NEGATIVE GEARING
The family home is a prized investment as it gives a great lifestyle as well as tax free capital gain. However, everybody likes to upgrade their home and a typical strategy for many Australian families it to almost pay off their first home and then use the equity they have built up in it to buy a better one. Naturally they like to save tax and often ask the question "should I keep the present home and borrow against it for the new house? If so will the interest be tax deductible as the mortgage will be over the house which is producing taxable income."
Because negative gearing has been sold as the panacea for all tax ills, it is certainly attractive to try to claim interest as a tax deduction. Unfortunately, the Tax Office is well aware of this and has a little rule called the "purpose test" to decide if interest on a loan is tax deductible. To claim a tax deduction for interest the purpose of the loan must be to buy an asset that produces taxable income. As borrowing to buy your own home is for a private purpose, the interest cannot be tax-deductible. Worst still those who keep the original home will find themselves paying tax on the rent from it, while watching it slowly drop in value as the tenants neglect it. It will also become liable for CGT on a pro rata basis.
People in this situation are much better off to sell the original property, while their furniture still makes it look attractive, enjoy the tax free profit and then put the maximum deposit on the new home. They can always borrow against the new home for investment and then can claim a tax deduction for the interest on the investment loan.
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