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How Investment Property Gives You Tax Back

Sometimes, the path to financial independence can feel like a never-ending cycle of earning, saving, and spending, with tax time thrown in for good measure to add a few more hurdles. So how do you get out of the rut and realise the financial and lifestyle aspirations you have for yourself and your family? Investment property may be just the solution – and its potential to give you “tax back” is what makes it so appealing to many Australians.

Investment Property – An Overview

There are all kinds of “get rich quick” schemes out there and, typically, they falter and disappear into the ether after a few years of being over-hyped. Naturally, that’s the kind of investment you want to avoid, and the investments you should consider offer different qualities. They’re the investments that have been established for decades, even centuries in some cases. The kinds of things that may even be taken for granted, like savings, trusts, shares and, of course, investment properties.

The reason investment properties are so great for reducing tax is that they come with a range of tax benefits (in the form of many deductions, among other things), and also have the potential to earn you more money in the future. The property market is also relatively stable. Naturally, there are fluctuations in prices and demand, but the fact remains that everyone needs to have a roof over their heads. And that simple fact could very well be the key to saving you potentially thousands of dollars in tax (or more).

“Isn’t Property Investment Expensive?” is a question people often ask before they start looking at buying into the rental market, and it’s definitely important to consider. The simple fact is, many people dismiss this avenue before they ever really look into it. They see the cost of buying a house or apartment and run in the other direction. That may seem fair enough – investment properties typically cost hundreds of thousands of dollars – but there is a lot more to it than just the price you pay for the actual property. There are many different tax deductions that become available when you invest in a rental property. Let’s take a closer look at each of them and the value they can bring to your tax deductions.

The Tax Benefits of Investment Property

1. Interest

You can claim interest charged for loans as a tax deduction when the accounts in question are used for investment purposes. This could include interest accrued through a mortgage on an investment property, money borrowed to buy shares, or other loans relating to investment portfolios.

For example, let’s say you have a $500,000 mortgage for a rental property, where interest is charged at 6.5% per annum and paid monthly over a 30-year period. Over a 12-month period, you would pay around $31,000 in interest for this loan. And that’s also a $31,000 tax deduction to offset the cost of your investment property.

2. Rental expenses

When you own rental properties, there are all kinds of expenses you can claim to offset the amount of tax you pay each financial year. Some of the most common expenses you can claim immediately include:

• Advertising for tenants
• Body corporate fees and charges
• Council rates
• Water rates
• Land taxes
• Cleaning
• Gardening
• Pest control
• Insurance
• Property agent fees and commissions
• Property repairs and maintenance

3. Depreciation of building

General wear and tear is inevitable for buildings, just as it is for vehicles and other assets. This process affects the financial value of items and is referred to as “depreciation”. When it comes to investment properties, depreciation is one of the best things for your bottom line at tax time, with some seasoned investors even considering depreciation before they buy new property.

What makes depreciation so beneficial is that it is a tax deduction that comes built-in with the cost of the property, so you don’t actually have to pay for it on an ongoing basis. Instead, the depreciated value of the building is calculated and claimed on your tax return as what’s known as a “non-cash deduction”. As long as the building was constructed after 1985 (and is used for investment purposes), you can claim depreciation on your tax return, and potentially save thousands of dollars without actually spending any more money on the property.

4. Depreciation of fittings

This tax deduction follows similar guidelines to the depreciation of building claims but relates specifically to fittings inside an investment property.

If a property is brand new, depreciation on items, such as carpets, blinds, cooktops, ovens, and air conditioning will depreciate based on their lifespan. Second-hand properties can no longer claim existing items, but if new items are purchased will become depreciable from date of purchase.

Qualified building surveyors can calculate the cost of depreciation on fittings and buildings, with the details then outlining how much the value of the assets decreases over time. Depreciation rates are calculated on the price paid for buildings and their assets, so can lead to some significant ongoing tax deductions.

5. Loan costs

Interest may be the big charge people think of when it comes to loan costs, but there are a lot of other charges that quickly add up – as anyone with a mortgage or two knows!

