There are a number of key tax benefits available to investors which don’t require an exhaustive knowledge of the taxation system or dodgy calculations. These benefits can be hugely helpful in offsetting the cost of holding a property while pursuing a ‘buy and hold’ capital growth strategy. We’ve outlined these strategies over the next few pages.
A few words of caution, though. Different ownership structures will affect the tax benefits you are able to claim and how they are operated, so bear this in mind before starting to claim every deduction you can think of (for more on ownership structures, see page 110). Remember, also, that the Australian Taxation Office takes a dim view of any strategies employed solely to avoid the payment of tax.
Negative gearing and deductible costs
This is the main tax ‘benefit’ that most investors are familiar with. It essentially softens the blow of holding a negativelygeared property by allowing you to claim the difference between income and costs as a deduction – thus reducing your overall taxable income. All the while, the property should be gaining in value.
There are also a wide range of deductible costs that you can claim: essentially, all the running costs of property investment – including magazine subscriptions – can be claimed as tax deductions.
Depreciation is another tax benefit that property investors can claim as a deduction from their overall income. Depreciation is a generic accounting term used to describe how an asset declines in value over time. Depreciation of an investment property is based on its ‘useful life’, or the number of years a property is expected to be in use. Depending on the type of property and when it was built, a property’s useful life ranges from 25 years to 40 years. In some specific instances this period may be shorter.
Investment properties can depreciate in two ways. All investment properties experience depreciation in the form of ‘depreciating assets’. Depreciating assets include items such as:
- clothes dryers
- blinds and curtains
- air conditioners
- hot water systems
In the case of depreciating assets, depreciation is based on the acquisition cost of the item, which may vary in value depending on the type of asset. Carpet, for example, can vary in price and quality, and this will be reflected in the depreciation allowance.
Some investment properties also qualify for ‘capital allowance’ or ‘building allowance’ depreciation. In this case, depreciation is related to the building itself, and is based on the cost of construction of the building rather than the acquisition cost. For example, you might pay $500,000 for a property, with the land portion accounting for $275,000, and the actual building cost being $225,000.
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Capital allowance depreciation ranges from 2.5–4%, depending on the type of building and when it was constructed.
For residential properties, depreciation on the building is calculated at a rate of 2.5% pa if construction started after 16 September 1987, and 4% if construction started between 18 July 1985 and 15 September 1987. Residential properties built prior to 18 July 1985 do not quality for building allowance.
To find out if you can claim depreciation, use an online depreciation calculator, such as the one on the Your Investment Property website, which will allow you to quickly determine if you should be claiming depreciation or not.
You should then engage a professional quantity surveyor to draw up a depreciation schedule. Quantity surveyors determine the value of depreciation based on historical data on the cost of construction and the cost of assets.
“Not claiming depreciation is almost like not charging rent, so you’d be mad not to,” explains Ken Raiss, director of accounting firm Chan & Naylor.
Tyron Hyde, director of quantity surveyor and depreciation specialist Washington Brown, agrees. “Many investors think that their property is too old to qualify for depreciation: in most cases this is simply not the case,” he says. “If you have forgotten to claim depreciation you can always backdate a claim,” adds Hyde.
“However, you should check with a financial advisor in order to determine the exact amount of time you can backdate your claim. If you do claim depreciation, the cost of a quantity surveyor’s report is also deductible in the year that you complete the report.”
It is also worth noting that you don’t necessarily have to wait until the end of the tax year to take advantage of these savings. If you fill in a PAYG Withholding Variation form, you can spread the tax refund that would normally be paid at year end throughout the course of the year. This is a really effective way to improve monthly cash flow.
Capital gains tax
Capital gains tax (CGT) is paid on an investment property when it is sold or otherwise disposed of. Generally speaking, your principal place of residence (PPOR) is usually exempt from any CGT liability upon its disposal – however, if your property has been used as both a PPOR and an investment property, you may be liable for CGT on a pro-rata basis for the period where the property was rented out.
A CGT discount is available for investment properties that have been acquired after 11.45am on 21 September 1999, and are held for at least 12 months. For individuals and trusts, the discount is such that only 50% of their capital gain is added to their assessable income.
SMSFs pay a maximum CGT of 10%, on the sale of a property if it’s held for at least 12 months, and potentially no CGT if the property is sold when beneficiaries are in ‘pension phase’.
Disclaimer: The advice contained in this article is for general purposes only, and does not take into account individual circumstances, objectives or financial needs. Readers are advised to seek appropriate advice from licensed professionals before embarking on any investment