In Australia, less than one in ten people own an investment property. The vast majority of homeowners are what we might label as ‘upgraders’ who only ever own their own home.

After buying their first home, upgraders continue to buy a bigger and better home as their family needs change and sell off their previous home in part to finance the upgrade.

But is that actually the best way to go about it? Or should you consider turning your first home into an investment property?

Assessing Your Options

The main reason people sell their original principal place of residence (PPOR) to buy their next home is because they need the money for the deposit on their next property.

A property is defined as your principal place of residence (PPOR) when a person resides, occupies and lives in it as their home. If a property is considered an owner's PPOR then the owner is exempt from Capital Gains Tax.

Generally speaking, you need to put a 20% deposit down or pay Lenders Mortgage Insurance (LMI), which can be a significant stumbling block for many people.  That’s going to likely be the case if you are staying in the same area and homes have appreciated in value at a similar rate.

LMI is an insurance policy that some home loan borrowers need to pay for. Its purpose is to protect the lender from financial loss if the borrower can’t afford to meet their home loan repayments.

The second issue is going to be borrowing capacity. Your earnings might simply not be high enough to finance your PPR and a further investment property.

While there is the option of drawing equity out of your home to buy another, it still comes down to how much money you need to service the debt and if you can borrow.

However, if you have some room to move, then holding onto the former PPOR could be an option.  But is it the best option?

Opportunity Cost

Just because you can, doesn’t mean you should. This is particularly true when looking at your former home as an investment property.

The first thing you need to consider is the potential for future capital growth. If the home has seen a significant increase in price in the last five years, then perhaps there might not be much more growth to come in the short term.

That would suggest you could use those funds to look for better options elsewhere.

Similarly, your current home might not be appealing from a rental perspective. If you own a two-bedroom apartment in an area where the greatest demand is for four-bedroom family homes, then it might not have strong rental demand or even as much growth potential as other investment options.

If you sell your former PPOR, you could actually deploy those funds and borrowing capacity and put them into strategies that might even help boost your borrowing power and create instant equity at the same time.

One example would be buying a positive cash flow property, which can potentially remove issues with serviceability and allow you to hold onto that property far more easily.

Similarly, looking to by a distressed property, might give you the chance to secure a property well under market value and in effect generate instant equity.

There’s probably plenty of sentimental reasons that you would like to hold onto your former PPOR as an investment - but those might not be the best reasons from a financial perspective.

Reasons to hold your PPOR as an investment

Many of the reasons to hold onto your property are based around taxes and transaction costs.

The one big advantage of owning and living in your own home is that the profits made on any capital appreciation are not subject to tax. 

However, if you turn your home into an investment property, you would also be entitled to certain tax deductions. 

The ATO also has what’s known as the six-year rule. That means, you can rent out your former PPOR for six years and it won’t be subject to capital gains tax. After that period it gets treated as a normal investment property.

Even with the 50% capital gains tax discount, this can be a big saving in comparison to purchasing a different investment property. This is something you should speak to an accountant about and look at the tax implications closely.

The second major issue is transaction costs. If you need to sell your PPOR to then buy another property, you’ll likely be spending around 2% on agents commissions, plus around 5% in stamp duty on another property.

These costs are significant and would mean you need to see significant price growth or buy at a large discount just to break even.

Whether to upgrade, sell or even do something like ‘rentvesting’ is all about opportunity cost and your own goals.

There’s no right answer, but you do need to weigh up your options and speak to the right finance professionals.