These loan costs can often be claimed for investment properties, with tax deductions available for things like loan establishment fees, account management fees, mortgage insurance fees, mortgage registration, mortgage broker fees and stamp duty on the loan (not the property). Most of these claims are made over a five-year period, as part of borrowing costs, and can add up to hundreds of dollars in tax deductions each financial year.

6. Accounting costs

While a lot of people pay accountants to manage their tax returns, not everyone realises that this service could actually help you pay less tax. As well as giving you access to professional accounting advice that may help you find more ways to reduce your tax, the actual fees and charges you pay for managing your tax affairs are claimable as tax deductions every financial year. This includes fees for the preparation and lodgement of your tax return and activity statements, travel to obtain tax advice from a professional tax adviser, and any taxation appeals lodged on your behalf. You can also claim costs for any valuations you need to obtain for certain tax deductions, such as qualified building surveying reports that you may need to lodge depreciation claims.

Accounting costs can range depending on what’s involved. Being able to claim these costs not only reduces the amount of tax you pay but makes it easier to justify going to an accountant who can help you find ways to get the most out of your tax return. All of these things are considered tax-deductible expenses when you have an investment property, and by adding them up accurately you can save money on tax and offset the actual cost of buying the property. In fact, when you’ve added up all the expenses and factored in your tax refund, the right investment properties may not cost that much at all.

How To Make Investment Property Affordable

The most important thing to remember about investment properties is that they should be affordable for you based on your current circumstances. There is no point buying a property if you go into thousands of dollars debt and end up with serious negative cash flow at the end of each financial year. It is also important to consider affordability should your circumstances change.

While many people think that the only way to get into property investment is to take a huge cut on their disposable income, with the right strategy for investment you should have neutral or even positive cash flow as a result of your investment.

For example, let’s say we have someone who is earning $107,000 per annum who decides to invest in a small rental property valued at $381,000.

Their purchase costs (conveyancing and stamp duty), loan and holding costs total $16,300, so they get a loan for the total of $397,300. With an interest rate of 6.5% p.a., they would then pay a total of $30,134.48 for the first year of the loan, or $2,511.21 per month, principle & interest.

Now, as far as rental expenses go, these vary from property to property. As a guide, generally expenses range from 13% to 30% of the property costs, depending on the maintenance and whether a professional property management agent is used. In this case, the investor has normal expenses as follows:

• Agent’s commission (8.25%): $2,145
• Letting fees: $1,000
• Rates: $2,000
• Insurance: $1,000
• Maintenance: $300
• TOTAL: $6,445

As well as these deductions, they have depreciation of the building at 2.5% of the property value and construction costs. Per year, this works out to be $5,400. With all of these details in mind, their expenses for the first year would look something like the following:

• Interest: $25,693
• Management expenses: $6,445
• Depreciation of building: $5,400
• Loan costs: $60
• TOTAL: $37,598

As well as these investment property costs, they also have the benefit of rental income, which is estimated at $26,000 per year ($500 per week).

This income is taxable, so when it is added to their salary of $107,000 the total is $133,000 before deductions are factored in. To work out their actual income after tax deductions, you calculate:

TOTAL INCOME (salary + rent) – TOTAL DEDUCTIONS (interest, management expenses etc)

In this scenario: $133,000 – $37,598 = $95,402

To put this into perspective, previously their tax on $107,000 WITHOUT an investment property would have been $27,382. WITH the investment property, however, they only pay tax on their new taxable income of $95,402 (thanks to all those expenses).

Total tax back: $4,001.31

With the right system in place, this kind of property investment results in an initial outlay of $0-$5 a week, and then works towards positive cash flow once the building is complete and rent starts to come in.

How To Make the Most of Property Investment Now

Are you ready to learn more and create wealth through property? Our Investment Property Calculator is available on our Resources Page for you to download for free. What’s more, our property accountants know how to make the most of the various tax benefits available to you as a property investor, saving you time and stress. To find out more about what we can do for you from an investment property tax perspective, call us today on 08 9325 2411 (Perth), 08 9301 2200 (Joondalup), or contact us via our website.