Investment Properties – Tips to Maximise Your Investment and Minimise Your Tax
Australians have had a long-established love affair with owning property. Indeed, the great Australian dream is often to buy your own home and raise a family on a block of dirt that you own. For approximately 20% of Australians (www.propertyupdate.com.au) they have acquired an investment property in the hope of making a capital gain and achieving a regular, passive stream of income. By gearing (borrowing to invest), many investors have also managed to reduce the amount of tax payable each year by offsetting tax losses from rental properties against taxable income from other sources (e.g. salary/wage income). This strategy has potential to work where the taxpayer achieves a capital gain with the eventual sale of the property.
This article highlights to readers some of the tax requirements and benefits available to taxpayers and also provide some education for those thinking about investing in property (or currently doing so) by considering a number of tips and tricks to assist in managing your investment.
What structure do I purchase the property in?
This is often dependent on the circumstances of each taxpayer. Options might include acquiring the property in your individual names, via a company or trust and even potentially via a SMSF. We recommend seeking advice from your tax advisor prior to signing a contract as getting things wrong at this stage can be very expensive to change and result in any potential tax savings being forfeited.
What level/type of gearing should I consider?
Again, this is often dependent on the circumstances of each taxpayer, your investment objectives and the borrowing requirements set out from your bank. Lending to acquire property can be done via related party loans (e.g. borrowing from related party trusts and companies), drawing down on current loans in place (e.g. home loans) and applying for a loan via your current banking institution.
Gearing ratio’s with your bank could be anywhere from 50% through to 100% dependent on the type of property (commercial or residential), your net assets and taxable income. Taxpayers will often assess whether they want positive gearing (investment income that results in a profit), or negative gearing (borrowing to a level that results in a net loss and potentially offsetting other taxable income) to achieve their goals.
- The income received is taxable to the owners of the property in the same proportion as the ownership interest as shown on the title.
- The rent received must be at normal market rates to be able to claim all the expenses in full. If you rent at below market rent (e.g. to family or friends), you can only claim deductions up to the amount of rent charged.
- The rent must be declared in the year it is received.
- Interest paid on the loan used to purchase the property is deductible (up to the proportion that was used for that purpose).
- For loans that are a line of credit and used privately as well (e.g. partly for your private residence and partly for investment), the interest claim also needs to be apportioned for the private expenses.
Other Tax Deductions
Repairs made to the property during the period it is rented are deductible. Care needs to be taken to ensure the expense is correctly classified as Repairs and Maintenance (R&M) and not Capital Improvements. For example, the cost of replacing a sheet of roofing with some left-over panels would be considered R&M, however replacing the entire roof with brand new sheeting would be a Capital Improvement. Care should also be taken with repairs carried out just after acquisition – these may potentially be considered Capital Improvements and added to the cost base/purchase costs of the property.
Improvements you make to the property are not deductible in full immediately. Some examples might include re-painting the entire house, replacing the roof, upgrading the kitchen/bathroom. These costs need to be depreciated and claimed over a forty year period along with building cost writeoff amounts.
Building cost write off
If the building is under 40 years old, you will be entitled to claim a deduction of 2.5% per year of the original cost of construction of the building for up to 40 years from the original date of construction. In some cases, the rate might be higher where the building is commercial and used for industrial purposes.
If you do not know the building cost you can contract a quantity surveyor to determine the building costs and prepare the depreciation schedules for the property and determine what can be claimed. They will also be able to calculate the depreciation rate of your fixtures and fittings (if relevant) to determine any tax depreciation that can be claimed. Engaging a qualified Quantity Surveyor to correctly calculate your depreciation is one of the most significant ways to efficiently manage your tax outcomes.
Other deductible expenses can include
- advertising for tenants
- bank charges
- body corporate fees
- council rates and water
- electricity and gas
- gardening and lawn mowing
- in-house audio/video service charges
- land tax
- legal expenses re leases etc.
- pest control
- mortgage discharge expenses
- property agent’s fees
- quantity surveyor’s fees
- postage, telephone and stationery
- borrowing costs including lenders mortgage insurance (usually written off over the shorter of the term of the loan or 5 years)
Tips & Tricks
- Talk to your Tax Advisor before acquiring the property to ensure ownership is in the correct name/entity;
- Engage a Quantity Surveyor to correctly calculate the amount of depreciation you can claim;
- Understand the difference between R&M (repairs & maintenance) and capital improvements before committing to these expenses;
- Carefully consider the timing of paying for expenses. Most property investments are taxed on a cash basis – expenses paid prior to June 30 will receive a deduction in that financial year;
- Carefully consider the timing when you come to sell the property. Triggering a capital gain in a year where there are capital losses to offset the gain (or minimal taxable income) will generally reduce your tax liability (remember CGT is determined on contract date, not settlement date);
- Keep accurate records of the investment income & expenses (consider keeping a separate bank account to track income and expenses).
- Discuss with your bank any options to avoid/minimise Lenders Mortgage Insurance. Whilst the cost is deductible, the premiums are significant and can reduce your returns on the investment.
How Can Alto Help?
The Alto team can assist with choosing the best structure to buy your investment property as well as maximising your deductions and minimising tax along the way and on sale of the property.
Author: Murray Kilpin