Ask Ban Tacs Question
Hi Julia
Firstly I’d like to say I’ve read some of your book and it’s very informative and factual compared to other books. It’s hard to read some sections for someone who isn’t familiar with tax and investing.
My question relates to the following situation:
I have a house which is fully paid off and valued at approximately $400,000. I want to buy another [established] house for the price of $500,000, and then fully pay it off, and then demolish it and build a new house there, and move into it. After doing this I want to convert my current house into a rental property so that I can use the income to help pay it off.
Question 1: Am I able to use the current house as an investment and obtain deductions. The reason why I am unsure is that I keep reading on that it’s better to sell your home and buy another property that can be used for depreciation, but I don’t know if I’m comparing apples with apples.
Question 2: When I build the new house I think it will cost me about $700,000 in today’s value. Is there any way I can structure so that I can claim deductions for this construction cost.
Other things to keep in mind:
I am married.
I do not intend to sell (unless recommended) so Capital Gains Tax is not an issue so take this out of the equation.
Thanks and regards
Answer
A Thanks for the positive feed back on the book. I agree that some parts just can’t be explained easily, that is why Noel suggested I set up this facility back when we wrote the first book.
Yes you certainly are able to use your current home as an investment property and qualify to claim expenses as a deduction including depreciation if there is any left to claim. But of course you cannot claim any interest against the rent because you have not incurred any interest in relation to the property that is earning the rent. This is why in most cases it is better to sell the property, further on in this answer I will show you how to work this out with your.
No you can’t claim the construction costs for the new property against the rent on the old property. Anything to do with the new property will not be tax deductible because it is used for private purposes.
Your building depreciation claim will certainly be less than a new home and because you will have lived there for many years there is probably very little left at all to claim on the plant and equipment. You may have recently bought a new stove or something so that will still have years to run. You don’t need a quantity surveyors report for that if you know the original purchase price so in the years you spend paying off the new property before you move there, make sure you keep receipts on the old one. The building depreciation is the same amount each year for 40 years if the property was built or renovated after 16th September, 1987. The problem is it is based on the actual cost so while your house may cost $300,000 to replace if it only cost $150,000 to build back in 1990 then you are only going to be able to claim $3,750 (2.5% x $150,000) each year where as if you buy a new property where the house cost $300,000 to build your building depreciation claim would double even though the market value of the property may not be much more than your current house. A lot of that has to do with what sorts of properties are popular in the area. Note that building is only a deduction the actual cash it leaves in your pocket is only a fraction of that, it needs to be multiplied by your tax bracket, maybe even an average of you and your spouse’s tax bracket if it is in joint names. So the buying and selling costs might erode any real benefit here anyway.
I would like to take the opportunity to show you how to calculate how much it is going to cost you to hold onto your old home when you consider you will be paying non deductible interest on $700,000.
I think you will find the big ticket item is not the depreciation but not being able to claim any interest as a tax deduction. Fortunately I answered a question on this in the November edition of API and put a calculator up on their web site that you can use. If you go to www.bit.ly/153-18 download the spreadsheet and put your particular numbers into it. You can work out how much your old property will put into your pocket after tax, if you were to keep it.
Then consider how much cash you would net from the sale of your old home, after deducting selling costs and CGT if it is applicable. Multiply this buy the interest rate you are paying on your $700,000 construction loan (this is already the after tax figure). The difference between this and the figure you get in the calculator is how much it is costing you to hold the old property and pay interest on the new one. If you pay down properties quickly then maybe it is worth it for a few years compared with the cost of selling and probably buying another rental later on.
You also have to consider whether your old home is a suitable investment property. Is it the sort of property renters in the area would looking for? Has the area got potential for capital growth? Is it a sound property etc. Ask yourself if you were about to buy a rental property today would you consider your old home to be the best choice? It doesn’t have to be the absolute best choice because it comes at a discount ie the buying and selling costs saved. Over time that “discount” lump sum becomes less valuable compared with the interest saving every year.
Another option is to buy your spouse’s share of the property and borrow to do so. If it is not in joint names then the non owning spouse could buy out the owning one. The selling spouse can then use their sale proceeds to make a fair dint in that $700,000 debt. The trouble is there seems to be no other reason for this choice that a tax benefit so it might be caught by part IVA. You should ask the ATO for a ruling on this first. Have a read of pages 104 and 105 of the book, the cartoon says it all.
