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How to Use Equity and Avoid Tax Deduction Disasters

A common property investment maximization strategy is to use equity in one property to buy another. However, before you engage in this sort of strategy, it’s important that you understand what’s involved and the best strategies to use – and why.

What is equity?

Equity is the difference between the value in your home and the debt level you still owe. In other words, it’s the portion of your home that you (not the bank) actually own.

How can I use equity to grow my property investment portfolio?

You can borrow money against the equity in your home – think of it like a deposit for a home loan. This can allow you to use the equity in your existing home to borrow enough to buy another property without needing to save a chunk of cash first.

How is just as important as what you borrow

At the end of the day the structure of how you purchase a property is just as critical as choosing the right asset. There are essentially two ways that a loan for a new property can be structured:

Cross-securitization

This involves increasing your current mortgage to cover the cost of the new property – all under one loan. The major problem with this method is that you now have one loan across two properties which have different tax deductibility laws against them – you can’t claim tax deductions on money spent on your primary residence, but you can on a tenanted investment property. However, separating property costs when bundled into a single loan is very difficult, and the ATO may well rule that it’s too complicated and hence you can’t claim any deductions at all.

Deposit and cost loan

A new loan can be created for the 20% deposit and sundry costs like stamp duties against your current home, with a new loan number. Then another new loan can be created against the new property for the balance of the property cost. This way, you have three loans in total: the original loan and the new deposit loan secured against your current residence; and the new cost loan secured against the new residence. The two new loans are both fully tax deductible and easily identified against the new investment property.

Summary

Using the equity you’ve already gained in your current home can be an effective way of raising money to buy an investment property. However, be aware that it’s important to set it up correctly. Talk to an investment advisor to figure out whether this strategy is right for you.