property investin
15-Oct-2020 By - team

When buying your investment property, it’s vital to keep costs and returns in mind. This perspective keeps property investment real and stops you from getting caught up in the savings hype. Let’s look at investment property tax from both sides of the coin, so that you can work out the costs and how much you could save.

Negative gearing investment property

Negative gearing refers to the situation where the costs of owning an investment property are more than the rental income, resulting in a loss. In this case, the Government allows investors to claim their investment property expenses off their income before paying tax, thus paying less tax. This income loss on your rental property can be used to reduce your overall taxable income (which may include salary, business income or other income), hence decreasing your annual tax bill. If your overall income does not cover the loss, it can be factored into the following year’s tax return period.

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To determine whether you have experienced an income loss or profit on your investment property, you need to calculate the rental expenses you can claim at tax time. These deductions are outlined below, but for more information, refer to the ATO’s guidelines on expenses and depreciable assets or talk to your taxation specialist.

So, how does it work? Well, when an investor buys a property, they incur expenses – loan interest, council fees, etc. – and they collect rent. As soon as the cost of owning the property becomes higher than the rental income collected, the property becomes negatively geared.

For example, let’s say you collect the rent of $15,200 a year on your property, but your property expenses are $17,500 yearly. Consequently, this means that your property expenses become tax-deductible. So, if you earn $52,000 in this financial year, then your taxable income becomes $34,500. So, you’ll incur tax on this amount.

How does negative gearing benefit me?

  • Reduces your tax.
  • The rental property becomes more affordable.
  • Encourages you to build a portfolio.

What are the risks for me?

 

  • You’ll have to cover some property expenses.
  • Some payments, such as paying the loan principal, are not tax-deductible.
  • You need good money management skills.

Not all investment properties are negatively geared. Some rental properties collect more rent than ownership costs making them positively geared. Once this occurs, the profit made on the property annually becomes a part of your taxable income. This will be factored into your overall annual taxable income.

Capital gains tax on investment property

If you make a capital gain when selling your investment property, you must pay tax on the profit. To determine your capital gain or loss when selling an investment, real estate takes the cost base (purchase price and capital expenses) away from the capital proceeds.

Importantly, the rate at which capital gains tax (CGT) is charged will be cut by 50 per cent if you own the property for more than one year. Though CGT is not charged on the sale of your primary residence, be wary of renting your home out for a period of time or if your land is on more than two hectares, as CGT may then be payable. CGT is charged on the sale of holiday homes, empty land, business premises and rental properties.

You can offset your capital gain in a financial year with other capital losses experienced within the same period. Investors try to time capital gains and losses, so they fall together to reduce their tax burden.

Property Tax

Also known as council rates, this tax covers the cost of local government services such as community services and rubbish collection. The cost of this tax varies from council-to-council, so ask about rates when buying to avoid unexpected charges.

Land Tax

All state governments charge land tax, excluding the Northern Territory. This tax varies depending on the state of property purchase and is payable only on the land value of the property; hence it excludes any dwellings or improvements. Also, this tax does not include your principal place of residence. To calculate costs of this tax, contact your tax adviser.

Investment Property Tax Deductions

A vast range of expenses that relate to your investment property are tax-deductible, so keep sound records and all receipts. However, remember that you can only claim these if the property is an investment that you don’t live in, which is either currently tenanted or available as a rental.

Properties built or renovated to a tenant are exempt from the payment of GST. However, if you’re building to sell for a profit or looking to ‘flip’ the renovated property for profit, then you’re liable to pay GST on the sale; you will also have to pay capital gains tax.

In most cases, the general tax allowances for your property investment are straightforward. These are as follows:

What can I deduct?

  • Tenant advertising costs – Paper, online and billboard.
  • Property management fees – Real estate agent or self-managed costs.
  • Any bank charges – Loan interest and ongoing loan fees.
  • Local government fees – Annual council rates and the emergency services levy and land tax.
  • Strata fees – Grounds maintenance and building insurance.
  • Depreciation – The building structure, lighting fittings, appliances – dishwasher, fridge, and hot water service – blinds, carpet and flooring, and new additions such as a kitchen upgrade.
  • Repairs and maintenance – Gardening, paint, plumbing and maintenance, as well as wear and tear.
  • Insurance – Building and property owner coverage.
  • Stationery – Receipt books, pens, printing, and paper, as well as phone costs.
  • Bookkeeping and accounting – Record keeping and taxes.
  • Legal fees – Conveyancer at the time of purchase.
  • Utilities – Water, gas, and electricity installation, along with ongoing sewer fees.
  • Travel – Costs associated with the inspection of the property.

While this is an extensive list of tax-deductible items, there may be more. Therefore, always consult your accountant before lodging your tax return.

Calculating your investment property’s tax deductions

The expenses you can claim as rental property tax deductions include those relating to your mortgage, ongoing management and maintenance costs, as well as depreciation on rental property assets. Make sure you keep expense receipts and make detailed records of any transactions relating to your investment property.

Capital gains tax is only applied to the sale of assets acquired after September 20 1985, when the tax was introduced. However, capital gain or loss on certain capital improvements made to the property after this date may need to be declared.

How is capital gains tax calculated?

  • The sale price of your property.
  • Less the purchase price and any buying, ownership and selling costs.
  • If ownership is longer than 12-months, you’re entitled to a 50% gains discount.
  • Your annual income in the year of sale.

You cannot claim:

  • The costs of acquiring or selling the investment property
  • Any expenses relating to your personal use of the investment property
  • Any utility expenses paid for by tenants
  • Any associated borrowing costs based on the equity of the investment property that relate to private use, for example purchasing or renovating your home.

