Turning your home into an investment property
Turning your home into an investment property should never be solely an emotional decision. It is understandable that people develop strong connections with their homes, but unless there are clear financial advantages to be had in converting a home into a source of income, there is usually more sense in selling this property and looking to invest elsewhere.
However, turning your home into an investment property can be advantageous for one big reason: the six-year rule.
You may be moving overseas, interstate or at least intend to move back into your old home after you have leased it out. If this is the case, you have six years in which to lease your home, claim income and expenses, return to the home and avoid capital gains tax once you do finally sell the property. Each occasion you do return to this property, for instance if you took different interstate jobs, than the six-year rule resets for these occasions. Note: you must live in your home for at least 12 months before you can begin treating it as an investment property.
While this tax exemption may seem like a clear incentive for turning your home into an investment property, unless you do intend on moving home, the financial disadvantages can contradict the worth of this decision.
Moving from your existing home, it is fair to assume that you have decreased your debt on that property through mortgage repayments. If you turn that property into an investment property, you will have a small debt on which to claim tax exemptions. Meanwhile, you will have a permanent place of residence (PPOR) with a new, larger mortgage, on which you cannot claim tax exemptions. In essence, you invert your financial position in a way where the largest debt is not exempt from deductions.
Rather than pay back mortgage repayments on a larger loan that you cannot claim, it may be wiser to sell your old home, free of capital gains tax, buy a new home and use the equity you built up on your original home to buy a different investment property that has a tax deductible loan.
Whether you do decide to keep your home as an investment property or start afresh, there are a few golden rules to never forget.
- Keep your loans separate. If you have an existing principle and interest home loan for your old home, can you convert it into an interest-only loan that will sit alongside your new home loan for your next primary place of residence? If you can, be sure to keep your loans separate so that it is crystal clear what relates to your investment property.
- Be sure of whether your new investment that was previously your home is positively or negatively geared. As a property that you have been paying your mortgage on for years, it is more than likely that it will be positively geared, where your possible income from rent is more than your loan and management expenses. In this case, you ideally want your loan to be solely in the name of a lower income earner. Because of this, a negatively geared investment property is often seen as a better way to increase your cash flow, helping you to repay debt more quickly.
- Will you be able to claim depreciation on items within your old home? If you bought these items new, then you can have a quantity surveyor estimate the value of the fixtures, appliances etc. in your home. If you buy a new investment property with second-hand fixtures, you may not be eligible to claim depreciation on these.
While you can save on stamp duty costs by keeping your existing home, one of the few situations where it may be worthwhile turning your home into an investment property is where you believe the property will experience significant capital growth, for instance if it is in a historically strong-performing area and where you think it will attract strong rental yields. But if this is the case, will you be able to handle strangers living in the property you don’t want to let go of?