Often when taxpayers have paid off the mortgage on their family home they decide to get a loan to purchase a new family home (and move into it) and then rent out their ‘old’ family home.
From a tax perspective this results in the rental income on the ‘old’ family home being taxable, but with no interest deduction against that income. There is no interest deduction on the rental property as the rental property does not have a loan that was used to purchase the property (it originally had a loan but it has since been paid out).
Unfortunately the new family home has a mortgage, and the interest on that loan is non-deductible (as the loan was used to purchase the family home). This applies irrespective of which of the two houses is used as security for the new family home loan.
Two strategies to make interest on the refinancing of the ‘old’ family home tax deductible include:
- Sell the ‘old’ family home and then use the sale proceeds to buy the new family home with no mortgage. Then get a loan to purchase a rental property. This results in all the interest on the rental property being deductible but involves paying stamp duty and selling costs.
- One spouse sells their 50% interest in the ‘old’ family home to the other spouse. The spouse buying the extra 50% interest in the ‘old’ family home gets a loan to do this and the interest on that loan would then be deductible against the rental income. The spouse that sold their 50% interest in the ‘old’ house uses that money to pay for 50% of the new family house.