Expense claims you can make include:

  • Mortgage interest rate charges and bank fees
  • Council rates, water rates and land tax
  • Cleaning, pest control, gardening, repair and maintenance costs
  • Insurance, strata fees and capital works
  • Advertising for tenants and agent management fees
  • Travel is undertaken to inspect or maintain the property
  • Loan interest charges and fees relating to the finance of a depreciable asset for the rental property or renovation of the real estate
  • The depreciation on assets as they devalue over time (for example stoves, air conditioning units, hot water systems and fans).

Investment Property Tax Depreciation Tips

Claiming depreciation on your property is one of the most important steps in an investor’s journey. And it’s the only deduction that can be subjective.

Avoid Properties with a 4% Building Allowance.

Residential properties built between July 18, 1985, and September 15, 1987, attracted a 4% building depreciation rate. Everything built since then attracts a 2.5% rate.

So, if you do buy a property built in 1986, that means 23 of its useful 25 years have been eaten away (from 2009 to 1986). You will only be able to depreciate the residual for the next two years at 4%. However, if you buy a property where construction commenced in 1989, you still have 20 years to depreciate the property, at 2.5%.

That’s 50% of the original construction cost left for you – as opposed to only 8% – I know which one I would prefer!

Claiming the Residual Value Write Off

I believe millions of dollars will be missed over the coming years in tax depreciation claims due to changes in what can be defined as ‘plant and equipment’.

When I first started preparing depreciation reports, there were several factors in determining what made a list.

These included whether the item was necessary to make the property available to be rented out. For instance, a kitchen is an absolute necessity – but a microwave wasn’t.

So the moral to the story is… if you are renovating a kitchen or bathroom on a property built after 1985 – get a quantity surveyor in before you demolish so they can assess what the residual value of these items is.

That value can still be claimed as an outright deduction and can generate huge savings in the first year.

For instance, a rental property with a 20-year-old $10,000 kitchen attracts an immediate deduction of around $5,000.00.

Depreciation schedule

If you owned or entered into a contract for a rental property before 7:30 pm on May 9 2017, you can claim deductions on the decline in value of the depreciating assets that were in the property before that date.

If you bought it after this date, you could only claim depreciation on brand-new assets, or if the property was newly built or substantially renovated and no one had previously claimed any depreciation deductions on the asset.

Furnish your Property

Furnishing your property is another way to increase your depreciation deductions as it attracts higher depreciation rates.

For example, a $20,000 furniture package supplied by a developer can result in an additional $10,000 deduction in the first year alone. In addition to your other depreciation opportunities, furniture really can enhance your overall claim.

Maximise the Cost of Construction

When depreciating an investment property, the original construction cost must be used.

Many of our clients are now buying properties at dramatically reduced prices – nearer to the original building cost. 

So the tip is to make the most of the current market conditions and search for properties where the actual construction cost is close to the current purchase price. 

We were the quantity surveyors on the project – and I know the original construction cost for that unit was $175,000. But its purchase price – brand new – was $335,000.

Guess what? You still use original construction cost as the basis for the incoming property investor.

So not only has the new purchaser paid less stamp duty and increased their chance of a capital gain – their depreciation deduction relative to the purchase price has also increased.

So this property would be cash flow neutral at worst – cash flow positive at best.

Old Properties Depreciate too.

Even properties built before 1985 (when the building allowance kicked in) are worth depreciating. The purchase price of your property includes the Land, Building and Plant and Equipment. As a quantity surveyor, we help you apportion or break down those categories.

In about 99% of cases, we find enough plant and equipment items to justify the expense of engaging our firm.

Small Items and Low-Value Pooling

A dollar today is worth more than a dollar tomorrow so deduct items as quickly as possible.

Individual items under $300 can be written off immediately.

An important thing to remember here is that provided your portion is under $300 you can still write it off.

For instance, say an electric motor to the garage door cost an apartment block $2000. If there are 50 units in the block, your portion is $40.

You can claim that $40 outright – as your portion is under $300.

You can also try to buy items that depreciate faster. Items between $300 and $1000 fall into the Low Pool Category and attract a higher depreciation rate.

So for instance, a $1200 television attracts a 20% deduction while a $950 TV deducts at 37.5% per annum.

The Taller the Building, the Higher the Depreciation

Taller buildings attract higher plant and equipment allowances, and the higher the plant and equipment, the higher the depreciation.

Plant and equipment refer to necessary services within the building, as well as items within the property itself.

Some of the services required as buildings increase in height are obvious, such as a lift (transport service). Other services are less obvious, with fire hose reels and intercoms all being depreciable under this category.

The other reason tall buildings have a higher ratio of plant and equipment has to do with the amenities the developer provides. For instance, some high-rise buildings have swimming pools, gyms and even mini cinemas.

OK, let’s look at the numbers. The first thing to do is to look at a rough ratio of plant and equipment relative to construction cost.

These allowances all relate to a $400,000 property in a capital city – and are very approximate to allow for illustrative purposes only.

As you can see, the taller the building, the more you can depreciate. But keep in mind that a tall building doesn’t necessarily make a better investment.

It often means there’ll be higher levies and additional expenses, and you own less land as well. But at the end of the day, it’s up to you to weigh up the pros and cons… and make that final decision!

Remember attaining wealth doesn’t just happen – it’s the result of a well-executed plan so please click here and find out more about our services.

Whether you are a business owner, a professional or a high-income earner we provide you with an individually tailored solution integrating the core disciplines of taxation, superannuation and property investment interwoven with finance, asset protection, succession and estate planning, personal risk insurances and philanthropy.

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