Tips to Reduce Tax on Investment Property

Are you looking to invest in a property but worried about the tax implications? You’re not alone. Many people are unsure of how much tax they’ll need to pay on investment property.

This blog post will give you some tips to reduce the amount of tax you’ll need to pay on your investment property. So, keep reading for more information.

It’s no secret that investment properties in Australia come with a hefty tax bill. However, you can do a few things to reduce the amount of tax you have to pay.

This blog post will outline some of the best tips for reducing your investment property tax bill. 

As an Australian taxpayer, you’re probably aware of the various tax incentives available for investment properties. However, did you know that there are ways to reduce the amount of tax you pay on your investment property?

In this post, we’ll take a look at some of the best tips to help reduce your tax bill. So read on to learn more!

How Investment Property Can Save You Money on Taxes

When you’re trying to build wealth, it can feel like making money is a never-ending cycle of working, saving, and spending, and tax season can throw even more obstacles in your path.

The question now is, how can you break free of this rut and finally achieve the kind of financial independence you really deserve?

There is a wide variety of “get rich quick” schemes available today, and it is unfortunate that a good number of them take us for a ride without ever arriving at our desired destination.

After a few years of being overhyped, many of these choices become ineffective and eventually vanish into thin air.

You should steer clear of investments like that whenever possible.

However, each of the potential investments you should think about offers something unique. In the first place, these are the kinds of items that have been around for many decades, and in some cases even centuries.

Things like savings, trusts, shares, and investment properties are examples of the types of things that may even be taken for granted by some people.

The fact that investment properties come with a variety of tax benefits (including, but not limited to, a large number of deductions) and have the potential to earn more money in the future makes them an excellent method for lowering your overall tax burden.

Additionally, the real estate market is quite steady. There are bound to be shifts in both supply and demand, but the undeniable fact remains that everyone requires a place to lay their heads at night. And the realisation of this one truth could very well be the one that results in a tax savings of $7000 for you (or more).

Isn’t Investing in Real Estate Expensive?

Before beginning their research on the possibility of buying a property to rent out, many individuals pose this issue to themselves, and there is no denying the significance of giving it some thought.

However, the unpleasant reality is that the simple answer is that the majority of individuals write off this possibility before they have even given it a serious consideration.

Instead, they take one look at how much it costs to buy a house or apartment, and decide that renting is a better option.

The majority of homes purchased for investment purposes are estimated to be worth hundreds of thousands of dollars, but there are many other considerations to take into account in addition to the purchase price of the property itself.

When you invest in rental property, you open up the possibility of taking advantage of a wide variety of tax breaks. Let’s take a more in-depth look at each one of them, paying particular attention to the value that it can add to your tax deductions.

Interest

When the funds from a loan are put towards investing activities, the interest paid on the loan is eligible to be deducted from the taxpayer’s taxable income.

This could include interest that has been accrued as a result of a mortgage on an investment property, money that was borrowed to purchase shares, or other loans that are related to investment portfolios.

Consider the following scenario: you have a mortgage on a rental property for $500,000, and the interest rate is 5% per year, and you pay it off in equal monthly instalments over a period of 30 years.

If you were to take out this loan, the interest on it would cost you around $15,542 over the course of a year. In addition to that, you are eligible for a tax deduction in the amount of $15,542 to reduce the overall cost of your investment property.

It is frequently worthwhile to prepay your interest for the upcoming 12 months if you have a fixed-rate loan and your annual income is on the cusp of moving into the next tax bracket.

By doing so, you will be able to deduct the interest in the income year in which you are filing your tax return.

This method can also be utilised in the process of paying for several other services. In addition, certain service providers may present you with a price reduction for doing so.

Rental Expenses

If you are the owner of rental properties, you are eligible to deduct a wide variety of expenses from the amount of income tax you owe during each fiscal year. You may quickly submit claims for the following, which are among the most prevalent types of expenses:

• 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

You are also able to submit claims for any trip that is directly related to the property, such as travel for the purpose of conducting inspections or collecting rent.

According to the Australian Taxation Office (ATO), you are required to include in your assessable taxable income any revenue from rentals that you receive throughout the course of the financial year.

This is done so that it can be evaluated on your tax return and, as a result, be subject to taxation together with any other income you may have, such as your pay.

To illustrate this point using an illustration, let’s say you had taxable income of $80,000 and you received $65,000 in salary and another $15,000 in rental income (before any deductions).

If you did not have any other taxable income or deductions, your total tax liability would be $17,547.

