by Jason Ginns
As a follow on from our property-related articles at the end of last year, we thought it was time to turn our attention to one of the most important, and also most overlooked areas with property investments – structuring the finance of your property investments in the most tax effective manner.
When you are thinking property investments, this isn’t just rental properties, but as you will see further below, this thinking should also include your main residence, and your plans for these and future main residence properties.
A lot of the time the focus is on getting the lowest interest rate, or ensuring you can get the finance you require, which are extremely important, but there are also other factors that should be considered to effectively structure your finance.
Tax Strategies For Property Investment
One of the most common tax strategies is to focus on paying off your main residence debt first, at the expense of your investment property debt. The interest you pay on your main residence debt isn’t tax deductible, so it makes sense to reduce this debt and the resulting interest expenses.
This can be achieved by structuring your main residence loan as a principal and interest loan, and your investment property loan(s) as interest only. This allows you to direct more of your repayments into the main residence loan, leaving the investment property loans with a higher proportion of the debt, maximising the portion of your interest expenses that are tax deductible.
Fixing Your Interest Rate
In the current economic climate, there is a focus on interest rates potentially starting to increase from the record low levels we have experienced over the last few years. Depending on your circumstances, it may make sense to lock in a fixed interest rate, to provide certainty over your loan repayments for the next few years.
However, this shouldn’t just be an interest rate decision, and you also need to focus on what your plans are for any property on which you are thinking of fixing your interest rate. If there is the potential that this property will be sold in the fixed interest rate period, then you may want to rethink this decision as there could be interest rate break fees and penalties charged by your bank if you sell the property and pay out the loan.
Planning Ahead To Maximise Tax Effectiveness
Another common occurrence that we all come across, is people upgrading their main residence as their families grow or their financial position improves. When this occurs, a lot of people are in the fortunate position where they are able retain the ownership of their existing main residence and decide to rent this out as an investment property.
If you don’t plan for this event in advance, then what usually happens is that you’ve paid down your old main residence debt over the years to a lower balance, leaving you to borrow a much larger amount (potentially 100% of the purchase price) against your new main residence. For tax purposes, the issue here is that the tax-deductible interest against your old main residence is the smaller of the two loans, meaning you are paying a greater portion of non-deductible interest against your new main residence.
However, if you plan well in advance of the above scenario, using loan offset accounts can allow you to potentially maximise the tax-deductible interest on your old main residence loan. Instead of paying down your main residence loan, you direct your repayments into a loan offset account, which still reduces the interest on this loan whilst it is your main residence.
The beauty of this arrangement is that when you do purchase your new main residence, you can use the funds in your loan offset account towards to reduce the amount borrowed for your new main residence. The result of this is that it leaves your old main residence loan with a higher balance, resulting in higher tax-deductible interest to be claimed against what is now a rental property.
How We Can Help
Even when you are purchasing your main residence, you should be thinking of your plans for the property and structuring your finance accordingly. However, you need to be extremely careful with getting this structure correct, right from the start of the loan, as this isn’t a strategy you can implement later when you suddenly decide to upgrade your main residence.
When considering any property investment, it pays to have a good relationship between your tax advisor and your finance broker, so that your loans are structured as effectively as possible from a finance and tax perspective. If you’re looking for some personal guidance in this regard, reach out to Lambourne Partners below, as we cover both areas in-house with our Business Advisory and Finance teams.