Property investment remains one of the most effective ways to generate wealth in Australia. This is due to the leverage that’s allowed with property.
For example, buying a $1 million property requires a 20% deposit ($200k), plus stamp duty. If the property increases in value by 5% ($50k), you have generated a return of $50,000 on your approximate $250,000 (20% + stamp duty) investment.
When done correctly — due to the deductions allowed — property investment can also be a highly effective way of minimising the annual tax you pay.
In this article we discuss our most effective pieces of tax advice for property investment, and how you can use this investment tool to your advantage.
An investment property is a big purchase, so make sure you get the right tax advice for your property investment. To discuss how you can maximise the tax benefits of your investment property, both now and for the long term, contact Liston Newton Advisory today.
Tax advice for property investment
We often get asked the question, ‘Is buying an investment property tax deductible?’
In short: the answer is yes. But not in the way you might think.
When you buy an investment property you don't claim the cost of the property as a tax deduction. Instead, you claim the expenses associated with generating income from your investment property.
Purchasing investment property can be a smart strategy for enabling you to minimise the amount of tax you pay.
Here’s how it works.
What can you claim on tax for investment property?
When claiming tax on your investment property it’s critical that you have proof of your income and expenses. This includes things like bank statements that show interest, receipts that show letting and advertising fees, or rental bond returns.
Essentially, you need to keep documents and receipts of anything that generates an income for your rental property, and all instances of expenses. Otherwise, it can’t be claimed.
You can claim things like:
- The interest charged on your loan (so be sure to file all loan statements come tax time)
- Property management and advertising fees
- Most expenses associated with borrowing, such as establishment fees, mortgage insurance, legal fees, broker fees, and stamp duty
- Most expenses incurred in running your investment property, such as strata fees, council and water rates, travel, maintenance, cleaning, pest control, and gardening
- Renters insurance
- Building and asset depreciation
- Accounting and tax advice costs
A note on claiming repair costs
When operating an investment property, things will crop up that need your immediate attention. These can include repairing a hot water system failing, fixing a broken window from a storm, or giving your property a new coat of paint. The cost of hiring a professional to take care of wear and tear can be claimed as a tax deduction.
However, improvements or repair work for existing damage or deterioration to your property — anything that is done to increase the property’s value — are considered capital costs. Therefore, they are not immediately tax-deductible. Instead, you can claim a capital works deduction of 2.5% on improvements and repairs over a long-term period of 40 years.
Your tax adviser can help you understand how this works.
You can be smarter with the interest on your investment property
If your investment property is held under a fixed-rate loan, then you know how much interest you’ll be paying each year.
Therefore, if your annual income is verging on a higher tax bracket, you can choose to pre-pay your interest for the following financial year. This way you can claim the interest paid as a tax deduction for the current financial year, avoiding the higher tax bracket.
Negative gearing explained
Negative gearing is when the expenses you pay on your investment property exceed the income you receive on your investment.
As an example, say your investment property receives $20,000 in rent each year.
The ongoing expenses for your property, things like strata fees, council rates, and loan interest, come to $30,000 each year.
You have $10,000 more expenses than income. Therefore, you can deduct $10,000 from your annual taxable income.
However, negative gearing only works effectively if your investment property is increasing in value. This enables you to justify the cost of the loss. If your negative gearing strategy costs around $5,000 annually, therefore the property’s value must increase by over $5,000 each year to make it worthwhile.
Applying for a PAYG withholding variation
For negative-geared properties, you can apply for a PAYG withholding variation. This can be useful if cash flow is an issue.
This way, if you’re claiming deductions that are higher than usual, this allows you to receive tax deductions on every regular salary payment, rather than an annual lump sum.
You can apply each year for PAYG withholding variation directly to the ATO.
Navigating Capital Gains Tax on investment properties
A capital gain is the profit you make on the sale of an asset. Your investment property is an asset, so you’re required to pay capital gains tax (CGT) on the profit you make when selling your investment property.
Without the right CGT minimisation strategies in place this can take a large bite out of your finances.
You buy your property for $1 million. You sell it for $1.5 million. This means you’ve made a $500,000 capital gain. Without any CGT exemptions or reductions, this $500,000 sum is added to your taxable income.
Exemptions and reductions on CGT
50% CGT exemption
If you’re looking at selling your property, make sure you’ve owned it for longer than 12 months. This allows you to qualify for the 50% CGT reduction. This means you only get taxed on 50% of the capital gain, rather than the full amount.
CGT indexation reduction
If you purchased your property prior to 21 September 1999, and you’re an Australian resident, you qualify for CGT indexation. This takes inflation into account, and calculates your net capital gain against what your property would be worth on the current market, rather than its original cost.
This method divides the consumer price index at the point you sell your property against that of when you bought it. This typically sees your initial purchase price increased, therefore reducing your net capital gain.
Primary place of residence
If your investment property can be considered your primary place of residence, you’re eligible for a full CGT exemption.
As the property owner, if you move out of your primary place of residence and then rent it out, you can claim a CGT exemption of up to six years. You can claim this exemption for each period in which you move out and rent your property, then move back in.
You can also receive a CGT exemption if, within a six-month period, you own more than one property that you consider your primary place of residence. This is only applicable if:
- One property was your primary residence for three or more months within the 12 month period prior to selling it, and
- You didn’t use this property to generate assessable income in any way within this period.
You can also consider exchanging contracts in the new financial year. This allows you to defer CGT for another year, giving you more time to save money for the inevitable CGT payment.
The final word
When undertaken properly an investment property can be a quite tax-effective. So when you start thinking about trying your hand at property investment, speak with your tax adviser.
They can walk you through everything you need to know about your investment, such as:
- How your property investment reduces your tax
- What can you claim on tax for an investment property, and importantly, what you can’t
- Strategies to structure your purchase for a tax effective long-term investment
- How to manage CGT when it’s time to sell
Liston Newton Advisory have been providing thorough and strategic financial advice for over 40 years. So for expert tax advice for your property investment, get in touch with us today.