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

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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