When making the decision of whether to purchase a home or continue renting, there are many factors to consider. You have probably found that the best areas surrounding the city, the so-called lifestyle hotspots, generally command a higher price tag than the more suburban or regional areas that are more affordable as well as suited to families. The gap in price between those areas that are close to work, leisure and the city and those that are on the fringes of the city has increased rapidly over the last decade and this has led those who making the decision to take a closer look at how they can make the most of a heated property market.
Rentvesting has often been pitched as a solution to housing affordability as well as a means for young people to avoid sacrificing their lifestyle to make their first property purchase. Instead, they can rent in an ideal location that suits their current lifestyle while their investment property is in a strategic area both earning them a residual income and increasing their net worth as capital gains increase.
On closer inspection, there may be far more benefits to rentvesting than most Australians are aware of. With many young people taking up the strategy, it could very well be an intelligent financial decision that would have positive effects on the economic health of an entire generation for many years to come. To understand this a little further, let’s look at the taxation benefits rentvesting offers as opposed to other strategies.
The taxation benefits are numerous, you can deduct virtually all the outgoings for your property on your tax return such as:
- Water and Council Rates
- Insurance on the property
- Advertising and marketing for tenancy
- Agent fees and commission
- Pest control, cleaning and gardening
- Repairs and maintenance
- Depreciation deductions in the wear and tear of the building
- Land taxes
- Interest on the mortgage repayments
There is another area of taxation that many investors may not be aware of and it certainly pays to know since you can tailor your strategy to save a small fortune in tax.
The Six Year Main Residence Exemption
Most property investors would understand Capital Gains Tax when it comes to purchasing and selling income producing assets. For those who own their own home as their principal place of residence, they would also understand that CPT does not apply since the property is not income producing. This is neither good nor bad, it simply is. For example, if you were to sell your place of residence at the peak of the property cycle in Sydney, you could make a tidy profit and not have to pay any tax. This is great if bought at the right time, however if you purchase a home at the peak of the mining boom in a regional area only to find that is not worth nearly as much as you paid, you would not have the option of deducting the capital loss.
With investment properties however, they are treated as income producing assets. This means that while you are required to pay CPT on any profit you make during the same, you are also able to deduct the capital losses. Additionally, you are also able to claim interest payments on the loan as a deduction allowing you to offset any losses incurred by a property in the case that it is negatively geared. A large majority of properties, when they are first purchased, take advantage of negative gearing tax benefits which encourages investors to keep rental rates low and continue to invest in real estate stock.
Now here is where it gets interesting. There is a little-known rule that is quite useful to wrap your head around if you are investing in property and even more so if you are a rentvestor. If you happen to move out of your principle place of residence for a period of under 6 years and rent it out to a tenant, you are actually able to claim the CGT exemption since the property is still considered your main residence. This is of course not the case if you were to claim another property as your main residence during this period of time.
Now let’s take a look and see how this could apply to us rentvestors. If you were to purchase a property not far from where you grew up, let’s say in Brisbane’s South suburbs, lived there for a number of years while paying off the mortgage and working before deciding that you wanted to get started rentvesting. You already have the asset and feel that you would like to rent a room in a share house while you establish your property portfolio on a well-planned budget. You rent out the property to a tenant and move into the share house a few suburbs over, closer to the city centre.
When it comes to tax time, you will still be required to declare the rent as income, but you are also able to claim any of the outgoings relating to the property as deductibles. This allows you to also take advantage of negative gearing benefits meaning you are able to receive a high tax refund.
Since you are living in a share house, you will not be required to claim any other property as your main residence meaning you will be able to hold the exemption for up to 6 years while you are temporarily absent from the property.
After a number of years, the share house is up for sale and you decide you would like to return to your property before making your next move. Since this is within the 6-year exemption period, you will not be liable to pay the CGT when it comes time to sell that same property that was producing income over the years. Even more interesting is that if you were deciding to move out once again for another 5 years, you are still able to claim it as a temporary absence for a further 6 years, there is no limit to how many absences you can take.
If you were remaining absent for a period of 10 years rather than 5, you are still able to claim the exemption however this would only apply for the 6-year period meaning you will only be required to pay tax on the following 4 years.
This exemption provides the perfect platform for rentvestors to get started if they happen to already own a piece of property meaning it is never too late, in fact it makes it even easier! There are a number of factors that you will need to consider before making this decision since the ATO will need to assess whether the property is truly your main residence. You will not be able to simply claim the property as your main residence if you purchased it with the intention of renting it out. The factors that will be most important to the ATO would be:
- The length of time you have lived there
- Whether or not you or your family have actually been physically residing there
- If the property is used as your mailing address
- Whether or not you have your personal possessions there
- The connection of utilities such as electricity, phones and gas
- Whether or not it is your official address on the electoral roll
Before making any decision, it is best to consult a professional on taxation before you decide to up and move out of your place of residence or purchase a property with the intention of making it your place of residence for tax purposes.
When look further into the financial and taxation benefits of rentvesting, it appears to be a strategy ideal for navigating the complex property market that has arisen following the mining boom. There is ample opportunity out there for young people to take advantage of the abundance our property market is offering and rentvesting is one of those strategies that can simplify the path to wealth, without requiring drastic changes to your lifestyle but rather offering unparalleled flexibility.