Turning PPOR into rental, selling to LAQC

[BusyLizzy]

Advice needed please!

I will soon be selling my home to my LAQC, and turning it into a rental. I am getting a new registered valuation (RV) done, as required by banks to sort out a new mortgage in the name of the LAQC.

QUESTION 1: I assume that I want the RV to come out as high as possible rather than at a lower value (as far as I can influence it, anyhow), to ensure that I can maximize equity when I need access to it. (It seems a pointless question.. but I thought I had better ask in case I’m overlooking something. right?)



Good friends will be moving into my home-turned rental, and they will be paying below-market rent for the first 6 months, then market rate after that. Reasons for doing this are essentially to help them out, and their rent will be more than covering the mortgage. These are close friends of mine for the last 20+ years; I have no concerns about them as tenants. But I will be doing everything by the book, in terms of TA and bond, and it will be PM’d while I am away.

QUESTION 2: Are there any IRD, tax or other problems with offering rent lower than market rates (other than the obvious loss of potential income)?



In another 6-12 months (after possible time-out for travel next year, etc), we will be purchasing a new property/home. I will then want to pull out as much equity as possible from my old-home-now-rental. I understand from my accountant that at the time I sell the property to my LAQC, I also have the solicitor draw up a letter of debt acknowledgement, which means I can pull out my equity when I am ready, and the increased mortgage interest will then be tax deductible.

QUESTION 3: Does this sound correct? This is the part that I am most uncertain about and obviously want to make sure I get this right. I know there are so many opinions, even amongst the professionals, so just wanted to see what ideas come out of the forum-woodwork!

Thanks in advance!

[cube]

Hi Lisa,

Sounds like you've already done what you would inevitably be told - get professional advice.

Turning a PPOR in to an IP seems like it can be full of traps, but re-establishing the debt, and making sure that the interest is deductible seem to be covered.

If you want to claim depreciation to the max, then getting a chattels valuation at time of sale to the LAQC is advisable.

cube

[xris]

Hello Lisa,

It seems to me that what you are doing and the way you are doing it is alright.

If there are two points which made me look twice at your post, they were

1/ You plan to rent to a close friend of twenty years standing.

2/ You plan letting the property to this good friend at below market rent.

If I were in your shoes, and to be extra, extra, safe, I would charge market rent. But I am naturally conservative.

xris

[drelly]

Geez Lisa... didn't that nightmare tenant experience teach you a lesson?

Sounds like a good way to lose an old friend. People are funny. Trying to help people out can sometimes backfire. What happens if they don't want to pay more rent later because *insert sob story here*...?

[CJ]

Two point I thought of when looking:

IF renting at below market rent to friends, you will be taxable on the market value (ie you will have deemed income).

Even if your property values at more, for depreciation purposes, you and the new purchaser are associated parties so the tax base for deprecation will be the original purchase price. I think you have to apply to the IRD if you want the new higher purcahse price to be the tax base.

YOu should make sure your professional adviser covers botht these points.

[BusyLizzy]

Thanks for the input, guys. I'll address a couple of raised points:

1. Renting to friends: Yes, I am aware this is fraught with danger, and I have many friends that I wouldn't rent to. But I am confident things will be fine with them. At this point, letting go of my 'home' as a rental is hard enough. At least I know that they will look after it as well as they did their previous homes. And it is only for a limited time while they build their new home.

Geez Lisa... didn't that nightmare tenant experience teach you a lesson?

Yes it did! That's why I explained to them that I don't expect them to throw dirty nappies out the windows (that didn 't impress their 15yr old daughter), throw wads of wet toilet paper onto the ceiling in the bathroom, or use a chainsaw on the walls to get the fridge to fit (borrowed from one of Glenn's stories!). Seriously though, it was tempting to just have an informal arrangement with them, but ... I AM running a business, and they appreciate that. Hence we will still do everything by the book in terms of agreements and bond.

2. Below market rate: The agreement is that it will go up in 6 months. If for some reason they decide they don't want to pay the higher rent, I would give them notice. However, I am now concerned about CJ's comment:

IF renting at below market rent to friends, you will be taxable on the market value (ie you will have deemed income).

I will look further into this with my accountant.

3. Depreciation:

Even if your property values at more, for depreciation purposes, you and the new purchaser are associated parties so the tax base for deprecation will be the original purchase price. I think you have to apply to the IRD if you want the new higher purcahse price to be the tax base.

Interesting point, CJ. Now that you mention this, I think I have read this before. I will also discuss with my accountant.


Does anyone have any comment about the third point raised in my original post, regarding the leter to acknowledge the debt so that when I pull out equity, the increased mortgage interest is still claimable? This is probably my biggest concern right now....

[CJ]

Q3 - there are ways to get cash back out. If the compnay owes you money (which is what it sounds like), you can demand the money and they will pay. It only gets more difficult when it doesn't owe you money and you need to increase mortgage based on equity gain in order to pay you out capital.

So - is the company repaying a loan you have made to it (no problems increasing bank debt to repay your debt)or is it paying out capital and if so, where is the source of funds for this.

[masteraccountants]

Hi Lisa,

If you are renting to friends at below market rent, do you expect IRD to allow your rental property claims, especially if the proeprty is making a loss? This is quite likely after selling the property to an LAQC at a higher market valuation.

IRD are likely to treat it as a private arrangement and not allow the rental property losses.

You would have to charge a market rent, or at least declare a market rent, to be able to claim the rental property losses. If you were living in the property, then even declaring a market rent would not satisfy IRD - you would not be allowed to claim the losses.

You do not need a deed of acknowledgemet of debt if it is not a Trust. You sell to the LAQC at the market valuation and you borrow 100%, so you pull out your net equity at that time.

If you borrow less than 100%, and go back later to borrow more against the property, then what is the purpose of the loan? If it is for private purposes, the interest will not be claimable on that part of the loan.

If the extra funds are to invest in other rental properties - an income-earning enterprise - then the interest will be claimable.

Also, you cannot automatically claim the higher depreciation based on the higher (market) value of the property, as you are an associated erson with the LAQC. So you would have to request the Commissioner's discretion to claim higher depreciation - refer to section EG 17 (2) of the Income Tax Act 1994 or section EE 34 of the Income Tax Act 2004.

Does that help you?