Understanding how your Investment Properties are taxed
Investment properties can be either positively- or negative-geared. Positively geared properties have income that exceeds allowable deductions, meaning that this increases the individual’s taxable income. Negatively geared investment properties have deductions that exceed its income; these investments reduce the individual’s overall taxable income.
This blog will discuss three of the most common deductions available; what they are, what they mean for you, and some pitfalls to watch out for.
The most common deduction is interest. Most of us are not lucky enough to be able to buy a property without the help of a bank, so we require a loan.
For investment loans, Interest Only is generally the best option, as this gives you the biggest deduction come tax time. Principal and Interest loans are more common in owner-occupier loans.
However, in saying that, I personally have one of each. Personally, I need to generate some equity in the property attached to my Principal and Interest loan, to put towards my next purchase.
Equity, in layman’s terms, is the difference between the value of the property and the loan you have against it. For example, if the value of your property is $300,000, and you have a $250.,000 loans against it, your equity is $50,000. Generally, you can use about 80% of this equity.
The is some conjecture around Interest Only loans at the moment, and most banks are offering them at a higher interest rate than that of a Principal and Interest loan.
At the end of financial year, you should be able to download an interest summary from your bank, which will show how much interest you were charged during the year. Please note that if you do have a Principal & Interest loan, only the interest portion of your monthly repayment is deductible.
2. Repairs & Maintenance
Every now and again, investment properties need a touch-up. From general wear and tear to replacing a dripping tap, this is a pretty common deduction.
Repairs are to fix deterioration, while maintenance is to prevent deterioration. A good example of claimable repairs and maintenance expense is repairing a fence that was damaged by a falling tree – this is to fix a broken part of the house.
However, you need to be careful in what you claim as a repair and maintenance deduction. There are some expenses that are actually considered improvements to the property and must be treated as capital works deductions (this will be discussed below). As mentioned earlier, you can claim the cost of repairing a fence damaged by a falling tree, but tearing down a sound fence with no deterioration and replacing it with a new, fancier fence would be considered to be an improvement. For this, you will not receive an instant deduction. There is also an issue around the initial repairs of a property. If you spend money, shortly after the purchase of the property, to fix any damage that was present on the date you acquired the property, these expenses are of a capital nature and are not instantly deductible.
3. Capital Allowances (Div 40) and Capital Works (Div 43)
This is one of my favourite deductions, as it is a ‘cashless’ deduction; and by that I mean that you generally don’t have to pay out a large amount of cash to get a large deduction! There are a lot of Quantity Surveyors, such as BMT Tax Depreciation, that create depreciation schedules for your property, and only cost around $400. Some depreciation schedules, depending on the age of your property, and its cost of construction, can provide greater than $10,000 worth of ‘free’ deductions per year!
There are two parts of tax depreciation on investment properties – Division 40 Plant and Equipment/Capital Allowances and Division 43 Capital Works Deductions.
Capital Allowances are assets that are ‘easily removed’ from the property; ie. items that don’t destroy the building by removing them. The rate at which the plant and equipment depreciate will vary depending on which asset class they belong to. For example, carpet has an effective life of 10 years, whereas window curtains have an effective life of 6 years.
Due to recent changes made by the Government, if you purchased a residential investment property after 7:30 pm AEST on 9 May 2017, from a previous owner, you will not be able to claim a Division 40 depreciation deduction for depreciable assets that exist within that property on the date of settlement. For example, if you are the second owner of the property, and it already has an air conditioner, dishwasher and stove installed, you will not be able to claim the Division 40 deduction. However, if you are the first owner of the property, you are able to claim depreciation on the plant and equipment.
Capital Works deductions are for the building structure itself, and items that are permanently attached to the property and cannot be easily removed. Residential properties ‘depreciate’ at a rate of 2.5% over 40 years, and this is based off the total construction cost of the property. For example, if it cost $300,000 to build your property, you can claim a $7,500 deduction every year until the 40 years lapse. If your property is older than 40 years, generally it is not worth getting a depreciation schedule put together, unless major additions were made to the house to improve its value, eg. new driveway, upgraded kitchen, or a renovated bathroom with new fittings.
Following on from here
There are many other deductions that can be claimed against investment property income, however, the three I have discussed are the most common ones to claim. These deductions also have some pitfalls that you need to watch out for to make sure you are making a legitimate claim.
For help with determining whether a deduction is legitimate and allowable, or if you need any help with your tax return, contact one of our Accodex Partners today!
Disclaimer: This article should not be intended as your primary source of Tax, Accounting or Financial Advice. Always contact your trusted Accodex Advisor for help.
Written By: Caitie Copley
An original member since the days of Cirillo Hooper, Caitie began as an intern, before transitioning to an Associate Accountant. Since then, her role has evolved, and she began to manage the internal finances of Cirillo Hooper as Finance Manager. Now, Caitie is Accodex’s Chief Financial Officer, responsible for not only the financial management of the company but also Accodex’s Pledge 1% initiative.