Face it: sometimes you need to move house. Usually the need is employment-related. As employment becomes less and less permanent, moving becomes more and more frequent.
In Australia, the stamp duty on the purchase of a home typically amounts to years of savings. So if you insist on owning the house you live in, you will blow away years of savings every time you move. And while the value of your home usually rises, it rises only so fast. If you move often enough, stamp duty eats up all your savings and all your capital gains.
The alleged advantage of buying your home is that you acquire an appreciating asset that saves you an increasing amount of rent. But if you rent one home and buy another, the one that you buy is also an appreciating asset, which earns you an increasing amount of rent. That's as good as saving an increasing amount of rent. But there's more: by renting your place of residence, you avoid the need to sell and buy again every time you move, and hence avoid the stamp duty.
At present, the stamp duty is calculated on the entire purchase price of the property. If, instead, it were payable by the vendor and apportioned to the unearned increase in the value of the property since the last transfer, then stamp duty would no longer discriminate against frequent resellers, and would no longer be an argument against owning one's place of residence. But stamp duty is not the only such argument.
Income tax: investors get the breaks
If you buy a rental property, and if the rental income is less than associated expenses (interest, rates, land tax, maintenance, etc.), the shortfall is deductible against other taxable income (e.g. your wages/salary). But if you buy a home to live in, the tax system is not interested in the imputed rent (i.e. the rental value) or the associated expenses, so any shortfall is not deductible. In other words, negative gearing is deductible for investors in rental property, but not for owner-occupants.
In the year to June 2006, Australia's 1.5 million individual property investors claimed about $9 billion more in deductions than they declared in rental income. About two thirds of these investors claimed losses. In short, the average property investor is negatively geared. This is remarkable considering that the average investor has already paid off a substantial part of the loan and that some investors are debt-free. Those who have invested only recently are even more negatively geared. Similarly, owner-occupants who have entered the market recently are heavily negatively geared (in terms of imputed rent). Thus the discrimination against owner-occupants is more severe in the case of recent entrants to the market.
So, if you're about to enter the market, and maybe even if you've been in the market for some time, you're better off letting one home and renting another than owning the home you live in. If you're going to pay more in interest and other expenses than you receive or save in rent, it's better to be able to claim the shortfall as a tax deduction.
At this point I hear you thinking: "What about Capital Gains Tax? You pay CGT on an investment property but not on an owner-occupied home!" Yes, but consider the following points:
- if you hold an investment property for more than a year - as you will if your aim is to avoid stamp duty - then only half the capital gain is treated as taxable income. This reduces the effective tax rate on capital gains and thereby reduces the value of the exemption for owner-occupied homes;
- capital gains are uncertain;
- when you first buy into the market, you don't get a capital gain; you pay for someone else's capital gain! (And you must outbid other buyers who have untaxed capital gains to spend; but that's another story.);
- a negative-gearing loss is claimable at the end of the financial year. By comparison, a capital gain may be a long time coming. For the purpose of relieving mortgage stress, it's better to get a tax refund each year than a tax-free capital gain after a longer wait;
- if you like stress, you can exploit the negative-gearing deduction to buy a more valuable property, and hence (probably!) get a proportionally larger capital gain, than would be possible without the deduction. This needs to be weighed against the CGT exemption;
- the more negatively geared you are, the more likely it is that the negative-gearing deduction outweighs the CGT liability even in the long term; and
- the more negatively geared you are, the more likely it is that you have bought into an overvalued market, so the less likely you are to get a capital gain at all. And if there's no capital gain, the negative-gearing deduction is decisive.
"But," you may ask, "what if the tenants damage my negatively-geared property or default on the rent?" You can get insurance against that sort of thing. And you can claim the premiums as yet another negative-gearing deduction.
Digression: what about business accommodation?
With commercial and industrial real estate, the various distinctions between owner-occupied and investment properties don't apply, but the basic argument on stamp duty still applies: don't buy the premises that you want to do business in; buy the premises that you want to invest in, and rent the premises that you want to do business in, so that you don't pay stamp duty every time business conditions force you to move.
Moreover, enterprises that rent their premises tend to grow faster than those that own their premises. The reason should be obvious: if you own your business premises, you have chosen to direct part of your capital away from your core business and into real estate, which is advantageous only if the return on the real estate is higher than that on your "core" business, in which case you're in the wrong game!
Owning your business premises does not make sense even as a diversification strategy, because if your business is adversely affected by any cause related to location, the value of the premises will probably be reduced by the same cause. To get the full diversification benefit of running a business and owning real estate, you need the business and the real estate to be in very different locations; that is, you need to conduct your business on rented premises.
Horses for courses
If you reside in a certain location, you want that location to be adequate right now; future amenities are less relevant because you might move away before they arrive. And you want the location to be adequate according to your criteria - not necessarily anyone else's.
But if you buy a property, you want its locational advantages to improve in the future so that it will rise in value. You don't want the property to have every possible amenity right now, because that would raise the acquisition cost and reduce the scope for capital gains. Moreover, if the property is to rise in value, its locational advantages must improve according to the criteria of the typical buyer or renter - not necessarily yours.
In short, buying a property and occupying it are two different things, done for two different sets of reasons. Therefore the property that you buy and the property that you live in (or do business in) probably shouldn't be one and the same. But if you become an owner-occupant, you force them to be one and the same.
Avoiding time wasters
It is said that when you buy a home to live in, you don't actually live in the home; you sleep in the home and live in the hardware store. Then suddenly you have to move, and someone else gets the benefit of all your work. The increase in the sale price due to your modifications is not enough to compensate you, because your modifications were what you wanted, not what the typical prospective buyer might want.
But if you own one home and live in another, you won't waste time modifying the former, because you don't live in it; and you won't waste time modifying the latter, because you don't own it.
Inducements and done deals
"But," you may say, "I want to qualify for the First Home Owner's Grant. If my first purchase is an investment property, I lose the FHOG forever." At best, that's an argument for buying the home that you want to invest in, living in it for long enough to qualify for the FHOG, and then treating the home solely as an investment. But a ruse like that would probably disqualify you anyhow. So look at it this way: How many times do you have to pay stamp duty in order to wipe out the benefit of the FHOG? Probably once. And how long do you have to forgo the negative-gearing deduction to wipe out the FHOG?
"But," someone else says, "I already own my home!" Great. So you've already paid stamp duty on your present home. (Maybe you even got the FHOG.) But is that any reason to pay stamp duty on the next home and the one after and the one after that? Next time you have to move, consider whether your present home is a good investment. If it is - at least to the extent that it's not worth paying stamp duty to get a better one - then don't sell it; put tenants in it and rent your next place of residence. If, on the contrary, you think your present home is such a lousy investment that it's worth paying stamp duty just once to get a better one, then pay stamp duty just once. It may make sense to pay stamp duty as part of a once-in-a-lifetime investment. But it makes no sense to pay stamp duty just because you have to move house.
By buying the home you want to invest in and renting the one you want to live in, you can optimise both decisions independently, avoid stamp duty on future changes of address, and claim the negative gearing deduction. These advantages are likely to prevail over the capital gains tax liability and, where applicable, the loss of the FHOG.
This article is not advice and is not to be acted upon without independent professional advice.