Investment Property Tax
Investment Property Tax Deductions and Advice
An essential part of any successful property investor’s portfolio building will be intelligent tax management and astute use of all of the available property tax deductions. This applies to both established and new build properties and to long term rental properties and there are tax considerations for whichever route you go down.
The ideal property investment will always be the one that allows you to achieve strong rental returns whilst also seeing strong long-term capital growth. Similarly, there are useful tax benefits and deductions to be used when renting a property out – such as deductions for expenses, loan interest and fees – as well as discounts on the costs of ownership such as capital gains discounts, leveraging and deductions for depreciation on new property developments.
Investment in residential property opens up a whole range of tax opportunities for the canny property investor and whichever way you approach your investment you’ll almost certainly need to take proper professional advice on the best tax planning and property tax deductions for you. This article will offer some tips but it is no replacement for professional advice that can take your personal finances into account on a one to one basis.
Tax Deductions for Rental Properties
When it comes to tax deductions for rental properties, there are a number of different expense claims that a landlord can make as part of the running of their rental property business. The most important of these is being able to claim a tax deduction for interest paid on the property loan as well as any ongoing fees related to that loan. (This can be claimed immediately and then deducted from the current year’s income.) However, landlords can also claim for a wide range of smaller expenses that are tax deductible. Your tax advisor will be able to give you a full run down of all the expenses you personally can claim, but in the meantime, the following list covers the most commonly claimed deductibles:
Real Estate Management Fees
– Fees charged by rental companies who might handle the finding of tenants for you and then take care of the rental agreement (as well as any problems that occur during the tenancy) are tax deductible.
– The cost of advertising for tenants is tax deductible. This could either be via a real estate agent or a management company like the one mentioned above or it could simply be the expenses you incurred when advertising in a local paper, local shop or online.
– Rates that are deductible include the council and water rates as well as the land tax and the strata fees.
– Landlords are permitted to claim for any insurance they pay for as part of the running of their business. This includes building insurance and landlord insurance.
– Any expenses incurred in the maintenance of the property (both throughout a tenancy and at the beginning and end of the tenancy) are tax deductible. This would include cleaning costs to get the property ready for renting, ongoing maintenance and repairs (such as hiring plumbers or electricians), pest control to get rid of any unwanted invasions and even gardeners to keep the place looking tip top (for selling or renting.)
Depreciation Expenses – As well as the tax deductions for building depreciation (which will be discussed below) it is also possible to claim for the depreciation on white goods, water heaters, air conditioners, stoves and carpets.
– It is also ok for landlords to claim for reasonable travel expenses that have been incurred in order to get to and inspect their property.
– One of the advantages of getting a good accountant to handle your taxes is that you can claim against their fees as a deductible expense.
– You can even claim for any stationery used in the buying or renting of your investment property.
Once again, this is not a full list and you should always talk to your accountant about the tax deductions that are relevant to your own investment. It is also worth noting that the rules state that such expenses can only be claimed in periods when the property is rented out or when it is available for rent.
“Available To Rent”
This phrase is one that potential property investors and landlords should pay close attention to. It is still possible to claim expenses for periods when the investment property has no tenants, but only if the property is genuinely ‘available to rent.’ What does that mean?
- The property must be advertised and must have a broad exposure so that it can be seen by potential tenants and
- Tenants should be likely to rent the property considering all circumstances.
If either of these factors is absent then it is safe to assume the owner would not be trying their hardest to draw an income from the property. For example, under part (a), if someone was to advertise their property solely by word of mouth, or through a noticeboard at work or only put adverts up at times of year when there would be very little likelihood of someone renting it then that would not be considered to be advertising it widely enough. And what would make a property unlikely to be advertised as per (b)? It might be that the property was in an inaccessible location or was in terrible condition which no one would opt to live in. Or it could even be that the landlord attached unreasonable conditions to the leasing of the property, including disproportionately high rents (to other similar properties in the area) or stating something unreasonable in the contract like ‘no kids’. Consequently if the property would not be seen as ‘available to rent’ then the available tax deductions would no longer apply.
