Efficient debt structure
Question from David updated on 22nd June 2020:
I have a large chunk of cash, enough to pay off my owner-occupier mortgage. My only concern is that this is not our “forever home”. We hope to buy a new house soon that will be! When we do our current owner-occupier will be kept as a rental.
But I do not want a mortgage free investment property and a big mortgage on our new owner-occupier. Ideally, I would like an 100% mortgage on my investment and all my equity in my owner-occupier. I'm not overly keen on selling it to a company or putting it in a trust. Do I have other options? If so, what are they?
Our expert Matthew Gilligan responded:
You want to use your cash to provide the greatest possible return. Thus, unless you have a use for it that will give you an after-tax return better than the interest you save paying off your owner-occupied mortgage, you should use the money to reduce that mortgage.
You have correctly identified that you will end up with an inefficient debt structure from a tax perspective if you buy a new home and retain the current home as a rental having repaid the mortgage. You say you are reluctant to move the existing home into a trust or company.
Unfortunately, the only way you will be able to get a tax effective outcome is to do so. Invariably you are much better off transferring a home that is about to become a rental into a company. This allows you to maximise the amount of deductible interest.
Note there are tax consequences that need to be checked before you proceed, particularly pertaining to the bright-line rule. In summary, the only way to get the optimal tax structure when you convert your home to rental use is to transfer it into a new entity, likely a company.
When the time comes, you should seek advice to ensure that no adverse tax consequences arise due to any specifics that I am unaware of and because we are talking about a future event which may occur when the law is different.
Matthew heads GRA's specialist property and asset planning division. He helps clients create optimal tax structures and build wealth through property. He has an extensive buy-to-hold property portfolio, is currently involved in over a dozen developments, and is author of two books - Property 101 and Tax Structures 101.