Join our investing community

Buying Second Home, Using Equity, Rent first place out

Discussion in 'General Investing Discussion' started by imessica, 9th Oct, 2012.

  1. imessica

    imessica New Member

    Joined:
    9th Oct, 2012
    Posts:
    1
    Location:
    Mermaid beach qld
    Hi All,

    Iam relatively new to this forum and seek expert opinion and thoughts about what you think to buy a second home ?

    Iam owning a unit which is worth 290K and am only owing about 50K to the bank. The purchase price was 260K. I have owned my unit for 4 years now and have been paying it off, I currently reside in it and rent out the other room which nearly covers my Mortgage. I am looking at buying a house to move into , rent out my current unit for $350 per week or more (The amount which it rented out when i bought it, since then have renovated kitchen and living area) The market is really low at the moment and i think it would be a smart move to invest into another home and rent this one out. I have 30K saved up in the bank. I own my property on my own and the second one will be as well.

    What best home financing strategies can I undertake so as to minimise any tax implications, leverage equity of my present home. I want to make sure that i do this properly.

    Once I Move into second home, I would rent my previous property..with rental income around $350 per week expected. Also will rent out the other 2/3 bedrooms in my new home.

    I look forward to your suggestions and advice. I want to this the smart way.
     
  2. Terryw

    Terryw Well-Known Member

    Joined:
    9th Jun, 2006
    Posts:
    653
    Location:
    Sydney
    Not much you can do really.

    Change the loan to IO and set up a LOC to pay for expenses maybe. You cannot increase the loan and claim the interest unless the borrowed money is used for this property.

    Make sure you get a depreciation report done too.
     
  3. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    From your message, I take it you have paid down your existing loan as apposed to putting your savings into an offset account attached to the loan?

    If so, unfortunately you have structured your loans all wrong and now are in an unfortunate position where if you rent out the first property only a very small portion of your loans will be tax deductible.

    Have you made use of a redraw facility at all on your loan? If so, the remaining $50k loan may be compromised as well.

    Deductibility is determined by purpose - the $50k left on your loan was borrowed for purchasing your existing place. So if you rent out your existing place the interest on this loan will become deductible.

    Any interest on money you borrow (or redraw on your existing loan - as this is treated the same as a new loan) to purchase a new place that you live in will not be deductible.

    If you had setup the original loan with an offset account and put your extra savings into the offset account, then you simply withdraw the funds from the offset account and use it to purchase your new PPOR, maximizing the tax deductions on the original loan.

    Unfortunately the only way you can handle this situation now is:

    1. Keep the existing place and pay more tax on it. Only the $50k loan will have deductible interest, so you will end up paying tax as the rent will be more than the interest.

    2. Look at doing a spousal transfer or sale to a trust possibly to "re-purpose" the debt. Eg. If married, sell it to your partner, and they borrow to buy it off you. Will incur purchase costs/stamp duty etc.

    3. Sell your place, and purchase a new IP - getting the loans structured properly this time.

    I made the same mistake with my first place and went down the spousal transfer path. In hindsight if I had my time over I would probably do option 3. (Actually if I had 20/20 hindsight I would have set it up properly in the first place with an offset account and then wouldn't have had to make the hard decision.

    Regards,

    Jason
     
  4. GregR

    GregR Reid Consultants

    Joined:
    13th Jul, 2009
    Posts:
    273
    Location:
    Berwick Vic
    Another option is to refinance your existing loan by setting up a new facility, then purchase an investment property using another lender.
    In this way you have effective 105% finance all interest for the purchase being tax deductible.

    What you have done is not wrong, just not tax effective. Ultimately wealth is about assets less liabilities so paying down debt is generally a good idea, it is how you do it that makes a difference. For anyone who may be a potential investor and lives in their own home, the use of an offset is very beneficial. If you ultimately decide not to invest, you can always transfer the funds into the loan. It gives you options.

    Good luck
    Greg
     
  5. boss

    boss Member

    Joined:
    10th Feb, 2013
    Posts:
    11
    Location:
    brisbane , qld
    hey gregr,
    could you go into a bit more detail on how that works as im new to all this and interested to how it all works cheers boss
     
  6. GregR

    GregR Reid Consultants

    Joined:
    13th Jul, 2009
    Posts:
    273
    Location:
    Berwick Vic
    Boss,
    It has been covered elsewhere but as a summary, it is about future flexibility where there is a possibility that a property owner will purchase another property to either upgrade to or move into and want to keep the first property.

    It relates to tax laws and the ability to claim interest as an expense for any borrowings relating to an income producing property. The tax laws are such that it is the purpose of the loan that determines whether the interest is an allowable deduction or not, irrespective of the asset used to secure the loan.

    In Imessica case below, he/she purchased a home, assume borrowed $200k, has paid down loan to $50k. The option could have been to pay the same amount but into an offset account, net result would be the same interest calculated on the net loan outstanding but if it was an interest only (IO) loan, then the original $200k loan would still be in place.

    As they have paid down the loan, I presume no additional savings, so to buy a new home (say $400k), other than selling and incurring additional costs, the option is to borrow the full amount including stamp duty. As the new property is their home, interest is non deductible on a whole lot of debt. The loan on the 'old' property, now used as an investment property (IP), interest able to be claimed as a tax deduction is only on the $50k loan (@6% = $3k @ MTR of 30% = $900 tax saving per annum). Needing to borrow up to $420k for the new PPOR, non deductible interest cost = $25k pa.

    If they instead had put the additional $150k into the offset, they pull that out and only need to borrow the rest of $270k. Non deductible interest cost now = $16k pa. Tax deduction for interest on old IP, loan still at $200k @ 6% = $12k @ MTR of 30% = tax savings $3.6k pa. Overall effect between the 2 is nearly $3k pa. depending on marginal tax rate.

    Offset is also immediate access (most lenders) and no cost or minimum to access as opposed to redraw. Also don't have issue of same lender and cross securitising etc.

    Hope this helps clarify.
     
  7. boss

    boss Member

    Joined:
    10th Feb, 2013
    Posts:
    11
    Location:
    brisbane , qld
    hey gregr,
    I really appeciate your time and reply , im knew to these type of forums and im amazed at the knowledge you guys pass around. It has opened my eyes up to what i need to do for the future which is how i came across this site looking for advice as it is hard to get it when you are as time poor but i find myself on here every night reading the advice given and buying recommended educating material suggested by you guys and has helped immensley!
    If i ever reach any heights it will definitley be because of this site and the direction it as enabled me to pursue through the advice given here ..thanks boss