Apportioning of Expenses
It is also worth noting that you can (and should) apportion your expenses to determine deductibles if your property is only going to be rented for some of the year, or if you’re going to rent it at a non-commercial rate or only one part of the property will be rented out. As an example, if you have a holiday home which you rent out some of the year, you cannot claim expenses for any of the periods when you used the property or when it was used by your friends and family. Similarly, if you rent one room of your house out then it is only that part of the house which can claim tax deductible expenses.
Capital Growth Tax Deductions
Aside from the short-term rental-related tax deductions that are open to property investors there are also a number of longer term considerations regarding tax deductions, the first of which will affect the type of property you invest in from the outset. Any residential property investor is permitted to claim depreciation deductions on new homes, which over time can significantly reduce the cost of owning that investment property. The Australian Tax Office currently permit investors to claim depreciation on a property for 40 years from the construction completion date. This deduction is set at a 2.5% per annum rate. What this means is that the closer a property is to construction date, (ie the newer the property), the more years and dollars-worth of deductions you will be able to squeeze out of it! This is one of the reasons that so many property investors opt for new builds over existing established properties. But depreciation deductions don’t stop there. It is not just the long-term depreciation of the property itself that offers up deductions. As we saw above, it is also possible to claim for depreciation on the wear and tear of the fixtures and fittings, writing off the cost of various items over their ‘effective life.’ We mentioned boilers, white goods and carpets above but there is a whole range of products you can claim back on. For more information on this it is worth consulting the Australian Taxation Office (ATO) guide which comprehensively covers everything that you can claim for.
Leveraging Your Property Investment
Nearly all property investments will be funded by loans and ‘leveraging’ simply refers to the use of debt to fund an investment. Most property investors use leveraging at one point or another, taking a loan and offsetting the interest of the loan and the property expenses against the rental income they are going to receive. There are however, different levels of leveraging. The ideal property investment, especially when starting out is a positively geared or ‘positive cash flow’ investment. Certainly, that is what we recommend here at Evergreen Investments. But, as has been discussed elsewhere on this site, there are some investors who sometimes like to ‘negatively gear’ a property to help them achieve further property tax deductions. ‘Negative gearing’ refers to properties in which the income received from rental is less than the cost of ownership. In such a circumstance, when the investor is seen to be making a loss, they can offset that loss against other income (such as their salary.) Thus, if someone is losing $10,000 a year on their negatively geared property but their salary at work is $70,000 then they will only have to pay tax on $60,000 per year. This still represents a loss on the property, but the investor is getting the advantage of the tax deduction and aiming to recoup the shortfall in the long term through the capital growth of the property when they sell.
Capital Gains Tax
When it does come time to sell, a ‘capital gain’ is the term used to describe the profit you make on the property. A capital gain is derived if the sale proceeds are in excess of the property’s cost base whilst a capital loss occurs if the sale proceeds are less than that cost base. What is the ‘cost base?’ The cost base consists of the property’s purchase price combined with the total costs of purchasing, holding and then selling the property. These would include borrowing expenses (loan fees for example), broker fees, legal fees, capital improvement costs, stamp duty and auction fees. Other deductions come along once you have held onto the property for more than 12 months. After 12 months you can get a 50% reduction on capital gains tax. So, if you own a property for more than a year and then sell it making $200,000 profit, you would only pay tax on $100,000 profit. This is a massive tax deduction for would be investors!
Rental properties purchased after 1985 are also subject to capital gains tax but there are some discounts that are worth exploring so it is well worth talking to your financial advisor. Additionally, rental properties qualify for the same 50% discount after one year and you can get further discounts still if it was ever your main residence.
Lastly, it is worth briefly noting that should you make a loss on a property all is not lost – you can report capital losses too and get a reduction on your tax return. Obviously though, this is not something any property investor will be aiming for!
Organizing Your Tax Deductibles
In order to be able to claim any of these deductions you will be required to keep all documentation as proof. This will include receipts for every expense and outlay, bank statements, credit card statements and an up to date and accurate capital works schedule and depreciation schedule. A capital works schedule lists all of the construction and building costs as well as the alteration costs and the capital improvement costs and the total amount claimable per annum. The depreciation schedule lists the property’s assets and the total amount of depreciation claimable per annum.