Tax system offers cream to some

The most common question I am asked is, ‘Suppose I upgrade from my existing home to another home, and rent out the original one, can I take a loan against the original home for the mortgage on the new one and claim the interest as a tax deduction?’

IF THE volume of emails is any guide, borrowing for investment is a hot topic with readers. And so it should be.

After all, we have a tax system that is biased against saving because the tax office takes up to 47% of the interest you earn on money in the bank.

On the other hand, if you take out a loan to buy property or shares, the tax office subsidises up to 47% of the interest. Yet provided you keep the asset for at least a year, you pay capital gains tax at a maximum rate of 23.5%.

On the face of it, the tax treatment is simple. Provided the purpose of the loan is to buy income-producing assets, the interest will be tax deductible.

The most common question I am asked is, “Suppose I upgrade from my existing home to another home, and rent out the original one, can I take a loan against the original home for the mortgage on

the new one and claim the interest as a tax deduction?”

The answer is an unequivocal no, because the purpose of the loan is for

private use – to buy a new home to live in – and that has nothing to do with the property being used as security for the loan.

However, a loan can change character.

The interest on your home loan will not be tax deductible while you are living in the property, but if you vacate it and rent it out you can then claim interest and other outgoings as a tax deduction.

But you will have to declare the rental income as taxable income.

The cream on the cake is that you can then be absent from that home for up to six years without losing the capital gains tax exemption – provided you don’t claim any other property as your principal residence in that time.

We will explore this in more detail in my next column.