When added up over time, these rental charges can total thousands upon thousands of dollars; hence, if you claim them as tax deductions, you may be able to reduce the amount of tax that you are responsible for paying by the same amount.

Borrowing Expenses

Borrowing expenses are any expenses that are linked with obtaining a loan for your investment property and can be deducted from the tax liability associated with your investment property. The following are some examples of this:

• costs associated with establishing a loan
• mortgage insurance taken out by the lender and charged to the borrower, also known as lender’s mortgage insurance.
• the mortgage is subject to a stamp duty fee.
• fees assessed by your lender for doing a title search
• expenses associated with the preparation and filing of mortgage documents, including fees for solicitors
• mortgage broker fees
• costs associated with obtaining a value that is necessary for a loan approval.
• if the total of these costs is less than one hundred dollars, you are eligible to claim them in their entirety for the current tax year. In the event that this is not the case, you have the option of dividing this deduction across the remaining years of your loan (whatever period is shorter).

This worked example, which was provided by the ATO, demonstrates how tax deductions for borrowing expenses are calculated. It may be helpful for you to utilise this example in order to calculate the tax break that applies to your portfolio.

Claim Initial Repairs As Capital Works

Investors frequently fall victim to a common pitfall when they make the mistake of claiming early repairs or capital improvements as an immediate deduction.

Initial repairs to rectify damage, defects, or deterioration that existed at the time of purchasing a property are generally considered to be of a capital nature and are not deductible, even if they were performed to make the property suitable for renting. This is because initial repairs are considered to be an investment in the property.

Claiming capital works deductions on these repairs and enhancements over a period of forty years would be a more effective strategy than the alternative.

Repairs and maintenance work

Any and all costs incurred in the upkeep and repair of an investment property are eligible for tax deductions. Nevertheless, each of these terms can be defined in their own unique way.

According to the definition provided by the ATO, repairs are any actions taken to correct, remedy, or make good faults, damage, or deterioration to the property. In general, repairs need to be directly related to the wear and tear or other damage that was caused as a direct result of renting out the property.

The following are some examples of repairs:

• Repairing or replacing broken windows or sections of guttering caused by a storm
• Repairing a section of a fence that was broken when a branch from a tree fell on it
• Performing maintenance on electrical equipment or machinery.

Work done to either stop more deterioration from occuring or repair damage that has already occurred is referred to as maintenance, such as:

• Painting a property that is up for rent
• Putting something that is normally in good operational condition through additional maintenance steps such as brushing, lubricating, or cleaning it
• Maintaining plumbing.

If the work in question does not fall within these definitions, then there is a good possibility that it represents an improvement. A modification is a piece of work that:

• Offers something fresh and new
• Enhances, in most cases, either the property’s capacity to generate money or its anticipated lifespan
• In most cases, this will alter the personality of the thing you have upgraded.
• Goes beyond simply bringing the building back up to its previous level of operational efficiency.

Investors may experience difficulties if they are unable to differentiate between enhancements, maintenance, and repairs.

Investors are claiming 100% of the deduction for repairs and maintenance, despite the fact that these expenses do not qualify. To begin, the property has to be rented at the time when the expense is being incurred.

You cannot make improvements to the property while you are still living there in order to get it ready for new renters and then claim those improvements as a deduction.

Second, let’s say that you’re going to replace an asset rather than fix something that’s already been established. In that scenario, it is quite likely that it will be a depreciable asset that needs to have its value written down throughout the course of its useful life.

Depreciation Of Building

Buildings, like vehicles and other types of assets, will inevitably experience some level of general wear and tear over time. Depreciation is the term used to describe the process that causes a decline in the value of an asset over time.

When it comes to properties held for investment purposes, depreciation is one of the finest things that can happen for your bottom line when tax time rolls around. In fact, some seasoned investors consider depreciation even before they buy new property.

The fact that depreciation is a tax deduction that is already included in the price of the property means that you do not have to make additional payments for it on a regular basis.

This is one of the primary reasons why depreciation is considered to be so advantageous. Instead, what is known as a “non-cash deduction” is computed based on the value of the building after it has been subjected to the process of depreciation and claimed on your tax return.

You are eligible to claim depreciation on your tax return if the building in question was completed after 1985 and if it is utilised for investment purposes. This will allow you to possibly save thousands of dollars without having to spend any additional money on the property itself.

Depreciation Of Fittings

This tax deduction applies especially to the fittings that are contained within an investment property and follows rules that are comparable to those that govern the depreciation of building claims.

