16/02/2012
Question: My current principal place of residence (PPOR) was purchased in 2007 for $300,000. I am now building a new home which will cost $600,000. I am planning to use my first home as an investment property, and move into the new house eight months down the track. In the meantime, a valuation on my first home came back at $450,000, and my borrowing limit is $360,000. My current loan on this home is only $200,000, but by the time my new home is ready, I would have drawn on the full $360,000. My questions are: 1) For the purposes of claiming tax on interest expenses, can I declare the outstanding loan on this first home as $360,000? 2) How is the capital gains tax (CGT) worked out when I sell this investment after say five years? 3) What precautions should I take now?
Answer: 1) For the purposes of claiming tax on interest expenses, can I declare the outstanding loan on this first home as $360,000?
- No, the interest on the total $360,000 cannot be claimed as a tax deduction. As your current loan is $200,000, when this property becomes an investment property, it is the interest on this part of the loan that will be deductible for tax purposes. The test for deductibility is “what are the borrowings used for”? In this case, the extra $160,000 is used to finance the new home which will be the principal place of residence, and the resultant interest expense is of a private nature.
2) How is the CGT worked out when I sell this investment after say five years?
- There is a possibility that if the investment property is sold in five years, then capital gains tax may not apply. You may be able to elect that the investment property continue to be your main residence, and maintain its capital gains exempt status. This exemption is only available for a period of six years from the last date you resided in the property. It must be noted, however, that if you elect the investment property as your main residence, then you may be liable for capital gains on the new property for that period for which the election was made.
3) What precautions should I take now?
- I agree that you should have a formal valuation of the current property as this may be useful when calculating capital gains. Additionally, you should keep an accurate record of the building costs of the new property as they may be required for capital gains calculation in the future. I would also be conscious of the market value of both properties when it comes time to sell one, as it may dictate which properties you elect for capital gains exemption.
- Answer provided by Dom Cosentino, Kennedy & Co Chartered Accountants (www.kennedy.com.au)
