Key Takeaways
- Turning a principal place of residence into an investment property can change how lenders assess rental income, existing debt and future borrowing.
- The tax treatment of loan interest can depend on how borrowed funds were used, making previous redraws and loan transactions relevant.
- Capital Gains Tax (CGT) considerations may arise when a former home becomes a rental, although available exemptions depend on individual circumstances and tax rules.
- Reviewing the loan structure, offset or redraw arrangements and potential tax position before moving out may help identify issues early.
Keeping a current home as an investment property rather than selling it can change more than the property’s occupancy. The existing mortgage, expected rental income, future borrowing capacity and potential tax treatment may all need to be considered when the property moves from private to income-producing use.
For homeowners considering this change, speaking with mortgage brokers in Sydney may help clarify how a lender could assess the existing loan and any finance required for a new home. Lending policies can vary, particularly where a borrower intends to retain one property while taking on another housing commitment.
Turning a principal place of residence into an investment property can also create tax considerations. The purpose of borrowed funds, previous redraw transactions, CGT rules and the timing of the change in use may all become relevant. Tax treatment depends on individual circumstances, so qualified tax advice may be appropriate.
What Changes When Your Home Becomes an Investment Property?
Moving out and renting the property changes its use from a private residence to an income-producing asset. Depending on the circumstances, investment property changes may include:
- the property becoming a source of rental income;
- the lender potentially needing to be notified of the occupancy change;
- different loan pricing or lending conditions potentially applying;
- rental income and expenses entering future serviceability assessments;
- possible deductions for eligible rental-property expenses; and
- CGT considerations becoming relevant.
The existing mortgage does not necessarily need to be replaced because the property becomes a rental. However, borrowers may need to notify their lender, and the lender could review the loan’s classification, pricing or other terms under its policies.
Homeowners considering investment property loans may also need to consider how retaining the former home affects finance for their next property.
Review the Home Loan Before Moving Out
The existing loan structure can become important when a home changes from private to investment use. Reviewing how the loan has been used may help distinguish the original borrowing from later amounts borrowed for other purposes.
Loan purpose can matter for tax
For Australian tax purposes, whether interest is deductible can depend on how the borrowed funds are used rather than simply which property secures the loan.
For example, a loan originally used to acquire a home may have a different tax treatment from amounts later redrawn for private expenses. If borrowed funds have a mixture of private and income-producing purposes, the associated interest may need to be apportioned.
Converting a home into a rental should therefore not be assumed to make all interest on the existing mortgage tax deductible. The loan’s transaction history and use of the borrowed funds can be relevant.
Offset versus redraw can become important
Funds held in an offset account are typically separate from the loan balance, while withdrawing amounts previously paid into a loan through redraw can represent further borrowing.
How redrawn funds are subsequently used may affect the tax treatment of associated interest. Homeowners considering offset versus redraw may therefore benefit from understanding this distinction before moving or transferring funds.
Because these issues involve taxation as well as lending, an appropriately qualified tax adviser should be consulted where the treatment of borrowing is uncertain.
How Could the Change Affect Borrowing Capacity?
Retaining a former home while purchasing another property can alter a borrower’s overall financial position. A lender may assess the existing mortgage, proposed new debt, household expenses and eligible rental income together when considering serviceability.
Lenders may not use all rental income
Expected rent can contribute to serviceability, but lenders may recognise less than the full gross amount to allow for possible vacancies, expenses or uncertainty. The amount recognised and evidence required can differ between lenders.
As a result, borrowing capacity for investment properties may vary even where expected rent and underlying financial circumstances are similar.
Existing debt remains relevant
Rental income does not remove the existing mortgage commitment. A lender considering finance for a new home may assess the former home’s debt alongside the proposed borrowing and other liabilities.
This is one reason why reviewing your loan structure may be worthwhile. Refinancing or restructuring should not, however, be assumed to improve borrowing capacity, as outcomes depend on lender policy, costs and individual circumstances.
Using Equity When Buying Your Next Home
Available equity could potentially contribute towards another property purchase, but equity and borrowing capacity are separate considerations.
Accessing equity usually involves additional borrowing secured against the existing property. A lender would still need to assess whether the borrower can service the resulting debt alongside existing commitments and any proposed new home loan.
Borrowers considering using existing home equity may therefore need to consider the additional debt and repayments rather than focusing only on the equity available.
Where the former home becomes a rental, keeping different borrowing purposes clearly identifiable may also be relevant for tax and record-keeping purposes.
Capital Gains Tax When a Former Home Becomes a Rental
Turning a principal place of residence into an investment property can affect its CGT treatment. A property previously used as a main residence may qualify for a full or partial main residence exemption depending on its use and the owner’s circumstances.
