Tax deductions on a rental property

Question

Hi Julia,

This question is a follow on from question #94 which you replied to on 22/1/09. The background to my question is the same, ie. –

"My partner and I are currently living in our own home (with a mortgage). We bought the land on 23/8/2003 and moved into our newly constructed home in February 2006.

On 16/8/2005 we purchased another block of land and in March this year, construction of our second house will be completed.

We have planned all along to sell the first house and move into the second when it was completed. We have not claimed any tax deductions on either property to date and we are planning to use our main residence exemption to exempt us from CGT when we sell our first home."

I have decided that exposing the second property to CGT is the best option, as you suggested.

My second property is now almost completed but my first house has not yet sold. Fortunately, I have a family member who needs a place to rent for a short time so I am able to receive an income from one of my properties until my first house is sold.

My broad question is, which property would I be better off renting? My second property is much higher geared than than the first.

My queries are,

a) If I rent my second property, will that enable me to resubmit my FY06/07/08 tax returns and claim deductions for costs associated with the second property during that time?

b) Down the track when I do sell my first property and move into my second, will the second property be covered with my main residence exemption from that point onwards?

c) If I was to enter into a ‘house swapping’ arrangement after moving into my second property, will I still be able to benefit from the 6 year CGT rule?

Kind Regards,

James



Answer

As you have chosen to expose the second property to CGT then it would be the best choice for renting out as you will have a greater tax deduction, not just because of the interest expense but the depreciation should be higher.

You say that you have planned all along to live in the second property so you cannot claim the interest while this was you intention. If you have now changed you mind you can claim the interest etc from this point forwards.

Once your first property is sold and you move into the second property you can begin to cover it with your main residence exemption

I gather you are talking about house swapping as discussed in Noel’s and my book. Yes once you have established your main residence in the new home you can then rent it out for 6 years while continuing to cover it with your main residence exemption. Unfortunately this won’t help you with any time before you move in.

Even though you have a tenant in the second property you will still be able to use the 6 months overlap to protect both properties for up to 6 months before you sell the first, providing you don’t rent the first out.

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