Turning a first home into an investment property – what to do, and what to avoid

After years of very long hours investing in their skills, it is extremely rewarding for doctors to reach a position where they are able to buy a home of their own.

But amid the celebrations, Jacqui Lombard, General Manager of Residential Lending, says it can be worth thinking ahead. A first home can often make an attractive investment property further down the track.

As this type of forward planning needs to address tax issues, we spoke with Matthew Holden, Managing Partner at Chartered Accountants and advisory firm Brentnalls SA, who offers insights to a significant number of medical professionals.

“We see a lot of doctors buy a smaller home when they are starting out,” says Matthew. “When they are ready to buy a larger home, they often can afford to do this without selling their existing home and instead rent it out as investment property.”

As high income earners, doctors stand to benefit from the potential tax savings of a rental property.

A key stumbling block however, can be the way the mortgage for a first home was managed as an owner occupied residence.

Maximising tax deductibility of loan interest

The golden rule of thumb is that mortgage interest will be tax deductible when the loan funds are used to purchase an income producing asset.

An owner occupied home loan is therefore not tax deductible. (Though there can be exceptions such as when a doctor practices from a home-based surgery.) The trade-off is that capital gains tax doesn’t normally apply to profits made on the sale of a primary residence.

It’s a very different situation for an investment property. Loan interest can typically be claimed on tax as the loan was used to acquire an income producing asset – being the investment property. Although, tax may be payable on any capital gains over the period you used it as an investment property if you decide later on to sell the property.

The upshot, says Matthew, is that if a first home is converted to a rental property, the tax deductible claims for loan interest can be maximised if the mortgage has not been paid down.

An example here may help.

Let’s say Sue, a GP, buys a first home using a loan of $600,000. It makes sense for Sue to save on interest charges while she is living in the home. So, she uses an offset account, which is a transaction account linked to the home loan. Instead of receiving interest on the account, the balance is offset against, or deducted from, the value of the mortgage when loan interest is calculated. 

If Sue has $400,000 in her offset account, she will only be charged loan interest as if the mortgage had a balance of $200,000 ($600,000 less $400,000).

Jacqui Lombard explains that it is not uncommon for doctors to have funds in an offset account that equal the value of the outstanding loan.

This isn’t just an interest saver. It can be a smart strategy if the home is earmarked to be rented out when the doctor upgrades to their next home.

Preserving tax deductible status

“Using an offset account preserves – and maximises – the tax deductibility of the original loan if the property is rented out at a later date,” says Matthew Holden. “And when the doctor is ready to buy their next home, the funds in the offset account can be used towards payment of the new home and reduce the private, non-deductible, debt.”

Doctors may receive well-meaning advice from friends or family to pay down their first home loan sooner by making extra repayments. But this can work against medical professionals who plan to rent out the property further down the track.

“There are many aspects to consider when turning a home into an investment property,” says Avant Finance’s Jacqui Lombard. “This highlights the benefit of seeking specialist accounting and tax advice at an early stage, as well as speaking to an Avant medical finance specialist to identify the loan best suited to a doctor’s needs.”

For further information on first home loans for doctors, call Avant Finance on 1300 99 22 08, or request a free consultation with one of Avant’s medical finance specialists.