Loan pre-approvals by banks can be confusing. They aren't a rubber stamp to buy whatever you want, but some buyers are being a little too cautious.
How to change a home into an investment property
Your home has become too large or too small. You need to move for work or the kids’ schooling. Or you just fancy a change of scene. Ordinarily, one would sell the current home and buy or rent a new principal place of residence or PPOR (to use the horribly clinical bureaucratic definition).
But would that be a missed opportunity to become a property investor (or add further to a portfolio)? With inertia leaving many people with an unfulfilled ambition to invest in property, is holding on to the erstwhile home and leasing it out the hassle-free route to financial security?
Maybe. There are several attractions of this route, but also a few downsides.
Retaining the former homes as an investment will cut out all those selling costs: real estate agent fees, marketing costs as well as the time and inconvenience of preparing for and undertaking the campaign. And you won’t have had to bear the additional costs of buying an investment property – stamp duty, building inspections, conveyancing fees. In total these transaction costs can shrink your pot of money by 10 per cent.
Keeping the former home leaves open the option of moving back into it one day. Perhaps your reason for moving doesn’t work out – say you end up hating the new job or location – or won’t be for the long-term. Indeed, retaining the old home as an investment property might allow you to be braver about taking big career decisions, knowing that you don’t immediately have to burn the bridges to your old life. Moreover, the ATO is quite supportive in this respect. Should you move back in to the former home within six years of leasing it out, any uplift in value over that period won’t be subject to capital gains tax (as long as you didn’t designate another property as your PPOR)
Of course, now that your former home is an investment, any costs – including interest payments and maintenance – are tax-deductible. However, owners often have substantial equity in their property at the time of transfer. Although that is mostly good news, it does mean that these properties tend to be positively geared, so there isn’t the opportunity to offset costs against other income. Furthermore, the ATO usually disallows owners who increase the gearing by re-mortgaging from claiming against the higher interest payments. The tax man has a purpose test that looks at what the new borrowings are for. In this instance, the extra borrowings didn’t secure any additional income-earning assets so are considered to be for personal use.
In some instances, couples have successfully increased their tax-deductible gearing after a change in ownership structure; namely, the property is transferred from dual ownership to either the husband or wife, who then takes out a new, larger mortgage on the property. The circumstances for this to be allowable and worthwhile are comparatively rare. In Victoria, a ‘for love and affection’ rule means the transfer would be stamp-duty free, but that’s not the case in other parts of Australia. Furthermore, the ATO would need to be satisfied that the transfer was done for genuine reasons (say only one member of the couple wanted to own an investment property). If it was done just with the sole or dominant aim of obtaining a tax benefit then it would fall foul of tax avoidance rules. Naturally, talk to your accountant on this issue.
One final point on taxation issues: with the base value for any future capital gains tax calculation being the day the former home is available for rent, it is important to obtain a valuation of the property around that time.Notwithstanding much of this article being devoted to tax, ultimately asset quality considerations should drive your decision. Try to be dispassionate about your former home and answer these questions. Does your former home have a track record of and propensity for strong capital growth? Is there a deep pool of potential renters for its property type in your area? If the answer to either of these question is no, then sell and seek out a genuine investment-grade replacement.