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TAX ON INVESTMENT PROPERTIES

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On top of the income from an investment property, there are other benefits such as tax deductions. You can claim costs related to the property, saving tax using negative gearing, and utilizing capital gains tax discounts.

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Tax deductions:

Generally speaking, the deductions are only available to the landlord when the property is tenanted or is available for rent. The following can be claimed as a part of tax deductions.

  • Advertising for tenants
  • Property Management Fees or Agent commission
  • Loan interest or on-going Administration Fees
  • Council rates
  • Land taxes
  • Strata fees
  • Building depreciation
  • Depreciation on fixtures and fittings such as air conditioner, carpet, dish washer, Oven, stove, etc.
  • Repair and maintenance
  • Pest control
  • Gardening
  • Travel costs related to inspection of the property
  • Stationery and phone costs related to management of the property
  • Accounting or Bookkeeping Fees

 

Please note that the above is not an exhaustive list of all deductions. Make sure that you consult with an Accountant or a Financial Planner to make sure that you don’t miss any deductions.

Tax Savings on Negative Gearing

Negative gearing refers to a situation where your rental income is not enough to cover the cost of owning the rental property. The loss you made on the rental can be used to offset your other incomes such as salary and wages.

Note: this tax loss does not necessarily mean a negative cash flow. For example, if you purchased an investment property costing $SOOK. Your cash outgoing would be $3000 per month including interest and management fees. Your rental income would be $3,000 as well. Therefore you are breaking even with the cash flow. However, once you factor in the depreciation of the property $12,500 (assuming the use of a straight line method), you have a tax loss and can use the $12,500 to offset your other income. If your annual income is $70,000, you would only need to pay tax on $57,500. 

Capital gains tax (CGT) on investment properties

When you sell an investment property, if the price is higher than your purchase price plus expenses, you need to pay capital gains tax. The capital gain will be added to your other income in the year you sold the property and taxed accordingly.

The cost base used to calculate the capital gain includes the price you paid for the property. Plus the buying and selling costs such as stamp duty, legal fees and agent’s selling commission.

If you have held the property for more than 12 months, you are entitled to a 50% discount on the capital gain tax. For an example based on a calculation that the capital gain is $50,000. And you have purchased the property more than 12 months ago. You only need to pay capital gain tax on $25,000.

Other important notes:

  • If you’re entitled to a tax refund for your investment property at the end of the tax year you can apply to the ATO to get your tax adjusted with your employer for each pay. Doing so you can receive more after-tax pay for each period. Refer to ATO website on PAYG Withholding Variation Application.
  • If you make a net profit from renting your property, you may need to make pay as you go (PAYG) instalments towards your expected tax liability.
  • If it is not rented or available for rent, it is still subject to CGT in the same way as a rental property. Since it does not generate any income, you can’t claim income tax deductions for the costs of owning the property. However, you may be able to include these costs to offset future capital gain when you sell the property.
  • Timing of repair and maintenance (R&M) work is critical if you want to claim the deductions in the same tax year. You cannot claim R&M in the year you paid them if they did not directly relate to wear and tear or other damage that occurred due to the renting out of your property. Therefore if you do R&M work right after you purchase the property and before generating rental income from it, you will not be able to claim a deduction in the year you paid the expenses.

Declaration: The Excel files and content of this website have been prepared without taking into account your personal financial situation or knowledge of your financial needs. Impact Taxation and Financial Services cannot be liable for any losses or damages arising from using the information provided. It is the user’s responsibility to seek independent advice from a professional accountant before implementing any financial plan.

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Impact Taxation and Financial Services Pty. Ltd. is a CPA Practice based in the Bankstown area. We are committed to customizing our services to meet your financial needs and help you achieve your visions and goals.

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    10 things you should consider before buying a property

    Are you considering buying a property? Do you know you could miss opportunities to save thousands, or tens of thousands of dollars if you don’t plan well before the purchase?

    Below are a few key considerations:

    1. How should you set up your loan structure? If you don’t have a loan offset account for a rental property, after you make extra payments directly to the loan account, you can only claim interest deduction on the remaining balance of the loan. For tax purposes, this deductible balance can’t be changed even if you redraw the overpaid amount later. A good loan structure could also help you to stabilize interest rate and speed up loan repayment by combining a standard variable loan (with an offset account) and a fix rates account.

