My husband and I jointly own our current home, own jointly – no debt.  We have bought an investment property as joint owners, which is a house (1930’s) on a block of land (775k) – to be financed at 80% LVR. We plan to rent out the investment property for 2 years and save as much money as possible.  Then we plan to demolish the house and build a new home (approx 500k in todays money). Once built, we will move into the new house and if possible, keep our current home as an investment property.  We both earn $130k+ per year. What is the most tax effective loan structure/finance arrangement that can be setup to support this goal? Regards, Maria

From the information provided it appears that the desired ownership of this new property is in joint names this limits the taxation advice that can be provided given the other variables.

The issue you are faced with is that it does not matter how you finance the purchase of this jointly owned property for taxation purposes it is the use of the borrowed funds which determines tax deductibility of interest.

In your example I will assume that you have saved the cash equivalent to the 20% deposit and other acquisition costs required and that the remaining 80% is in fact mortgaged over the new property purchase. In addition, I have assumed there is a reason why you want to retain the property that you currently use as your principle place of residence beyond that period which you need to live in it.

During the first two years it is fairly straight forward you will have a typical rental property with tax deductible interest, the issues arise once it ceases to be a rental property; at this point the interest is no longer tax deductible. In very general terms you will end up with a new principle place of residence which will have some minor capital gains tax issues and a former principle place of residence now a rental property with no debt and an ongoing capital gains tax issue.

In order to maintain a rental property with tax deductible debt you would have to give consideration to disposing of your current principle place of residence ideally timing it in a way that you do not lose its tax free status. The proceeds could then be used to reduce the loan on your new principle place of residence subject to your loan allowing this lump sum reduction and the resulting new equity being used to acquire a new rental property. This would result in a rental property which was acquired with borrowed funds and therefore would have tax deductible interest. The down side would be that you would have disposal costs in selling one property and acquisition costs (including stamp duty) on buying another. An accountant will be able to do a cost/benefit on this strategy.

In order to obtain the best tax outcome for your situation I suggest that you seek further advice as there are a number of questions that need to be answered to maximise the interest deduction and minimise the capital gains tax.  I would also suggest that you discuss your future needs with a financial planner.

Troy Wink is a Chartered Accountant and tax agent and has worked in and on businesses for over 20 years in both commerce and public practice. Troy is Partner of VBD Chartered Accountants based in Charlestown, NSW.

This advice is general in nature and should not be relied upon to make investment decisions as it does not take into account your specific circumstances, of which are not known to us.

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