Hi Nicole,
I currently live in my home with my spouse and two kids. Due to schooling requirements we are moving to a new house in a different suburb. I would like to refinance my current home, which I am retaining as an investment property. Can I claim a deduction of interest? Will I be able to claim the interest deduction on the purchase price of the property (in 2001), on the refinance amount or market value of the property? Thank you.
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Chris, Ashwood
Chris, you know I am a massive advocate of ditching your debt … but that doesn't apply if – at some stage in the future – you're likely to buy a new home and turn your existing one into an investment property.
This is because the answer to your question is actually behind Door No. 4: you can only claim interest deductions for a home-turned-investment on your lowest ever loan balance. It matters not if you reborrow against it all the way to its current value – you're really financing the purchase of your new, non-tax-deductible home. It's the use of the money that's key; it needs to be for an income-producing property.
Put simply: if you borrow for a home and pay it down, that portion is forever lost to you in terms of future tax deductions for interest. If you've paid it down far, usually an admirable achievement, a property potentially becomes useless to you as an investment (from a tax point of view).
In case it helps, any improvements you make with borrowings can be added to the deductible portion of your loan.
I hope this news isn't too bad, Chris. It's where an offset account really comes into its own: you can make extra repayments into this "quarantined" parallel account and they don't technically pay down the loan. What's more, they remain at your fingertips if you later want to use them to purchase your next home.
You can also enhance this strategy and maximise your official loan balance by taking out owner-occupier loans on an interest-only basis but note I have reservations unless you are disciplined with your saving and that interest-only borrowers are at present being hit with some hefty out-of-cycle rate hikes.
Your decision whether to keep the property will come down to the size of the new non-deductible loan, the investment outlook for property in the area, the size of your deduction and your marginal tax rate, says Paul Moran, a principal at Moran Howlett Financial Planning.
"If the deduction is small and the 'relative' rental return [when compared to the new repayments] is low, you might consider selling the existing property," he says.
In any event, you'll know for next time. And a decent education for your kids is priceless.
Nicole Pedersen-McKinnon is a money educator and consumer advocate: themoneymentorway.com. You can write to her for help solving your money problem, or with a consumer question, at nicolehelps@fairfaxmedia.com.au.