Strategy: Get the Main Residence First or Last? Or in the middle?

There are multiple things to consider with this question, the 2 main ones being CGT and servicing.

If a person were to buy their main residence upfront they would have a large amount of non-deductible debt which would hurt servicing but they would have a CGT fee asset. Over time they would pay down the non-deductible portion of the debt and reborrow to invest. This would slowly improve serviceability.

Over a longer period, they would have no non-deductible debt left at all and this is when servicing jumps while those renting and investing will still have the cost of rent paid to factor into servicing.

For these reasons I would generally favour getting the main residence first.


But many living in places like Sydney will struggle to buy the main residence there because of the high costs involved. The ideal situation with this might be to buy one which can be rented out initially and this will get some tax savings to help and keep debt recycling against this property and later move into it.


The other option is to move in initially, get the 6 year rule for CGT working, and then move out and rent it.


The trouble with renting and investing in areas that you might not want to live in is that you are not getting any tax exempt assets which can be sold later to help with retirement coming sooner. You might also end up paying a higher interest rate due to all the debt being investment debt, and often with smaller loan amounts for each loan. After a few properties there might be extra costs with land tax as well.


The other issue with getting rental properties first is that you use up cash, generally, which could have been used to fund the main residence. This will result in later non-deductible debt later.

For instance, I had a person who had come and seen me and they have about 3 properties which they have sunk $300,000 into – cash deposits.

But this person now wanted to buy a main residence for about $500,000. Had they structured things right they could have had an extra $300,000 x 4% in deductions each year (for the next 30 years potentially). That was about $5,000 lost per year. It was actually higher as the rates were about 5% back then.


So as a general rule:

a) For anyone with cash savings I would say look at buying your main residence first and then go for investments by debt recycling

b) For those with little cash, try to borrow off parents to buy the first investment property with 105% finance. Ideally get something you could move into now (and out again) or later.

c) Try to invest where you want to live in the future so you could move in.

d) If you can’t do the above, consider a sacrificial investment property which you pay down as quick as you can with the aim of selling it later and getting that main residence.

Get some tax advice as well as credit advice.

 

What about places you want to live but the price you're limited to are units (~5% CG). Wouldn't that null the general rules a) and c)?
Compared to buying an IP with stronger capital growth in the outer burbs where you don't particularly want to live in for the next 5-10 years but can potentially be a place to live in after, which potentially has 7% stronger CG.

 

It depends if you think units are an acceptable investment or not. You could always start off with a unit and sell it later CGT free and move into a house in the area you want to live in.

 

Let's say a unit that you would like to live in but can also be a good IP. If it needs a $40-80k renovation would you be better off buying it as PPOR and getting FHB concessions, do the reno's and after a year rent it out with improved rental rate. However you would be losing out on the depreciations.

Or buy it primarily as IP, do the reno's and get all the depreciation benefits.

 

This is the approach I have gone for. I have no regrets so far however still unsure how to proceed going forward.
We bought the PPOR. We spent 95k renovating and my partner would like to spend an additional 250k to complete everything on the wish list (kitchen relocation, landscaping, house and garage extension etc etc. The aim would be to complete everything over a medium to long term time-frame approx 10-15 years. We would be up for 1.1 mil but would not over capitalize based on the area, land size and purchase price.

My dilemma what do we do with our disposable income:
A) Continue to renovate (currently doing)
B) Pay extra towards Mortgage (currently doing)
C) Invest 15% of income into ETFs (not doing at all now)
D) Save for Investment Property (Or use equity as a result of renovating?)
E) All of the above

I feel as though its difficult to know what is the clear way forward and I am juggling my partners emotional needs with whats best for us financially.

 

If you are going to remain living in it just debt recycle into investments rather than using cash. If you don't you will be losing tax savings.

Renovating will potentially delay investments though as you will be diverting funds and serviceability. If you could delay the renovations you might get into investments earlier to allow for more compounding. But renovations will help in the longer run as you will have a bigger CGT free asset to sell on retirement.

 

Depreciation benefits would be minimal - at most 2.5%pa on building works but could be more on fxtures and fittings if new at the point of renting out.

I think you just have to run the numbers.

 

My understanding in a nutshell of debt recycling is using income from labour and an investment property to pay the Main Residence Home Loan and using a Line of Credit (from what source?) to pay the investment loan. Is that summary accurate?

In terms of renovations the absolute necessary $$ to be spent for us to remain here would be approx $35k. The additional $215k is to make it the "ideal, dream home". I could convince the other half to delay the latter as I am a strong believer of allowing the magic of compounding to work for as long as possible. I also think renovating later on would be more beneficial as the property would need an update in 40+ years if we were to stay that long!

 

This is not debt recycling but borrowing to pay loans = capitalising interest.

Debt recycling is the payment of non-deductible debt which is then reborrowed to invest in income producing assets which is makes the interest deductible.

 

Hi @Terry_w , thanks so much for sharing your knowledge with your strategy posts, I've learnt so much by reading them.

This strategy is currently our dilemma. I've just been running some numbers and found I saw the best return for us would be to buy as PPOR initially and live in for 12 months for CGT exemption; then rent out and sell at the 6 year mark to realise the capital gain. That would become our deposit for a more expensive PPOR in closer proximity to CBD where we would prefer to be. We're looking to do a cosmetic renovation before moving in to gain some equity as well. Holding onto the property and accessing available equity + savings just doesn't quite meet our PPOR deposit needs. We'd then obviously be starting from scratch, buying the PPOR then looking at future investments when equity is available.

What I'm torn with is whether this is a silly idea and we just suck up the fact that if we want to buy a PPOR we need to go further out where we can afford. We're in Melbourne. For further detail, we have around $170k deposit, and borrowing capacity of $700k. We'd rather a PPOR around $1.5M but can only do about $800k (with additional savings allocated to renovation costs). Our alternative was buy the PPOR cum IP around $400-600k (regional - eg Geelong, Ballarat, Bendigo) and take a seachange for 12 months (won't require change of work). If a reno and buying with decent CG can turn our deposit into $400k within 5 years it seems like this strategy could work for us over sucking up a PPOR purchase on the other metro fringe and living a commuter lifestyle until we can upgrade. We have small children and havedone the commute hence this option isn't appealing to us. My husband isn't a first home buyer either so no benefits there (no longer holding though).

Would love to hear your thoughts on these options

 

Hi Harriet, you do not need to live in a property for 12 months for CGT reasons - it could be much shorter.

That could be a good strategy, but it will depend on growth rates etc.

 

Thanks Terry! I'd probably do it to align with the school year so the kids can do a full year of kinder in the same place, so give or take 12 months. Nice to have some leeway here. Shall keep working on the numbers side of things now

 

Don't forget there could be timing issues to consider if land tax is payable. Delaying moving out could mean no land tax for that year.

 

Under what condition? I thought you need to live in property first 12 months to qualify for CGT exemption.

Also: if you took out an investor loan and wanted to purchase an IP but upon settlement you changed your mind and want to live in it as a PPOR for the first 12 months, would that still be meeting the CGT exemption?

 

Nope.

Loans have no bearing on CGT