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TAX Q&A: Maximising Investment Property Loan – Tax Implications

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Q: I have two properties: an investment property that I built and an existing home that I live in.

By July 2017, I will have owned my investment property for two years, and at that stage I am planning to move into it as my own home.

I paid $750,000 for the land and construction costs. I have no plans at the moment to sell this property, unless my job situation changes.

At the same time, I am planning to convert my current existing residence into an investment property. I owe $350,000 on the loan and the median price of houses in the area is $550,000–$575,000. Can we maximise the loan on this property by refinancing so that I can gain negative gearing benefits as well?

Overall, what are the tax implications of what I am planning to do? Can you please advise of any CGT implications or other issues to do with tax?

Best regards, Madhav
A: As soon as you convert your current existing residence into an investment property, and provided it is available for rent and for income-producing purposes, the current debt of $350,000 converts to an investment debt. (Note that an investment property can also be a property that you decide to keep vacant, which therefore generally precludes you from negatively gearing the property for tax purposes in this instance.)

The interest expense on your loan, which is now an investment debt, can be tax deductible, as well as the other additional outgoings of the property, such as council rates, maintenance, real estate agent fees, insurance and depreciation for income tax purposes.

If you maximise and increase the current debt over and above $350,000, then the question becomes: what is the purpose of increasing the loan?

If there is a legitimate investment reason as to why you wish to increase the current loan (for example, you wish to borrow additional funds for repairs to the investment property and/or to renovate the investment property), then you may be eligible to claim the additional interest expense as a tax deduction for income tax purposes.

If there is no investment purpose for increasing the debt, then you will not be allowed to claim the additional interest expense as an income tax deduction. Merely increasing the debt because your property has now increased in value and gained equity is not an investment purpose, and therefore you will be unable to claim the additional interest expense as an income tax deduction.

Be mindful that if the dominant purpose of doing something is to obtain a tax benefit, then Part IVA of the Tax Act will disallow you from claiming such costs as income tax deductions – and the ATO will also impose substantial fines and penalties as well.

Furthermore, there are potential capital gains tax (CGT) considerations to bear in mind, in that from the moment you convert your current principal place of residence (PPOR) to an investment property, it then becomes subject to CGT if you sell it in the future.

Provided this property is held in your own individual name and was never used for income-producing purposes in the past, then the period prior to this should be CGT-free.

Similarly, your current investment property will be subject to CGT up until the moment you move into this property as your new PPOR. However, post this date it should be CGT-free.
– Angelo Panagopoulos


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Preparing for tax time as a property investor

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Preparing for tax time as a property investor

Prepaid expenses
If you prepaid a rental property expense, such as insurance or interest on money borrowed, that covers a period of twelve months or less and the period ends on or before 30 June of the relevant year, you can claim an immediate deduction. Otherwise, your deduction may have to be spread over two or more years under the prepayment rules if the expense is $1,000 or more.
Claiming interest expenses
You can claim the interest charges on the loan you used to: purchase a rental property, purchase a depreciating asset for the rental property (for example, to purchase an air conditioner for the rental property), make repairs to the rental property (for example, roof repairs due to storm damage), finance renovations on the rental property, which is currently rented out, or which you intend to rent out (for example, to add a deck to the rear of the rental property), purchase land on which to build a rental property and interest you have pre-paid up to twelve months in advance. You cannot claim interest: you incur after you start using the rental property for private purposes, on the portion of the loan you use for private purposes (for example, money you use to purchase a new car or invest in a super fund), or on a loan you used to buy a new home if you do not use the new home to produce income.
Record keeping requirements
You need to keep proper records in order to make a claim, regardless of whether you use a tax agent to prepare your tax return or you do it yourself. You must keep records of: the rental income you receive and the deductible expenses you pay – keep these records for five years from 31 October or, if you lodge later, for five years from the date your tax return is lodged, and you also need to keep records of your ownership of the property and all the costs of purchasing/acquiring and selling/disposing of it for five years from the date you sell/dispose of your rental property.
Tax Variation
If you are expecting a large tax refund at tax time you can access the funds in your pay cycle throughout the year rather than receive the money as a lump sum annually. This also especially is beneficial for your cash flows during the year. An Income Tax Withholding Application is an annual application that your accountant can lodge to the ATO and once approved, the ATO will notify your employer of the reduced/varied amount of tax to be withheld from your pay each period. This means that your net take home pay will increase.

Choose the right accountant
Choosing an accountant who is a specialist in property tax and property investment is invaluable.