There are tax issues to consider if you want to turn your home into an investment property

So you’re thinking about turning your home into an investment property because you’ve decided to upgrade to a new place but want to hang onto the existing one and rent it out.

One of the first things you’ll need to look at is your loan. You should let your lender know about your plans and be aware that as an investor your interest rate might be higher. You can stick with your current lender or refinance with a new one.

You may also think about changing your loan from principal and interest to interest only. Make sure you keep this loan and any loan for a new property completely separate so you can be clear about what debt is tax deductible and what isn’t.

There are, of course, tax issues to consider – a key one being capital gains tax.

“If you live in your home, that home can be sold capital gains tax free because of the CGT exemption which exists for main residences,” says Mark Chapman, director of tax communications at H&R Block.

“However, if you convert your home into an investment property, you may eventually lose that CGT exemption.”

You can choose to continue to have a house that is rented out treated as your main residence for CGT purposes, provided you don’t elect to treat another house as your main residence at the same time, he explains.

This is known as the “six-year rule” because the grace period lasts for a maximum of six years if the home is rented out. You are also entitled to another period of six years if you move back to the house and live in it as your main residence before renting it out again, adds Chapman.

“This ‘grace period’ is ideal if you’re going overseas for a period or working away somewhere in Australia and living in rented accommodation,” says Chapman, pointing out that if you buy somewhere you can’t treat that new house as your main residence for capital gains purposes.

This is an important caveat to understand because it could mean turning your home into an investment property is a bad financial decision, especially if the new home is likely to garner a bigger capital gain, which you may then be taxed on.

If you keep the property for more than six years you will be subject to CGT on the period that is not covered by the main residence exemption, says Chapman.

“A special rule applies when a property is first rented out. The market value on the date it was first rented becomes the deemed cost of the property for tax purposes (meaning that the original purchase price becomes irrelevant for tax purposes). Any capital gain is then calculated by deducting the market value of the property on the date it was first rented, plus the cost of any improvements and any associated sale or purchase costs, from the proceeds of sale. If the proceeds are higher than the deemed cost, the difference is your capital gain,” he says.

“The gain would then be time apportioned. That part of the gain reflecting the period the house was covered by the main residence exemption will be CGT free and the part which is not covered by the exemption will be subject to CGT. For example, if you owned the house for 20 years, first started to rent it out 10 years ago and never moved back in, 4/10ths of the gain will be chargeable to CGT. That’s because the first 10-year period is ignored for tax purposes, the next six years are covered by the absence rule, leaving just the final four years chargeable to CGT.”

If you do convert your home into an investment property, and the house was built after July 1985 and purchased before 7.30pm on May 9, 2017, you can claim depreciation on the construction cost of the house and any structural improvements you have made, as well as claiming a deduction for depreciation on any capital assets – furniture or appliances for instance – over their effective life, says Chapman.

You should employ a quantity surveyor to help with this. If you purchased the house after 7.30pm on May 9, 2017, you may not be able to claim depreciation on capital assets if they were already part of the property on purchase and the property was previously owned by somebody else.

ref: http://moneymag.com.au/turn-home-investment-property/

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