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  4. Q&A: Tax implications of moving into an investment property

Q:
My wife and I bought an investment property in Sydney three years ago, which we are currently negatively gearing. We are renting our PPOR while we save a cash deposit for our own home: being Sydney, this is taking longer than we expected. We are seriously considering moving into our investment property in order to cut our spending and improve our short-term savings. We have been advised to get a property valuation on the day we move in, so that we can accurately determine our CGT liability (in case we ever sell it in the future). What would happen if we moved into the investment property and lived there for 3-5 years (while paying down a chunk off the mortgage).  Under current tax law, could we then turn it back into an investment property after we've moved out and we've bought a new PPOR? How is CGT determined if we ever sell it down the track?

A:
When you move into your Investment property the interest on the loan will no longer be tax deductible. Getting a valuation is a good idea because it sets a cost base to work out your capital gains tax in case you sell it in the future.

If you lived in the property when you first bought it and later rented it out, you can continue to deem the rental property as your home for up to 6 years which means there is no capital gains tax should you sell it within the 6 years even though you have rented the property out. However once the six years is up and the property is still a rental property it will be subject to capital gains tax on a pro rata basis. So, if you owned it for ten years and for the first six years it is deemed your home (no capital gains tax even though it was rented), then the last four years is subject to capital gains tax. Its important that you know what the property is worth on the sixth year to determine the capital gain from the sixth year to the tenth year. If you move back into the property before the sixth year is up than the six year rule starts again.

However if you have never lived in the property and it was rented out from day one than you will not qualify for the six year rule.

If you moved into the investment property and lived there for 3-5 years and paid off a large chunk off the mortgage you could turn it back into an investment property simply by moving out and renting it to a tenant.

However you have to be careful because you would have borrowed a large loan to buy your new home and when you move into your new home the interest on that loan is not tax deductible.
You have on the one hand reduced the original loan which will be tax deductible when you rent it back out again and you will have a large non deductible loan on the new home that you live in. This is not tax effective.

A better way to do it is to put your cash savings into a Savings account which can be used as an Offset account with the original loan. Meaning you will save interest on the loan when you are living in your first property. This is a great strategy because whilst you are living in the house the interest is non deductible so you would want to reduce the amount you have to pay. However, when you are ready to rent it back out again you would want the loan to be as large as possible because the interest is now tax deductible and you want the loan on your new home to be as low as possible because its not deductible. When you are ready to buy your second property which is to become your home you should use the cash that you have saved up towards the second property which is not tax deductible because you will live in it.

Capital gains tax is calculated depending on whether you lived in it when you first bought the property. If you did live in it than its as above but if you rented it out after buying it and only moved in later than it will be pro rata,  base on the years you lived there and the years it was rented out.

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