The Australian Taxation Office (ATO) provides main residence CGT guidance for homes used to produce rental income.
The main residence exemption may still apply
Moving out does not necessarily mean the main residence exemption ends immediately. Where a former home is used to produce income, the ATO’s absence rules may allow it to continue being treated as the owner’s main residence for up to six years in qualifying circumstances.
Different considerations can apply if another property is treated as a main residence or the former home is rented for a longer period. CGT outcomes depend on dates, ownership, occupancy and other circumstances, so a full exemption should not be assumed.
A market valuation may become relevant
Where the relevant ATO conditions are met, the property’s market value when it is first used to produce assessable income may become relevant when calculating a later capital gain or loss.
This rule does not apply to every PPOR-to-investment conversion. Where it applies, retaining appropriate evidence of market value at the relevant date may be important for future tax records. A qualified tax professional can help determine whether the rule applies.
Rental Income, Expenses and Cash Flow
Once a former home is rented, rental income is typically assessable for Australian income tax purposes. Certain expenses associated with earning that income may also be deductible where relevant requirements are met.
Potential expenses can include property management fees, council rates, insurance, repairs and eligible interest costs. Not every cost is necessarily immediately deductible, and private expenses may not be deductible. Keeping records of income, expenses and loan transactions can therefore be important.
Cash flow also warrants consideration. Rental income may contribute towards mortgage repayments and ownership costs, but vacancies, repairs and other expenses can affect the amount available.
Moneysmart describes borrowing to invest as a high-risk strategy. Property values and rental income can change while loan repayments and ownership costs continue.
What Should You Review Before Moving Out?
Before turning a home into an investment property, relevant lending and tax considerations may include:
- the current loan balance and repayment structure;
- previous redraw transactions and offset funds;
- the lender’s requirements when occupancy changes;
- expected rental income and property expenses;
- borrowing capacity if another home is being purchased;
- potential CGT and main residence implications; and
- record-keeping or valuation requirements.
These areas can interact. Changing the loan before moving out, for example, could have implications beyond the immediate repayment amount, while accessing equity may provide funds for another purchase but also increase total debt.
For investors considering future property decisions, understanding the relationship between borrowing capacity and equity can provide useful context when reviewing debt and loan structure.
Conclusion
Turning a principal place of residence into an investment property can affect lending, borrowing capacity, cash flow and taxation. The existing loan structure, use of borrowed funds, rental income and future property plans may all influence the position.
Reviewing these matters before the property becomes a rental may help identify potential issues early. Tax outcomes, particularly around interest deductions and CGT, depend on individual circumstances and applicable tax rules, so professional advice may be appropriate.
This information is general in nature and does not constitute financial, investment, tax or legal advice. Lending eligibility, borrowing capacity, interest rates, loan features and approval outcomes depend on individual circumstances and lender policies and may change over time. Tax outcomes, deductions and Capital Gains Tax treatment depend on individual circumstances and applicable legislation. Property investment and borrowing involve risk. Consider obtaining advice from appropriately qualified professionals before making financial, investment, tax or legal decisions.
Frequently Asked Questions (FAQs)
1. Can I turn my principal place of residence into an investment property?
A homeowner may be able to retain a former principal place of residence and rent it out, subject to relevant lending, ownership, insurance and other requirements. Tax implications can also depend on individual circumstances.
2. Do I need to change my home loan when the property becomes an investment?
Not necessarily. However, a borrower may need to notify the lender of the occupancy change, and different pricing, classification or other requirements could apply under its policies.
3. Is mortgage interest deductible after I rent out my former home?
Interest may be deductible to the extent the relevant borrowing relates to earning assessable rental income and other tax requirements are satisfied. Previous redraws or mixed private and income-producing borrowing can affect the treatment.
4. Will I pay Capital Gains Tax if I rent out my former home?
CGT may apply when the property is eventually sold, although a full or partial main residence exemption could be available depending on the property’s use, relevant dates and the owner’s circumstances.
5. Do I need a property valuation when my home becomes a rental?
A market valuation may be relevant where the ATO’s home-first-used-to-produce-income rule applies. Whether this rule applies depends on the property’s circumstances.
6. Can rental income help me borrow for another home?
Rental income may contribute to serviceability, but lenders may not recognise the full gross amount. Existing debt, proposed borrowing, household expenses and other liabilities can also affect borrowing capacity.
7. Can I use equity in my former home to buy another property?
Available equity may potentially contribute towards another property purchase, subject to lender approval. Accessing equity usually involves additional borrowing, so serviceability and total debt may also need to be considered.