Restructuring Your Home was featured on Stuff  and in The Press, 9 January 2021. Renting out your home to buy a new one.

Update: The removal of interest deductibility announced in March 2021 renders the below information out of date. If the law ever changes back, it may be relevant again, otherwise it remains here for the purposes of posterity only.

At some point, your home just isn’t right for you anymore. If you own the property this means it is time for a significant decision. Will you sell up, or try to leverage the equity to buy your new home, and keep the existing one as a rental property – and if you do, what is restructuring and do you need to do it?

Keeping the house can be the start of a great investment journey that leads to earlier financial freedom and a comfortable retirement. But it is not always financially possible. And if it is, it’s not always the right time. And if it is, your ex-home is not necessarily the best rental property available to you.

If the finances and the timing align, ensure that the actual suitability of the property is considered. Does the home make for a good rental property?

• Check TradeMe listings and speak to a local property manager to see if there’s tenant demand in the area

• What does the return look like? Gross Yield = Weekly Rental x 50 / Property Value. Compare this to other investments (property and otherwise) and your cost of debt.

• Can you improve the return by subdividing or adding a minor dwelling?

• Is it a reasonably low maintenance property? Homes are often bought on love, not sensible financial choices.

Then, consider whether your emotional attachment to the property might make managing it as a rental difficult – great tenants may treat the home as well or better than you did, but you won’t always get great tenants.

Often the personal home isn’t your best possible rental, and it would make more sense to sell it and buy a better residential property investment. But this ignores the inertia of apathy. Would you ever really get around to it? If not, and the signs mostly point to keeping it, you need to book some time with your accountant for restructuring advice.

The public hears a lot about tax advantages given to property investment, but on inspection most of it washes up to nothing. But there’s a huge disadvantage if you turn your home into a rental property and don’t look into restructuring the property ownership.

Common advice is to pay down your mortgage. It’s generally very good advice; that’s why it’s given so commonly. Having lived in your home for a few years, hopefully you’ve taken this advice and paid down your mortgage a bit – or a lot. That’s great. But not so great when you want to make your home a rental property, as the following example will show:

Imagine a family who purchased their home in 2012 for $400,000, with a mortgage of $320,000. They worked hard to pay the mortgage down, taking advantage of dropping interest rates, and in early 2021 they now only owe $100,000 – and even better, the house is now worth $900,000. But it’s time to move on. A new home is purchased for $1.2M, but since they have put all their money into the mortgage this is all new borrowing leveraged against the equity in their old home. Total debt stands at $1.3M.

Without any restructuring of ownership, this new $1.2M of debt is private, for the purpose of buying their own home. It doesn’t matter which property it is secured against, it’s all non-deductible debt. The remaining $100,000 used to purchase the initial property is deductible – that is, the interest costs can be offset against rental income before calculating tax.

By shifting the property into another entity (most likely a look-through company, or possibly a trust; ask your accountant or contact me!) the debt can be restructured too. The new entity buys the home at its market value of $900,000 and can raise up to $900,000 of deductible debt against it. Total debt still stands at $1.3M, so only $400,000 is non-deductible private debt. At current interest rates of 2.5%, this could provide tax benefits of over $6,500 per year. If rates go up, that benefit gets exponentially larger.

There are a few things to be aware of, including that the above restructure would reset the Bright Line test, so if the property were sold again within the Bright Line period (currently 5 years) any subsequent gain in value would be taxable. Additionally, if selling within a few years of initial purchase get specific tax advice to ensure you’re not already caught by the bright line rule – assessing the private home for investment property tax on its capital gain. There are exemptions from bright line for private dwellings, but they don’t always protect you in all situations. Particularly if your home was bought off the plans.

The vast majority of New Zealand landlords are small players – mums and dads with one or two rentals as their nest egg. A 2015 Official Information Act response indicated almost 80% of landlords have just a single rental. In many cases this is a previous home. And in many cases, it has not been restructured, creating significant unnecessary tax pain. If you’re looking to move on up and rent your home – don’t let that be you!