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When home owners should learn to let go on property investing

When home owners should learn to let go on property investing

 

HOME buyers with an idea of holding onto their old home as an investment should take some advice from Elsa, star of the popular Disney movie Frozen.

“Let it go, let it go, turn away and slam the door,” sings the ice queen as she magically constructs a magnificent castle while performing her Academy Award and Grammy Award-winning song.

For us non-Disney mortals, our home is often seen as our castle, but holding onto an existing property when upgrading or moving usually makes no financial sense, largely because of our tax system.

The “shall I rent out my former home” query is none of the most common questions I’ve been asked in almost 20 years of writing about money stuff.

On the surface it can seem like a good idea, because if you’ve got enough overall equity, the bank will lend you the money. Plus you could then see yourself as a property investor rather than a homeowner, and the emotional attachment to your first family home prevents you from wanting to let it go.

But tax can turn this seemingly good idea into a very costly one.

Income you get from an investment property is taxed at your marginal income tax rate, usually 34.5 per cent but up to 49 per cent for high income earners. Investors get to offset that income with tax deductions for all the expenses of running the investment property such as council rates, property management fees, interest charges and depreciation.

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Our emotional attachment to our first home can prevent us from making more money. Picture: Thinkstock

Interest charges are usually the biggest property investment expense, allowing total expenses to exceed total income and giving investors an overall tax loss, which is negative gearing.

If you have a smallish mortgage on your existing home — say $100,000 — and turn it into an investment property, there’s a good chance you won’t be able to have enough deductions to offset the rental income. This means you pay more tax.

On top of that, if all your equity is tied up in the old property, you’ll have to pay more interest on the next home’s mortgage. And your primary residence’s mortgage doesn’t come with the handy tax deductions of investment property loan.

So even though you are paying 5 per cent on your next home’s mortgage, it’s being paid with money that has already had income tax taken out, so the effective interest rate is probably 7-10 per cent.

Another tax trap comes from capital gains tax. A principal place of residence is exempt from CGT — a tax on profits that get added to income in the year of sale — but we are only allowed one principal residence at a time.

So if the old home starts earning an income as an investment, CGT kicks in pro-rata. If you’ve held the old property for many years, the CGT impact can be painful.

Always seek independent advice when buying and selling investments because other issues — such as stamp duty — can suck more money from you.

When investing in property, remember — as Disney’s Queen Elsa does — that the past is in the past. Don’t be frozen by emotion to your old home, and always make cold, hard decisions based on what works financially.

Thank you to Anthony Keane from News Corp Australia Network. Originally Published on 9 December 2016 at news.com.au

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