Maximise your tax advantage

The Australian Taxation Office allows property investors to claim some income loss incurred through real estate investment against other income such as salary. Tax can be complicated though so it’s advisable to talk with a tax professional.

A tax advisor can talk to you about negative gearing. Note that three main types of tax deductions you may be able to claim are:

  1. interest on an investment loan
  2. property maintenance and property related expenses
  3. property fixtures and fittings, and depreciation of these assets based on their lifespan (for example, an oven has a lifespan of 12 years).

Tax is payable on the capital appreciation of your property at the time of sale. This is called capital gains tax.

However, some capital expenses made can change the cost base of your property. So keeping good records of adjustments and renovations that you make to your property could mean less capital gains tax at the time that you sell.

We have put together the following information to help you understand negative versus positive gearing a little better.

Negative gearing

About negative gearing

A property is negatively geared when the costs associated with the property (such as loan repayments, maintenance, repair work) are more than the income the property produces. Most of these costs can be claimed at tax time.

With the correct financial advice (from your financial planner or accountant) and selection of the right investment property, negative gearing may be a tax-efficient investment strategy.

But you need to be aware that there are risks associated with borrowing to invest. For example, the Australian Tax Office allows property investors to offset an income loss incurred from property investments against other income. One risk is when the losses are greater than your ability to cover those losses from your salary or other income sources.

For negative gearing to work, investors must be able to cover costs such as lack of rental income and afford payments. A financial advisor or an accountant will help you to work out if you’re able to take advantage of negative gearing.

Here are some tips that could help minimise the risk of negative gearing.

  • Choose your investment property carefully. It's important to invest in a property that's likely to increase in value throughout the investment period. You should do your homework and get an understanding of the market in the area you want to invest in.
  • Make sure you have enough income to make repayments if your property is vacant for any time. You’ll also need to be able to pay other costs such as maintenance and body corporate fees. It's a good idea to consider personal insurances such as life cover and income protection. These insurances may replace a portion of your income if you can't work for a period of time due to illness or injury. A financial planner can give you specific details and identify the right protection for you.
  • Landlord insurance can provide you with added protection from the risk of an untenanted property, non-paying tenants or damaged caused by tenants. Talk to one of our insurance consultants to find out more about landlord insurance.

Case study

Case study: Negative gearing for first time investors

Liz earns $85,000 per annum and has borrowed $400,000 to buy an investment property. She is receiving rent of $360 per week ($18,720 pa). After one year, her interest costs and other deductible expenses come to $31,700 pa.

 No investmentGeared investment
Salary
$85,000 $85,000
Rental income-$18,720
Total income
   
$85,000$103,720
Deductible costs-$31,700
Taxable income$85,000$72,020
Tax1
   
$20,672$16,034
Tax savings
-$4,638
1 includes Medicare and flood levy

Note: the above calculations are based on marginal tax costs applicable for the 2013-2014 financial year.  Rates are subject to change at any time.

Here are some things to consider.

  • Budget for the shortfall.
  • Have a buffer in case interest rates increase.
  • Organise a lump sum or redraw facility for one-off expenses.

Positive gearing

About positive gearing

Positive gearing occurs when the investment income is more than your investment property's deductable expenses (such as interest). With positive gearing, you may have to pay extra tax on any income earned.

Over time, positive gearing may be ideal for those who wish to use their rental income from their investment property as cash flow. It’s useful to seek professional advice from a financial planner or accountant to see if this is right for you.

Here are some useful links if you wish to read further about negative and positive gearing.


Depreciation

Depreciation is an allowance for the cost of wear and tear on assets over several years. When you invest in property, you can depreciate assets such as carpet, kitchen appliances (stove, oven) and furniture over a period of time.

Depreciation scheduling

To claim some of the depreciation, you'll need to prepare or obtain a Depreciation Schedule before you see your accountant at the end of the financial year.

A Depreciation Schedule is a full report outlining how much depreciation you can claim for every year you have your investment property. Often the newer your investment property, the more depreciation you can claim (and the older the property, the less you may be able to claim).

The cost of obtaining a Depreciation Schedule is 100% tax deductible. Note that while depreciation provides you with a deductible expense, it also reduces the 'cost base' of your property. When the time comes to sell, this means your capital gains are higher and will affect the tax you pay. It's advisable to check with a tax advisor so you understand how depreciation scheduling works.


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