Moving tenants into your home can save you thousands while you wait for prices to rise
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House sales have fallen by a whopping 50 per cent this year. And property investment commentators are expecting a flood of erstwhile owner-occupied homes to enter the rental market later this year.
There isn't any real evidence of many fire or mortgagee sales happening yet. But if supply continues to exceed demand and other economic indicators such as employment head south, prices will almost certainly fall back. In such times when people can't sell their homes, many find their way on to the rental market.
In many cases, renting out the house instead of living in it may save an owner from having to hand the keys to their lender. But there are negative factors to be considered.
First of all, owner-occupied homes don't tend to be the most profitable rentals because they don't command all that much extra rent over and above that of a standard rental in the same suburb. What's more, gross yields on properties stand at a paltry 5 per cent across the country, according to the ANZ/NZPIF New Zealand Property Investors Survey 2008.
With most two-year fixed mortgage rates sitting around 9.4 per cent, that's a sizeable loss even before maintenance, insurances and other costs are taken into account.
The good news is that once your property becomes a rental property, any losses from the day-to-day running and some depreciation can be claimed against the tax paid on your day job, providing you don't fall into any of the following traps for the unwary.
In recent weeks Stuart Wills, director of Mortgage Link West, has helped two clients turn their own homes into rental properties.
One was a young property owner who simply couldn't afford the mortgage payments. The man wanted to sell, but faced losing $50,000. Wills suggested keeping the property as a rental and the man decided to move back in with his parents rent-free.
"We worked out he could rent his place out for about $400 a week and, even if he'd moved into a flat [not his parents' house], he would have paid about $150 a week rent."
He will also save thousands of dollars in tax every year, says Wills.
The property owner kept his existing loan, but altered it to interest only, and set up a facility that allowed him to pay off chunks of the loan when he got bonuses.
Another example Wills dealt with in recent weeks was a couple who each owned their own home and wanted to move in together. In this case the properties were remortgaged so that 100 per cent of the borrowed money was moved to the rental property because it is tax-deductible and their joint home was left virtually mortgage-free.
Wills then arranged floating finance that they could draw on for a deposit on a second rental property, which they plan to buy together.
It's a good idea, says Wills, to build in a buffer if you can so that you don't need to go cap in hand to the bank if you need to do work such as re-roofing. Tenants can be hard to come by or fail to pay their rent for a period of time and this needs to be budgeted for.
One ideal time to rent your own home out is if you're borrowing against it to buy or expand a business. By renting your own home out and moving into a rental property yourself, there are several tax advantages.
First of all the mortgage payments on your own home can become tax-deductible, and losses can be claimed against your personal tax.
Secondly, if you have a home office in the property you're renting, a proportion of your rent, utilities and office costs can be deducted against income.
It's worth seeing an accountant who specialises in property investment for advice. There are a number of tricks worth knowing, such as the IR23 form, which allows investors to reduce the tax rate they pay up-front on income from a day job if there are losses from property. This increases monthly cashflow, rather than having to wait for a tax refund at the end of the financial year.
If you're turning your own home into a rental you may want to consider the type of ownership structure most relevant to your circumstances.
Many people fall into the trap of leaving the property in their own name, says accountant and company structure expert Garth Melville of Company Solutions.
What that means is that they can only offset the interest from the existing mortgage against their taxes, and not any subsequent top-up.
"The [Inland Revenue Department] only allows you to deduct the amount that was actually borrowed to fund the property when you purchased it."
Instead home owners who plan to rent their properties out should sell them to a structure such as a family trust or loss attributing qualifying company (LAQC), which borrows up to 100 per cent of the cost of the property. The borrower would then have a small mortgage on their new home.
Melville points out that depreciation can also only be claimed on the original cost of the property, which may have appreciated since you first bought it. If you sell the property to a structure, it can then claim full depreciation.
Another trap for the unwary comes where owners (including LAQCs and other structures such as family trusts) fail to claim depreciation, says Melville.
"If you don't claim, you can end up with a tax bill for the depreciation you should have claimed but didn't when you sell the property or move back in."
The type of ownership structure you choose for your property will depend on your personal situation. LAQCs allow you to claim rental losses against your day-to-day income, but don't protect the property from business creditors. Family trusts only allow you to roll losses forward, but if you have a business or trading trust that is making a profit, you can allocate those profits to the family trust and save tax that way, says Melville.
Views about having your property managed are polarised. Some property investors are totally hands-off and once they've bought a property, give it to a manager to look after. Others do everything themselves, from finding tenants to doing maintenance. There is a middle ground where someone uses letting agents to find and vet tenants and then manages the property themselves from then on.
The deciding factor may be the cost. Property managers charge between 8 and 10 per cent of the rent, which can hurt on a loss-making property, as most are these days.
Wills says he advises clients to use a property manager if they're renting out properties which they used to live in. Otherwise it's too easy to become emotional about tenants mistreating the home you've lavished care and attention on.
New landlords who have fallen into the role because they couldn't sell a property need to be aware that property investment is a business. Accidental landlords should keep the following tips in mind:
* Don't forget to inform your buildings and contents insurers that your property is now tenanted.
* Consider taking out specialist landlord insurance that will cover loss of rents.
* You will need to fit smoke alarms and ensure that all locks work properly.
* Consider joining a local property investors association, details of which can be found on: nzpif.org.nz .
* Read practical books such as Working Landlord, Happy Tenants, by Roger Clist.
*Check out property investment forums such as landlords.co.nz and propertytalk.com.
