The following section should only be used as a guide. We recommend you contact your financial advisor for advice on matters related to your personal taxes, especially property tax.
One of the most popular methods Australians use to reduce tax is to buy an investment property. Property Investment allows buyers to have the bonus of certain tax benefits; however when it comes to property investment and tax there are a number of things to be aware of.
Know the risks of property tax
As popular as it may be, property investment is not without risk. Investors reduce their tax through a process known as negative gearing.
To put this into perspective gearing essentially means purchasing using debt. Negative gearing involves funding a purchase with debt, where the interest charges you pay on the loan exceed the rental income you earn on the property. In other words, you incur an annual loss. That loss is then deducted from your annual income, which then reduces the amount of income tax you have to pay.
Now the sound of loosing money sounds less then appealing, but there is a strategy at work. Simply put, by reducing your annual income, you can save on income tax! (Obviously, the more money you earn and the higher the tax rate you pay, the more income tax you will save).
So how does it all work? Say you’ve bought an investment property for $400,000. You pay around $25,000 in interest on the loan that you used to buy the property. But the rental income you receive is $15,000. That means you’ve incurred a 10,000 loss before other expenses. That is then deducted from your taxable income. There are some smart strategies to reduce tax associated with our home.
So, now we have a better idea about some of the terminology surrounding property tax – here is a breakdown of taxes related to investment property. Take note of each element in the list below and discuss these with your tax adviser when you next meet with them.
Tax incurred by the investor:
• Income Tax – You will be required to pay tax on income (rent and any other money) which you receive from your property. This may be offset however, by interest repayments on your loan as well as other deductions
• Capital Gains Tax – Capital gains tax is required to be paid on any profit made from your investment property once sold.
• Council Rates – This is a local tax that typically funds local government investment and expenditure, such as rubbish collection, parks and public facility maintenance and other community services.
• Land Tax – Land tax is payable based on the combined unimproved value of the land you own and is calculated on what your land would be worth if it was vacant; therefore it does not include existing dwellings on the property. Land tax is payable on all property you own, except your principal place of residence.
Deductions of an investor:
As an investor, there are three categories of expenses which you can deduct from your tax:
Acquisition and Maintenance Costs
• Advertising costs to find tenants
• Bank fees and charges on your loan accounts
• Borrowing expenses
• Body corporate fees
• Cleaning costs
• Council rates
• Electricity and gas not paid by the tenant
• Insurance – building, landlord, etc.
• Interest on your investment loans
• Land tax
• Legal expenses
• Property manager fees and commissions
• Surveyors’ fees
• Repairs and maintenance
• Stationery and postage expenses
• Investment related telephone bills
• Tax-related expenses
• Travel and car expenses for rent collection or inspections
• Costs incurred for the inspection or maintenance of your property
• Water charges.
All Investors who own an investment property are eligible to claim depreciation on newly purchased items. You can deduct depreciation on fixtures and fittings in the property, such as:
• Hot water system.
Negative gearing occurs when the annual cost of your investment is greater than the return which you are receiving. Put simply, when the ongoing costs such as maintenance and loan repayments are greater than rental income, then the property is negatively geared. If you are negatively geared, the government allows the loss on your property to be deducted from your gross income, creating a reduction in your tax.
In summary having an investment property can save you money come tax time, but it is important to remember that although you will pay less tax, this is still a loss – only slightly smaller, which in time will hopefully be made up for due to the property’s capital growth! Property Tax can be tough to get your head around but it is worth all the effort.