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- Is Rentvesting Right for You?
Is Rentvesting Right for You?
A relatively new word has entered the jargon of real estate – rentvesting.
It’s a strategy for first homebuyers to break into the property market faster than they might anticipate while not compromising on their lifestyle.
The Concept of Rentvesting
The concept is simple: a rentvestor purchases an investment property in an affordable area while simultaneously renting in a more expensive location that offers easy access to cafes, restaurants and other entertainment.
This strategy has become popular with young Australians who want to enter the property market as soon as possible but have been priced out of inner-city markets.
Rentvesting is an opportunity to capitalise on the capital growth of property without compromising on where you want to live.
Benefits and Challenges of Rentvesting
There are some benefits and challenges associated with rentvesting.
Firstly, federal and state government incentives for first homebuyers require you to live in the property for a minimum period, usually 12 months.
Your lender may also charge you higher interest on your loan if you’re going to rent the property.
Usually, the uptick is 0.5% on a current retail mortgage rate of between 5%-7%, depending on your deal.
Arguably the biggest challenge is Capital Gain Tax (CGT). When you sell the property, the Australian Taxation Office will calculate the CGT, based on rental income and any profit from the sale.
On the upside, you will gain the tax advantages of a property investor, such as negative gearing.
Pros And Cons of Becoming a Rentvestor
The Positives:
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Lifestyle - You're not limited to where you can afford to buy, allowing you to be closer to work, family and favourite amenities.
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Early Entry - Rentvesting may accelerate your ownership journey. With values continuing to rise, the earlier you can make your move, the more affordable it should be.And you’ll be building your wealth sooner.
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Extra Income- The rent paid on your investment property will supplement costs associated with ownership.
You’ll likely pay a slightly higher interest rate because the property is rented.
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Tax Benefits- You may be able to claim tax deductions on expenses related to your investment property, such as loan interest, property management fees and maintenance.
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Extra Income- The rent paid on your investment property will supplement costs associated with ownership.
You’ll likely pay a slightly higher interest rate because the property is rented.
The Negatives:
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Your Rent - You’re still in the rent trap, but now you have a seat at the property investment table. So don’t feel bad if you believe rent money is “dead money”.
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Cash Shortfall - The rent may not cover the full cost of the mortgage. Make sure you have the cash flow to cover any shortfall and know how long you can cover a gap before it becomes financially unsustainable.
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Responsibility- Maintenance expenses and strata fees will need to be paid. Unless you have a property manager, you’ll also have to deal with the tenant.
You’ll likely pay a slightly higher interest rate because the property is rented.
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Capital Gains Tax- Be aware your rental property will incur CGT, whereas your primary residence will not (under current legislation). Other taxes may also apply.
See a financial adviser for personalised advice.
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Extra Income- The rent paid on your investment property will supplement costs associated with ownership.
You’ll likely pay a slightly higher interest rate because the property is rented.
Rentvesting vs. Renting Out A Room
Another rental strategy to ease the financial burden of a mortgage is to move into your new home but immediately rent out a room. Again, it’s important to be aware of the tax implications.
By occupying your new home – known in tax circles as your Principal Place of Residence (PPOR) – you’ll benefit from the government incentives for first-home buyers, such as grants and exemptions from stamp duty or transfer tax.
However, if you use your property to earn income by having a flatmate, there are tax implications that differ from those of the pure investment property that a “rentvestor” would purchase.
Renting out part of your PPOR for any period can affect your CGT main residence exemption.
The rented portion may not qualify for the full CGT exemption when you sell your home. Instead, the ATO may grant only a partial exemption, calculating the capital gain based on the portion of the property that was rented out.
If you’re contemplating this strategy, check whether the property satisfies the “Home First Used to Produce Income” rule (Section 118-192 ITAA 1997), which states the property:
- Can only qualify for a partial exemption because it has been used to produce income.
- Would have otherwise qualified for a full exemption had it been sold just before it was used to produce income, and;
- Was first used to produce income after August 20 1996.
If these conditions are met, you will need to determine the market value of the property at the time it was first used to produce income. This is important as it becomes the new cost base (“reduced cost base”) for the CGT calculation.
Here’s an example: if a rented room (or granny flat) makes up 20% of your property you may be liable for CGT on 20% of the capital gain (based on the reduced cost base formula). The remainder could still be exempt if the property qualifies as your main residence for that portion.
This arrangement means you need to maintain clear records and accurately measure the rental portion to correctly apportion income, expenses and eventual CGT liabilities.
It’s advisable to consult a tax professional to ensure you comply with ATO guidelines when part-renting your PPOR.
For more detailed information, check out the ScaleApp academy and read our chapter on “Taxable Income from Property“.
NOTE: The information in this article is general in nature and provided as a market overview only. Always consult your financial adviser or accountant for advice specific to your personal circumstances.
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