This includes items like lighting, fans, power outlets, windows, sinks, showers, and other fixtures that are all susceptible to wear and tear over time, or depreciation.

Calculating the depreciation cost on fittings and structures is something that qualified building surveyors are able to do. The details of the calculation then outline how much the value of the assets declines over time.

Due to the fact that depreciation rates can be anywhere from 2.5% to 4% of the total price paid for a building and all of its contents, this typically results in very sizeable ongoing tax savings.

Loan Costs

When most people think of the costs associated with loans, they focus on the interest rate as the primary expense; however, there are a variety of extra fees that, as anyone who has taken out more than one mortgage can attest, quickly add up.

These loan costs can frequently be claimed for investment properties, and tax deductions are typically allowed for items like loan setup fees, account administration fees, mortgage insurance fees, mortgage registration fees, mortgage broker fees, and stamp duty on the loan itself (not the property).

The majority of these claims are made over a period of five years as a component of the costs associated with borrowing money, and they have the potential to mount up to hundreds of dollars in tax deductions for each fiscal year.

Holding Costs

The majority of the time, holding costs are associated with the purchase of land before anything is developed on it. For instance, if you buy land with the intention of constructing a home on it, you will have to pay interest not just on the land itself but also on the various phases of building.

These fees are referred to collectively as holding costs, which may also be understood as the amount of money that must be spent in order to “hold onto” the property until it can be rented out.

People who are new to the field of property investment frequently overlook or have difficulty understanding holding costs, despite the fact that they represent one of the largest categories of tax-deductible expenses related to investment properties.

They may choose to invest in preexisting structures and properties instead, despite the fact that doing so would result in the loss of tax benefits amounting to tens of thousands of dollars.

Accounting Costs

Although many people hire accountants to handle their tax returns, not everyone is aware that doing so may actually result in a lower total amount of tax liability for the taxpayer.

In addition to providing you with access to professional accounting advice that may assist you in discovering additional ways to reduce your tax liability, the actual fees and charges that you pay for managing your tax affairs are claimable as tax deductions each and every financial year.

This benefit is in addition to the fact that managing your tax liability provides you with access to such advice.

This includes costs associated with the preparation and submission of your tax return and activity statements, as well as travel expenses incurred in order to consult a qualified tax advisor and costs associated with any taxation appeals that were filed on your behalf.

You are also able to claim the costs associated with any assessments that you are required to get for certain tax deductions. One example of this would be property surveying reports that are required in order to make a claim for depreciation.

The costs associated with accounting might vary widely depending on what all is involved.

However, being able to deduct these expenses from your taxable income lowers the total amount of tax you owe and makes it simpler to justify consulting with an accountant who can advise you on how to maximise the amount of money you receive back from your taxes.

All of these things are considered tax-deductible expenses when you have an investment property, and by totalling them up appropriately, you can save money on tax and offset the real cost of buying the property.

In point of fact, once you’ve tallied up all of the costs and accounted for your anticipated tax return, it’s possible that the correct investment properties won’t set you back more than $5 per week.

Apply For PAYG Withholding Variation

Applying for a PAYG withholding variation is something you should consider doing if you have been having trouble with cash flow over the past year and have a property that is negatively geared.

This technique allows you to collect your tax breaks every time you are given your salary, rather than as a lump amount at the end of the financial year, and it is often employed by those who claim bigger than typical deductions. If you follow this strategy, you can reduce your overall tax liability.

You are required to submit an annual request to the ATO for a PAYG withholding adjustment. You have the option of submitting the application on your own or asking an accountant to handle it for you.

Negative Gearing

The concept of “negative gearing” is one that is frequently discussed, but what exactly does that term refer to?

When you borrow money to invest, but the ongoing costs of the investment are more than the recurrent revenue from it, you are said to be “negatively geared,” and this indicates that you are experiencing a loss from the investment.

If you have a property investment that is producing a loss, you may be eligible to deduct the loss from your overall taxable income. Negative gearing does not result in a profit; rather, it is utilised as a means of mitigating the financial damage caused by an investment.

The plan is for you to take these losses on in the near term, with the expectation that you would make them up in the long run when you sell the property.

When you have positive gearing, on the other hand, this indicates that the revenue from your investment property is more than the costs, such as the interest charges on a loan.

When it comes to negative gearing, the most important concept to grasp is that its use lies in the ability to carry a loss forwards in order to eventually create a profit.

