Tax implications of selling your property to LAQC

Question from JKR updated on 8th November 2006:

I have a friend, Bob, who is considering the following scenario. Bob owns his family home worth approximately $350k, most of which is paid off. Bob's family is growing and he needs to buy a bigger place. He is considering selling his existing house to his newly formed LAQC at the current market value and fully mortgage that place to 100%. He wants to use all the equity from this house to purchase his new bigger place. If all transactions are formal and through lawyers, valuers, etc, are there any pitfals that Bob needs to be aware of in terms of tax?

Our expert responded:

One of the most important things to be aware of when considering using a home as a rental property is the deductibility of the interest. Interest paid on a mortgage taken out to purchase the family home is not deductible, and the worst case scenario you can end up with is that the rental income and expenses are taxable, but the interest, being your biggest cash cost, is not allowable as a deduction.

The way around this is to transfer the ownership of the home to an entity, in this case, an LAQC (assuming Bob's over-riding need is for tax benefits rather than asset protection). The sale from Bob to the LAQC must be at market value, so a registered valuation will be needed to determine this. Once the price has been determined, the LAQC must then get mortgage finance to the maximum amount that it can (with Bob as guarantor) so that it can pay Bob for the property.

The idea is to load up the LAQC with as much debt as possible, so that the loan on the new home is as low as possible. The purpose of the loan for the LAQC is to buy an investment property, so the interest will be tax deductible. Bob should also get a chattel valuation on the property to maximise his depreciation. And a question always to consider is whether or not the home actually works as a rental property. Analyse the property as if it was being bought as a rental property from a separate third party and ask yourself if you would still buy it. Sometimes, it can be better to sell the family home and buy another property as a rental rather than keeping the family home.

Kenina Court is a director of Acorn Solutions Limited, an accounting firm dedicated to working with clients to help them create wealth. She is an avid property investor, entrepreneur and seminar presenter on asset protection and wealth strategies.



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