Understanding the tax benefits of investing in property

25 Sep 2014

By David Shaw

Investing in property is very popular in Australia, in part because of Australian tax laws. The ‘negative gearing’ tax laws allow you to offset any shortfall between the rent that you collect from your investment property and the expenses that you pay for against your other assessable income. This works particularly well for higher income earners in Australia who are currently paying a top marginal rate of 49%.
Most people know that when you rent out an investment property you can claim a deduction for the outgoings such as council rates, water rates and agent management fees. However,  many investors forget about claiming depreciation especially in properties which are older.
Depreciation is the decline in value of property assets over a period of time. The ATO sets out rates of different items, such as floor coverings, kitchen appliances and air conditioners that can be depreciated. Even if a property is not new most will have some depreciation benefit available in the fixtures and fittings of the property. These depreciation benefits can be easily calculated by engaging a qualified quantity surveyor upon purchase to prepare a depreciation schedule for your property.
Building depreciation or capital works deductions are available for residential properties constructed or renovated after 18th July 1985 at a rate of either 4% or 2.5%. For older properties depreciation of the fixtures and fittings of the property are still available.
Positive Cash Flow
In certain circumstances a negatively geared property can become positively geared as a result of the depreciation deductions and tax benefits available. As mentioned above this works particularly well for higher income earners. Below is an example of a negatively geared property which has positive cash flow after tax benefits.

Rent $23,400
Rates, management fees, insurance etc -$4,500
Interest -$23,500
Cash flow before tax -$4,600
Depreciation -$2,500
Capital Works/Special Building write-off -$5,600
Tax Loss -$12,700
Tax Refund at 49% tax rate $6,223
Positive cash flow after tax $1,623

Many investors are experiencing the benefits of a positive cash flow on their investment properties presently because of the current low interest rates.
Investment Loans
The majority of property investors finance their investment properties by way of interest only loans.
There are two primary reasons for this:

  • Many investors still have debt on their own home or other private debt  which they wish to pay down as a priority over their deductible debts
  • Each dollar you pay off interest for a property is deductible.   However, principal payments are not.  As a result of this, principal payments can distort the true cash flow of an investment property

Capital Gains Tax
Capital Gains Tax (CGT) is the tax payable on the disposal of an asset which was acquired after 19th September 1985. You only have to pay tax on capital gains if your capital gains for the year exceed your capital losses.
In short, your capital gain is calculated by subtracting the purchase price of the property from the sale price. However, there are adjustments for capital gains for example, depreciation which you have claimed, agents’ commissions charged and improvements made to the property.   You will receive a 50% discount on capital gains for any asset which you have held for longer than 12 months. This means that effectively the highest tax rate on a capital gain is 24.5% at present (this is half of the current top marginal rate of 49%).  We recommend that you seek professional advice to calculate your capital gain correctly.
Getting the tax benefits on your investment property right can be tricky business, contact the experts at WSC group for a free initial consultation and a 10% discount off your first tax return when you mention this article.

David Shaw is the CEO of WSC Group: Certified Practising Accountants and Business Advisors, and was voted Property Tax Specialist of the Year in the Your Investment Property 2013 Readers Choice Awards (runner up in 2012 & 2014 ).

The above information is supplied by WSC Group.
Disclaimer: while due care is taken, the viewpoints expressed by contributors/sponsors do not necessarily reflect the opinions of Your Investment Property.

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