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How Investment Property Gives You Tax Back
Sometimes earning money can feel like a never-ending cycle of earning, saving and spending, with tax time throwing even more bumps in the road towards wealth. So how do you get out of this rut and to get to the financial freedom you deserve?
There are all kinds of “get rich quick” schemes out there and, unfortunately, many of them take us for a ride without ever reaching the ideal destination. Many of these options falter and disappear into the ether after a few years of being over-hyped.
That’s the kind of investment you want to avoid. But the investments you want to consider offer different qualities. They’re the kinds of things 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, 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. Sure, 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 $7000 in tax (or more).
Isn’t Property Investment Expensive?
This 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 answer is that 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 – most investment properties are worth 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 rental property. Let’s take a closer look at each of them and the value they can bring to your tax deductions.
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 5% per annum and paid monthly over a 30 year period. Over a 12-month period, you would pay around $15,542 in interest for this loan. And that’s also a $15,542 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
- Pest control
- Property agent fees and commissions
- Property repairs and maintenance
You can also make claims for any travel you do that’s directly related to the property, such as inspections or rent collection.
Over time, these rental expenses add up to thousands and thousands of dollars, so when you claim them as tax deductions you could reduce the amount of tax you need to pay by just as much.
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. This includes things like lights, fans, power points, windows, sinks, showers, and so on, which are all subject to wear and tear – or depreciation – over time.
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 can range from 2.5% to 4% of the price paid for buildings and their assets, so it often leads 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. Holding costs
Holding costs generally relate to the purchasing of land before anything is built. For example, when you purchase land with plans to build on it, you will have to pay interest on land as well as interest on phases of construction. These expenses are known collectively as holding costs – or, what you have to pay to “hold onto” the property before you can get tenants in.
While holding costs are one of the biggest areas of tax-deductible expenses when it comes to investment property, people new to property investment often overlook or struggle to understand them. Instead, they may opt for already established buildings and properties – and miss out on tens of thousands of dollars in tax deductions in the process.
7. 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 property surveying reports that you may need to lodge depreciation claims.
Accounting costs can range depending on whats 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 you more than $5 per week.
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 new 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 4.75% p.a., they would then pay a total of $18,872 for the first year of the loan, or $1573 per month.
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 or not a professional property management agent is used. In this case, the investor has normal expenses as follow:
- Agent’s commission (8.25%): $1605
- Letting fees: $780
- Rates: $2000
- Insurance: $1000
- Maintenance: $300
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 $5400. They also have depreciation of the fittings, which totals $22,860, but is claimed over 19 years (as is often the case with these types of investment claims). With all of these details in mind, their expenses for the first year would look something like the following:
- Interest: $18,872
- Management expenses: $5685
- Depreciation of building: $5400
- Depreciation of fittings: $3667
- Loan costs: $60
- Holding costs: $10,000
As well as these investment property costs, they also have the benefit of rental income, which is estimated at $19,449 per year (just over $1620 per month or $374 per week).
This income is taxable, so when it is added to their salary of $107,000 the total is $126,449 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: $126,449 – $43,634 = $82,765
To put this into perspective, previously their tax on $107,000 WITHOUT an investment property would have been $29,677. WITH the investment property, however, they only pay tax on their new taxable income of $82,765 (thanks to all those expenses), which works out to be $20,225.
Total tax back: $9452
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
There are basically two kinds of property investors in the world. There are those that are the average or novice investors, hoping to earn enough rent to offset the cost of the mortgage and other expenses, without too much of a loss to their own cash flow.
Then there are the astute investors, the ones who see the full potential of all the tax breaks available through investing in property, and the long-term wealth it provides. Astute investors won’t have to spend more than $5 a week for their property purchases, and often spend $0 or end up earning money off their investments after as little as 12 months.
Anyone can be this kind of investor and make their money work for them. You don’t even have to know a lot about property. Armed with this knowledge, and a team of experienced people that can guide you through the process, you could become an astute investor and change your whole financial situation over the next year and beyond.
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