    2. Timing of renovation. You might want to do a renovation right after you have bought the rental property. But do you know for any genuine repair & maintenance included in the renovation, you can claim an outright deduction against the rental income when the property is available for rental? If the work is done before the date when the property is available for rental, you can only claim the deduction against future capital gain when the property is sold. Depend on when you are going to sell, it could take years or up to decades before you can claim the deduction.

    3. How should you split ownership? You might want to share the property ownership with a family member. For tax purposes, the percentage of ownership is based on the legal title, regardless of who is paying more on the mortgage. If the property will give you a tax profit, you might want to allocate more
    ownership to the low-income earner to utilize the lower marginal tax rate. If it is giving you a tax loss, you might want to allocate more ownership to the high-income earner to utilize the loss. The goal is for the family to pay minimum tax together.

    4. Should you use a family trust to purchase the property? There are many pros and cons related to a family trust. The advantages include tax savings on rental profit or capital gain, asset protection and succession planning on family wealth. However, family trust can’t distribute losses. All losses are trapped in the trust to be used to offset future trust profit. Therefore, you can’t utilize any rental loss in a trust to offset other income such as salary & wages. Family trusts also attract high accounting fees on initial setup and annual fees on financial statements and tax returns. State governments also charge much higher land tax on family trusts.

    5. Will the income level change in future years for different owners? You might want to forecast the possible income for different owners to understand total tax payment / savings related to the property. This could also impact on your decision making on point 3 and 4 above.

    6. Understand when you can treat your property as main residence to receive an exemption on capital gains tax. When eligible, even if you have received rental income, you could still treat your rental property as main residence and receive the exemption. To be eligible, you will need to treat it as your main residence at the beginning. Please check out this ATO link: Treating former home as main residence.

    7. Decide whether you need to purchase a depreciation report. Most taxpayers don’t know that the depreciation on the building will need to be added back to calculate capital gains tax when the property is sold. When the property is held for more than 12 months, after applying the capital gains tax discount of 50%, it will effectively cut the tax rate by half at the time of sales. This makes depreciation deductions desirable for high income earners. However, for low-income earners it might not be ideal to claim depreciation as a rental deduction since they could be paying more on capital gains tax in the future. It could get more complicated if the property is under joint ownership between high and low income earners.

    8. You might want to consider Centrelink payments for future or existing owners. Most Centrelink payments are income and asset tested. Before attaching a rental property to a family member who is receiving, or plan to receive government benefits, you might want to check the testing thresholds first to see if the Centrelink payment will be impacted. This is also applicable when you are making distributions from a family trust to different family members.

    9. Have you considered using your SMSF (selfmanaged super fund) to make the purchase of a rental property? There are a lot of tax saving opportunities with a SMSF since the income tax rate is only 15%. And the capital gains tax rate is effectively only 10% after factoring in the 1/3 discount. The major downside with a SMSF is normally you can’t get the money out until you retire or on compassionate grounds (SMSF does have more flexibilities compared to normal retail super fund. But the choices are still very limited). It could be expensive to set up and operate a SMSF too. There are also strict legal requirements on the trustees. Penalties on incompliance could be severe. Tax law around SMSF is very complicated too. You will need to find a good tax accountant specialized in SMSF to help you to understand the structure, also do a cost-benefit analysis before setting it up.

    10. Consider internal ownership changes. For your existing rental properties, you can also consider whether you should transfer the ownership between family members, or between different business structures (this is not applicable for SMSF). You might want to do this when the income level changes with family members, or rental property changes between tax profit and loss. Before the change, you need to consider the cost of transfer including capital gains tax, stamp duty, conveyancer fees, etc. Again, a cost-benefit analysis is a must before the change.

    Last but not the least, did you combine all the above strategies and compare your choices? If you haven’t yet, how would you know that you have picked the best strategy to minimize your taxes? We can help you to factor in all considerations, compare different scenarios, also present you with a Property Prepurchase Report with all our findings to help you to make a decision. Contact us today to book in a consultation with an experienced tax accountant!

    IMPORTANT INFORMATION
    This is general advice only and does not consider your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from your financial adviser and seek tax advice from your accountant.

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