Property investors who do not own their own home risk missing out on Australia’s biggest legal tax dodge, but financial specialists say there are other factors at play.

As home values soar, more first-home buyers are making their first purchase a rental property, while some seasoned investors only buy rentals and do not plan to buy their own home.

The capital gains tax (CGT) exemption on Australians’ principal place of residence makes property among the most powerful assets for building and preserving wealth tax-free.

At the upper end of the scale, a wealthy homeowner can buy a $5m home, sell it a decade later for $10m and pay zero CGT, which is something that shares, property investments, holiday homes and other assets do not allow.

On the other side of the coin, investment properties allow tax deductions for costs such as mortgage interest, insurance, maintenance and council rates, plus the benefit of a tenant’s rental payments helping the investor to pay their costs, although rental income paid by tenants is taxable.

Crunching the overall numbers is effectively impossible because there are so many variables for each individual, but experts generally agree that owning your own home at some stage in life – particularly by retirement – makes good tax sense.

Chartered accountant and Mr Taxman founder Adrian Raftery said he was seeing more people rent near their work and social activities while buying an investment property in outer suburbs or regions to “stay in the property game”.

“From a tax perspective, there certainly are benefits in having a mortgage that is tax deductible but the downside to this strategy is potential CGT implications down the track as well as land tax,” Dr Raftery said.

He said property purchases should be considered on a case-by-case basis, with factors including:

• Capital growth over time

• Whether the owner was a single or couple

• Employment income levels

• Rent amounts for both properties

• Buying and selling costs such as stamp duty and agent commissions

• Potential downsizer superannuation contributions

• First-home buyer benefits.

“For first-home owners there have been a myriad of incentives over the years so it may be valuable to consider living in a property initially before renting it out,” Dr Raftery said.

He said owning property could be a great wealth creation strategy, whether an investment or a principal place of residence.

“The CGT principal place of residence exemption can create the bulk of someone’s retirement wealth tax-free.

“For those with investment properties, it can be great to have the deductibility of mortgage interest and other running costs such as council and water rates, strata levies et cetera to assist with purchasing a home, but ultimately you want to pay down your mortgage to nil.

“In this instance, a property will go from being cashflow negative to positive and at that stage you will start paying tax on net income.”

The Australian Taxation Office says the main residence CGT exemption does not apply to holiday homes, demolishing your home and selling the vacant land, subdividing your block and selling it as vacant land, and for larger landholdings.

“You’re eligible to claim a partial main residence exemption for the area your house is on up to 2ha of land,” the ATO says in a tax guide.

“The rest of the property is subject to CGT.”

A main residence is also exempt from Centrelink means testing, so someone with a multimillion-dollar home can still access a full age pension if their other assets and income are below relevant thresholds.

Financial strategist Theo Marinis said the tax benefits of property investment were also impacted by a person’s taxable income, with bigger tax deductions available for higher earners, while some people used short-term tax benefits to grow their property portfolios faster.

“The theory is if you’re not putting as much money into your home, you’ve got greater cashflow to gear yourself up and buy multiple properties,” he said.

“There’s no simple answer – you’ve got to weigh up the pros and cons of every situation, and it’s not one size fits all.”

Mr Marinis said big winners from the property tax game were wealthy people who bought their home before 1985, which made it CGT-exempt. They could turn that into an investment property, then buy another home to treat as their principal place of residence – and both properties would be CGT-free.

Diversification was important for property owners and investors, he said, and this often involved superannuation because the first $2m owned by each individual was potentially tax-free after age 60.

“There comes a point in time where do you want to keep paying tax forever?” Mr Marinis said.

“If you have four properties at $1m each and are paying full tote odds tax on them, it’s not flexible and you can’t break a piece off to go on holidays,” he said.

“There comes a point where you start to realise ‘maybe instead of renting all the time I buy a place that I actually own’ or move into one of them, and start throwing money into super for tax-free income.

“If it’s been a rental property and you owned it for 10 years then you’ve lived it in for 10 years, all of a sudden the capital gain when you sell it is going to be halved, because for half the time it was your principal residence.”

Original article published here in The Australian.