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TAKE ADVANTAGE OF OUR FREE DYNAMICS OF ECONOMICAL COST GUIDE

What is Economical Cost? Put simply, economical cost is a concept which will tell you how much money you have given up by making a different choice. As an example, an individual earning an annual salary of $100k decides to open his own business and earns $50k in the first year. If he continued to work in his original job he would have increased his wealth by $100k instead of only $50k. The $100k is the economical cost that he has given up by choosing to work only in his own business. When he uses his profit of $S0k, minus the economical cost $100k. He is actually worse off by $50k working in his own business.

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In the following situations you might find the dynamics of economical cost relevant to you:

  • If you are running a business, understanding your economical cost is critical to you maximising your real profit. Accounting profit ignores what you have sacrificed if you have applied your time or resources elsewhere. Go through your own time1 finances and assets to see whether your business is really earning the best profit for you.

 

For example, if you have invested $100k into a business and are earning $2k accounting profit after all expenses (including a salary to you of $60K). Is the business earning you good profit? If you can earn more than $60K in a different job, it might not be a good investment, since the current bank interest rate could be more than 3%. And if you found a different job and had saved the money in the bank, it would have earned you $3k instead of only $2K. By choosing to stay in your own business1 you are worse off by $1K per year.

  • Understanding economical cost will help you to understand your real cost when you purchase an item at home.

 

For example, if you decided to use money in your mortgage offset account and the cost is $S0k. You might think you only need to consider the cost of $SOK. However, remember if you can leave the money in the offset account, you are saving $43K interest for a 30 year home loan on 4.8% interest rate. You can use the mortgage calculator on our website to do the calculation yourself. At the same time, if you don’t purchase a car, you could be paying $3k per year on Taxi expenses. This would mean a $21k saving if you only used the car for 7 years. In the purchasing of a car there are many scenarios and factors you need to consider other than just the cost of the car.

Of course, in our examples we didn’t mention the pros and cons that are not in dollar value. Of course It could be more flexible and rewarding to own your business and more convenient to have your car! The main purpose of understanding economical cost is so that you understand what you are really giving up for the benefits, helping you make a sound ‘financial decision.

There are other areas in which you can utilise the concept of economical cost. Remember at any time no matter how you are using your time and resources, there are always other scenarios that could generate some income for you. Compare the other scenarios so that you can understand your real cost at any time. 

To use the mortgage calculator visit our website www.impacttfs.com.au.

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.

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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