Buying a first home is a significant milestone. But forĀ young professionals or thoseĀ with careersĀ that promiseĀ rapid income growth, such as doctors moving from intern to specialist roles, thereās an opportunity to not just own a home but to plan strategically for future financial gains.
One powerful strategy to consider is turning your first home into an investment property down the line. By planning early and making informed decisions, first-time homeowners can significantly enhance their financial outcomes. This article explores a practical case study to illustrate how careful planning can lead to greater tax benefits and improved returns on investment, providing a roadmap for those looking to maximise their long-term financial potential.
We do a lot of work with young professionals buying their first home. People who start their working life on a solid income but who can expect their incomes to grow significantly in a short period.
For example a first year intern doctor might earn around $100K but by the time they specialise their income will be more than $300K and can be alot higher.
The trajectory for their income creates opportunities. For example, it can create the possibility that when they seek to upgrade from their first home to their next home that they could keep the first home as an investment.Ā
It is hard for a first home buyer to contemplate the idea before they have even bought their first home but it is something that ought to be considered and planning for the possibility will make a significant difference to the financial outcome if it does eventuate.
Example
Jennifer purchases their first home with a $600,000 loan.Ā Ten years later the home loan has been paid down to $150,000 and Jennifer wants to buy a new home for $1m and keep the existing property as an investment.
She now needs to borrow around $1.06m to fund the purchase of the new home. If she needs to borrow the funds to do this she will have a home loan of $1.06m and an investment loan of $150K (the balance of the original home loan). The interest on the home loan is not tax deductible while the interest on the investment loan is.
If instead of putting savings into the home loan, Jennifer had instead put her extra savings into an offset account then after 10 yrs her home loan balance would be around $500,000 and she would have $350,000 in her offset account.
So when she buys her next home, her initial home loan will be $710,000 ($1,060,000 total cost less $350,000 she can contribute from her offset account) and an investment loan of $500,000.
The total debt does not change but the tax deductible portion is far greater. Assuming Jennifer is in the top tax bracket of 45% by this stage that means the tax deduction for the investment loan is $8,775 pa greater than if she has paid the home loan down rather than placing savings in an offset account.
| Paying Down Home Loan |
Placing Savings in Offset |
|
| Investment Loan | $150,000Ā | $500,000 |
| Interest pa (6.5% pa Int Only) | $9,750 | $29,250 |
| Tax deduction pa (45% tax) | $4,387.50 | $13,162 |
The end tax deductible amount then gets deducted (along with other property costs) from the income earned from the investment property with the final Net figure carrying onto your tax return. If the Net figure is a loss then the property is negatively geared and has the effect of reducing the overall tax bill of the tax payer.
As the success of an investment property is judged by the return generated, having a greater tax deduction will enhance the overall return. Starting with a lower Home Loan also assists with paying off the home loan quicker.
Other considerations
If the intention to turn a home into an investment property down the track is strong and it is clearly a realistic possibility then the First Home Buyer might consider setting up their first home loan as Interest Only so that the loan balance does not reduce and this will really maximise the tax deduction down the track.
I am always cautious about clients only paying Interest Only on a home loan (especially First Home Buyers). My concern is that they will just spend the extra savings. But for a homeowner who is disciplined about putting the extra savings away into offset and building a deposit for the next purchase then this can work and āturbo chargesā the plan.
Misconceptions
Clients often think that if they borrow against an investment property then the loan is automatically tax deductible. That is not the case, the test for tax deductibility is around purpose/use.Ā If you borrow funds to buy a home then, no matter what the security, the interest on that loan is not tax deductible as the home is not an income producing asset. Hence the need to plan ahead and not pay down the home loan (rather put savings in offset).
Warning
This advice is general advice and does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs.
This case study does not constitute tax advice and you should consult your tax advisor rather than relying on the information contained here.
