It is not unusual for people who are upgrading their home to have such a love affair with residential real estate that they cannot think of anything other than renting the house they used to call home. The original home loan is possibly paid off but in any case there is likely to be substantial equity in the “old” home.

Using both the new and the old house as security they borrow money to buy the new home, and then rent out home #1 believing that they can negatively gear.

The concept seems simple enough. There is a mortgage on the house and interest is payable, rent is being charged on the old home, therefore the interest is tax deductible.

Think again.

The purpose of borrowing determines tax deductibility. In this case the purpose of the loan was to buy the new home. Borrowing was not done for the purpose of gaining assessable income, the borrowing was done for the purpose of securing a new bigger and brighter home.

I have even had clients who did not have a mortgage on their new home because they were trying to save stamp duty and they still believed that because the rent and the mortgage had the same address tax deductibility for interest was automatic.

You will need good professional advice to ensure you do not fall into this tax trap.