When you first start out in the world of real estate investing, one of the terms that will become extremely familiar to you is “negative gearing.” When your monthly mortgage payments and other property-related expenses exceed your monthly rental revenue, this is referred to as negative cash flow.

Although it may appear to be a disadvantage, an investor actually has the opportunity to benefit from it.

Depending on the objectives you have for your investments, this can even be a way to reduce the amount of taxes you owe. This is due to the fact that any losses you incur as a result of owning a negatively geared property are eligible for tax deductions.

When you have a positively geared home, on the other hand, your rental revenue will be higher than whatever expenses you have.

This results in a rise in your overall taxable income as well as a positive cash flow for your business. As a result, the amount of tax that you owe will be higher if you own a positively geared property.

Reducing Capital Gains Tax

Investors are the only people who are required to pay capital gains tax (CGT) on any property gains they make. When you sell a piece of property and realise a profit or loss on the sale of that property, it brings up this issue.

If you make a capital gain, it is very likely that you will be required to pay CGT (i.e. your profit by selling your investment property). If you have a capital loss instead of a capital gain, you won’t have to pay any capital gains tax.

CGT is frequently unavoidable, and the rate will normally be comparable to your marginal tax rate. CGT must typically be reported and paid. Nevertheless, there are ways to cut back on it.

If you have owned the property for more than a year, you almost certainly qualify for a capital gains tax reduction of fifty percent (CGT).

In addition, the amount of tax that you will be required to pay on the property will be partially offset by the costs that are connected with being the owner of the property.

How To Reduce The Cost Of Investment Property

When thinking about investment properties, the single most crucial point to keep in mind is that they should be within your financial means, taking into account your existing situation.

There is no purpose in investing in real estate if doing so would result in you incurring debts worth thousands of dollars and leaving you with a significant cash flow deficit at the end of each fiscal year.

However, you should also assess whether or not the cost will be affordable in the event that your circumstances alter.

When it comes to real estate investments, many people have the misconception that the only way to get started is to forego a significant portion of their discretionary income.

However, if you choose the appropriate investment strategy, you should be able to generate a cash flow that is either neutral or even positive as a result of your investments.

Take, for instance, the case of a person with an annual income of $107,000 who makes the decision to invest in a brand-new rental property with an appraised value of $381,000.

Their acquisition expenses, which include conveyancing and stamp duty, combined with their loan and holding charges, amount $16,300; hence, they obtain financing for the sum of $397,300.

They would owe a total of $18,872 during the first year of the loan if the interest rate was 4.75 percent per annum (p.a.), which is equivalent to $1573 a month.

Now, when it comes to the costs of renting a house, these costs differ from one location to another. As a general rule, expenses account for anywhere from 13 percent to 30 percent of the total cost of the property.

This, of course, is contingent upon the level of maintenance performed and whether or not a qualified property management agency is employed. In this scenario, the investor is responsible for the following regular expenses:

• Agent’s commission (8.25%): $1605
• Letting fees: $780
• Rates: $2000
• Insurance: $1000
• Maintenance: $300
•           TOTAL: $5685

In addition to these deductions, they are entitled to a depreciation of the building equal to 2.5% of the property’s worth and the costs of construction.

This comes out to $5,400 over the course of a year. They also have the fittings’ depreciation, which comes to a total of $22,860 but is claimed over the course of 19 years (as is often the case with these types of investment claims).

Keeping all of these factors in mind, their costs for the first year would likely be something along these lines:

• Interest: $18,872
• Management expenses: $5685
• Depreciation of building: $5400
• Depreciation of fittings: $3667
• Loan costs: $60
• Holding costs: $10,000
•           TOTAL: $43,684

In addition to these investment property expenditures, there is also the benefit of rental revenue, which is predicted to be $19,449 per year (just over $1620 per month or $374 per week). This income can be used to offset the costs of the investment property.

Since this income is subject to taxation, it must be added to their base wage of $107,000 to arrive at a grand total of $126,449 before any deductions are taken into account. Consequently, in order to determine their true after-tax income, you compute as follows:

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

In this scenario: $126,449 – $43,634 = $82,765

To put this into perspective, if they had not owned an investment property, their tax liability on the sum of $107,000 would have been $29,677.

Nevertheless, because of the investment property, they are only subject to taxation on their newly calculated taxable income of $82,765 (due to all of those expenses), which comes out to a total of $20,225.

Total tax back: $9452

This type of real estate investment results in an initial outlay of between zero and five dollars a week when the appropriate system is in place. After the construction of the building is finished and rent begins to come in, the investment begins to generate positive cash flow.