Your Home could be your Money Making Machine
If you’re considering turning your current home into an investment property, that’s great news. Property is a great way to build wealth for your retirement and for the future of your kids. There are considerations that you should keep in mind. We will cover some of the important factors below.
Can you Afford it?
First and foremost, you have to make sure you can afford it. A property investment is a long play strategy. So although you can make substantial gains long term, you have to be able to afford it along the way.
If you are in a current mortgage and are only just making your loan repayments, then it would be wise to wait it out until things get a bit better, or maybe after you get that big promotion at work.
Do the Maths
The rent you get plays a big part in the affordability matrix. But you have to consider all your costs. Like rates, water rates, maintenance, insurance etc. Will you still be able to afford the new home’s mortgage, your current home’s mortgage and all these other expenses?
If you work out your budget conservatively and you can still meet all these commitments, then you are heading in the right direction. But there’s more. So read on.
If you are using your current home as an investment, then the emotion needs to be removed from the equation. It is now only about dollars and cents.
If your home is in a growth location, then it makes sense to consider turning it into an investment property. Property values grow at different rates in different locations, so being in a high growth area can give you passive wealth in future. Looking at median price growth in your area over the last 5 to 10 years can reveal quite a bit. Of course, there is no guarantee it will still continue with the same trend but it is an indicator worth looking at nonetheless.
We all love our homes. But will others love it as much as you? Renting your home out in an area where rentals are not in demand can be tough.
Similarly renting a home that is not be in high demand for the average renter demographic in that area may also give poor results. For example, if you are renting out a large home in an area that primarily has singles and young couples, then you may find it harder to rent and you may not get the rental you expect. Similarly, renting out a 1 bedroom studio apartment in an area primarily inhabited by families may be tough. It’s best to talk to a number of local real estate agents.
Capital Gains Tax - The 6 Year Rule
We all hate to pay more tax than we legally have to. When you have an investment property, any gains you make when you sell it have to included as Capital Gains and you would be taxed accordingly.
It is important to note that when you turn your principle place of residence into an investment, capital gains will be counted from the increase in value from that date onwards. In other words, if you bought your home for $400,000 a few years ago, and today you decide to turn it into an investment property and its value is $600,000 today then in a few years time you sell it for $900,000, then the capital gain is only calculated on the $300,000 gains achieved from the day it became an investment and you would only be taxed on that portion.
Another little known perk is that if you live in your home then decide to turn it into an investment property, you can leave it as your principal place of residence for a period of up to six years and get an exemption from Capital Gains Tax altogether. This means you can move out, rent it to tenants for up to six years and still be eligible for the exemption.
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Depreciation - What is it?
Depreciation is the decline in value of an asset. The ATO allows you to reduce your income by the value of the reduction in the value of the asset.
However, depreciation laws changed in 2017. You can now no longer depreciate the value of the home unless it is brand new. However, you can still depreciate items of a capital nature that you replace or add. For example, if you replace your stove, or add a new carport, these items can be fully depreciated if you use your home to earn income.
The benefits of depreciation help in reducing your taxable income and the reduction in tax can assist with your out of pocket expenses that may arise making the investment property a bit more affordable – thanks to the Tax Man.
Please see * note below.
Negative Gearing - More Mumbo Jumbo explained
So what is it? Negative gearing is when you borrow money for investment purposes and invest that money into an income producing asset (usually a property) and the income you make from that property (the rent), is less than your expenses (bank interest, council rates, maintenance etc). In that case, you are deemed to be making a loss.
This may seem counter intuitive. You may ask, why would I own a property that makes a loss? Recall that we talked about property being a long term play. So it is the capital appreciation that investors look for over a longer period. The short term losses are balanced by the long term gains. So whilst you hold the property, the losses made can be deducted from your income and your total taxable income is reduced. This reduced taxable income can net you a sizable tax return each year helping in the cash flow shortfall experienced.
Please see * note below.
Use The Equity - Luke
The power of Equity is like the power of The Force – The value of your home minus what you currently owe is the equity you have in your home. If you have paid down your home a bit and it has increased in value, then the equity you’ve built up could be more than you think.
You could use that equity to assist in getting another home. So if you have $300,000 in equity in your home, ordinarily you could borrow up to 80% of that equity which is $240,000. You could then use that money as the deposit for your new purchase. If the value of the new home that you wish to buy is $800,000, then the 20% deposit of $160,000 would be more than covered by the equity available to you. The additional funds could go towards the stamp duty, legals and other costs encountered in purchasing the new home.
Doing this means that it may be possible to keep your existing home, up-size to a new home and use little or none of your savings to acquire the new home. How good is that?
For information about how to use the equity in your home for your next purchase or when buying an investment property, please call us on 03 8560 5000 or leave your details by clicking here and we will call you
* PLEASE NOTE: It is important to get the right financial advice. As we are not financial advisers or tax advisers, this post is informational only and must not be treated as tax or financial advice. Our team can refer you to a registered and experienced financial planner or tax specialist if you need one.