing their future, yet the ideas are always to try and future proof things as much as possible.

ta

rolf

 

[goddessk]

Wow Rolf, your response seems a bit harsh. Not all of us can predict the future and set ourselves up in the right way. If we could I guess we'd all be rich by now!!

 

[Rolf Latham]

Hi GK

That wasnt directed at you, in now way , please dont take it that way

Simply to show that obviously no one had sat down with you and showed you the way to future proof your situation.

What Im on about is the people that are given the tools and info and then dont use them.

ta

rolf

 

[Richard Hunt]

Hi Goddess,

Sure, things may have been structured better in the past, but at least the changes to your personal life and the consequential financial decisions you are now forced to contemplate will provide you with opportunities to "set things right" and optimise your financial structures going forward.

If you do decide to hold onto the property there are some positive steps you can take today.

1. Review and summarise your loan repayments and any redraws since the draw-down of the $100k private use loan to allow an accurate itemisation of the principal and interest components therein;

2. Formulate a reasonable basis for apportioning the principal reductions identified at step 1 between the $190k and $100k loans;

3. Using the information from steps 1 & 2, calculate the current balance owing on each of the original loans of $190K and $100k;

If you need help with steps 1-3 your Accountant should be able to offer the appropriate assistance.

4. Refinance the current balances identified at step 3 from the existing "mixed purpose" loan into two distinct loans or sub-accounts (a combination of interest only and P&I loans would likely be appropriate);

These abovementioned steps will optimise the loan structure for tax purposes once the property becomes income producing.


The captial gains position and the immediate options available to you on any future disposal of the property will be impacted by two main factors as follows:

- the nature of the relationship with your partner (ie are you in a defacto spouse realtionship - probably "yes");

and,

- whether your partner has an existing ownership interest in property.


Irrespective of whether you are in a defacto spouse relationship, if your partner has no ownership interest in any property, then you could simply elect for your existing property to continue to be your PPOR and continue to preserve the CGT exempt status of the property notwithstanding that it becomes an income producing property (subject to 6 year limit rule).

Alternatively, if you are in a defacto relationship (as seems likely) and your partner does have an ownership interest in property, you will both need to consider how the PPOR CGT exemption split provisions for spouses can be best utilised to provide the most efficient CGT result for you and your partner as a combined "economic unit".

...so you see, "Love is a Many Spendid thing!"

 

[Kristine..]

Love ... Is A Many Splendoured Thing (violins stage left)

sorry, Richard, just splitting hairs

Although I must admit I appreciate your fiscal pun!

Yes, it is a pity that we can't plan for every eventuality in life, but sometimes achieving the action at all is just wonderful.

goddess, it seems you have done just fine with your apartment - buying with very little of your own money at the start and enjoying the equity as it built up.

Now, you have a nest egg which in itself is a great gift.

I look back at the first property I bought, in Ivanhoe, Melbourne, for $33,000 in about 1976 (two storey, views of the city, etc). I lived on boiled rice and tinned fish for months, worked three jobs (yawn) etc etc. I don't have many regrets in life but I regret selling that for $65,000 in early 1982.

Rent at that time would certainly have paid the balance of the mortgage without contribution from me, but 'we' wanted to pay cash for our first home (which we did, just the carpets were put on the credit card for six months). Once bought, unless there is some splendid, fantastic reason, try and not sell.

Congratulations on the happy turn of your life's events, and on the success of your 'happened to be' investment.

... and read Richard's post a few times just for good measure!

Cheers

Kristine

 

[goddessk]

What to do?

Kristine,
Thanks...yes it did turn out to be quite a nest egg and that's not what I intended it to be! I just wanted a little home of my own to live in. Now, although sad as I will be to move out (I love my apartment!) I would like to either sell or rent, whatever is the most sensible thing to do from a financial perspective. From the advice been given so far, it seems that renting it out is the way to go.

Richard,
What you have said makes sense and I am sure that my accountant can assist me to work out the numbers. I have a few questions though.

1. Re the 6 year CGT rule. What does this mean? That I won't pay CGT because I have owned the property for over 6 years and I may decide to rent it out?
2. Can you help me to understand more about splitting the loan. How does this work?

And although love is in the air, my long suffering partner of 3 years still rents with friends, and I live on my own. Reasons: (1) My apartment is not big enough for two distinct personalities and (2) I love my freedom and after 6 years of living on my own I am not willing to give it up yet. Yes, I am one of those weird species of women that doesn't want to rush to get married and I don't want children. Give me night clubbing, partying and my career any day! You would think that being six months off 40 I would grow up!

So we have no joint ownership issues/advantages. He has never purchased property before (yes he is a toy boy 8 years my junior) and is eligible for the first home owners grant so we are thinking that he will buy an apartment big enough for the two of us to cohabitate finally, and then I should rent/sell mine and I can merrily commence on the property investing path. Hopefully this is the right strategy. I can't see that buying a house in Sydney with a huge mortgage and no tax benefits is going to help either of us at this point.

My instinct is to keep my property as I can offset the loss against the horribly large amount of tax I pay and also I will have something to fall back on just in case true love turns into true disaster. Not one to assume the negative but I have been burnt one two many times and believe in being sensible!

 

[geoffw]

Although I must admit I appreciate your fiscal pun!

As in lets get fiscal, fiscal?

 

[Richard Hunt]

The six year rule allows you the option to continue to treat your apartment as your PPOR for "CGT purposes" even though you no longer actually live in it. Where you rent the property during your absence you can effectively continue to treat it as your PPOR for "CGT purposes" for a maximum period of six years. You can also be entitled to another six year period each time the apartment once again becomes and ceases to be your "actual" PPOR.

So for example, if you sold the property within the six year period that it first became a rental property, you would be entitled to the full PPOR CGT exemption.

The loan splits are important if you are going to rent the apartment as they will allow you to better manage the deductible and non-deductible components of your existing borrowings to increase the after-tax returns.

By identifying and segregating these components into separate accounts you have the ability to stream all "principal repayment" reductions first to the non-deductible debt which will maximise the interest expense tax deductions available from the total interest expense on your loans. In effect, more of your interest will be tax deductible than would otherwise be the case under your current loan structure.