Turning your home into an investment can be a great way to generate income. In some cases, you could use the rent money to repay your home loan. But there are income tax implications to consider.
Regular homeowners don’t have to worry about the tax implications of owning their own homes. However, they can’t deduct any of their home’s expenses from their tax returns either. All this changes when you decide to take on a tenant. Firstly, you will have to declare any income you receive on your tax return. Think of it like running a business. Any income you generate must be taxed, otherwise, you’re running the business illegally.
On the plus side, you can make claims for various utilities. For example, you could deduct some of the money you spend on water and electricity from your taxes. You can also take the depreciation of the home assets into account if you take on a tenant.
Joint ownership muddies the waters a little. You must ensure that any rental income is split in the same way as the home ownership. If you pay 50% of the home loan, with your partner paying the other 50%, you each must receive half of the income it generates when you take on a tenant. Both owners must take this into account when filling out their income tax forms.
Can I claim interest on my home loan payments?
This is a difficult question to answer. You can claim home loan interest. However, you can only claim it on the sum of the original loan. This affects you if you have used a redraw facility.
Let’s say that your original home loan was for $550,000, and you have repaid $150,000 of that loan so far. You then redraw $50,000 of those payments for another investment. This now means you have $450,000 left to pay on the loan.
However, $450,000 isn’t the figure you need to take into account when deducting the interest. Instead, you have to ignore the redraw facility entirely. As a result, you can only claim interest on the $400,000 that would have been outstanding on the loan had you not used the redraw facility.
Capital Gains Tax
Capital Gains Tax (CGT) becomes an issue as soon as your home starts to generate income. CGT doesn’t apply to regular homeowners, as they receive exemptions because the home is their principal property and place of residence. However, taking on a tenant means you’ve turned your home into an investment, so you have to pay CGT.
Here’s how CGT works. Your home becomes a taxable asset as soon as you sell it. The Australian Taxation Office (ATO) will look at the capital gain you made through the sale, which is the difference between the price you paid for the home and the price you sold it at. You have to pay tax on this figure.
However, there is some good news. The time that you’ve lived in or owned the property can lower your CGT bill. The longer you’ve owned the house, the less CGT you will have to pay when you sell it. Furthermore, there’s the issue of making the home your principal place of residence. You can designate a home you own as your principal place of residence for a maximum of six years after you’ve moved out. Again, this can reduce your CGT bill.
This is a complicated area of property tax, so it’s best to speak to a professional to find out how turning your home into an investment will affect your taxes.
What to do next
You can potentially generate a lot of income if you turn your home into an investment. The money you earn from tenants could provide the boost you need to start building a portfolio. You should always speak with a tax professional before exploring your options. We recommend you:
- Find out more about financing an investment property
- Talk about your next steps with one of our advisers.
This information is general in nature, and you should always seek professional advice when making financial decisions.