What you need to know before renting out your home

Thinking of converting your home to an investment property one day?
You’re not alone…

Bigger picture

This is a very common question but you need to look at the bigger picture.

If the property is, in fact, a good investment grade property with solid long-term growth and rental upside then it makes sense to keep it if you can.

Wealth creation is all about increasing your asset base not reducing your debt – all other things being equal.

Let’s put some numbers against this scenario

If you have $200,000 equity in the existing home and you sell it you would reduce your non-deductible debt on the new home and save your interest expense by, say $10,000 annually.

However, if you used it as a deposit on a rental property you could purchase an $850,000 property, which if it grew at 7% on average over 10 years would generate capital growth of $850,000 or $85,000 per annum on average.

Yes, I know property growth is not guaranteed or evenly achieved every single year but in both Sydney and Melbourne the average compound growth was more than 7% over the past 10 years.

And in Brisbane, the better-performing properties achieved similar growth.

You need time to build your asset base so 10 years should be a minimum and you should at least target average long-term growth rates.

Selection is key

It is therefore critical to purchase good investment-grade properties, not just any old property.

What is that old saying: "Anyone can become a property millionaire if they live long enough”?

However, time is also a risk so you should buy better-performing properties, which you can add value to as well as those that have a level of uniqueness.

In the above example if the home is investment-grade then it may be better to hold it, save selling costs and any required maintenance, which could be postponed if rented.

You will also save on the purchase fees such as stamp duty, legal costs, and associated inspection and buying fees.

The costs of selling your existing principal place of residence and buying a new investment property include the agents’ commission on the sale, stamp duty on the new purchase as well as legal costs on selling and buying.

At the end of the day, your asset base swap – even if you sell and buy at the same gross price – has cost you a significant amount.

In fact, you have probably gone backward.

All up, this could save you $85,000 on an $850,000 sell and buy.

I am sure you can find a better use for these funds even if you use this sum as a buffer.

If your goal is to improve your financial position and your asset base using property, it is better to hold your existing home if it is investment grade.

Tax implications

Only the debt on your existing old home will be tax-deductible, but additional expenses such as depreciation on the building (note recent changes to fixtures and fittings depreciation loss), rates, repairs, insurance, etc. can also be deducted.

The tax consequences will be dependent on whose name the property is held.

If jointly held, then the profit or loss will be divided 50/50.

If any new debt is incurred to complete a renovation, then this debt will also be deductible.

Monies borrowed for the new home will not be deductible even if the previous home is used as security.

Deductibility of the interest is dependent on the purpose of the loan and not on the security for the loan.

Property investors need to know about finance, tax, and the law (good name for a book that one).

The Australian Tax Office keeps an eye on investment property claims so be careful, but do claim all your legitimate expenses.

Wealth creation is all about growing, protecting, and passing on your wealth.

So the key is to build a solid asset base and then reap the rewards over time.

Property needs time to achieve its desired outcomes but a good investment grade property will usually take less time, which reduces risk and allows you to move to the next investment more quickly.

RememberEinstein’s8thWonder of the World compound growth?

This lets you calculate how long it will take for an asset to double in value at a particular growth rate.

As an example, if a property is growing on average at 7% per year (not necessarily evenly) it will take 10.3 years for its price to double.

If the property is growing at 5% then it will take 14.4 years to double.

Let me put it another way…

An $850,000 property will grow to $1.672 million in 10 years if growing at an average of 7% per annual but at 5% it will grow to $1.384 million over the same time period.

What could you do with the extra $288,000 (equivalent to $28,000 per year) of non-taxable capital growth?

Over 20 years, the difference in capital growth is more than $1 million.

Wealth creation is all about asset accumulation but more importantly the right investment-grade assets.

Therefore, were possible, accumulate assets not divest them to reduce debt.

This must be done with a proper plan and within acceptable risk tolerances using the correct structures to purchase.

After all, the slow and steady tortoise beats the hare every time.

Article Source:  propertyupdate.com.au

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Jason Gwerder
Friday, 30 July 2021

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