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Are you paying the government too much of your property investment capital?

The amount of tax we pay matters to us all. As the late Kerry Packer (at the time he was Australia’s richest man) once said to a government inquiry, ‘Of course I am minimising my tax.

‘And if anybody in this country doesn’t minimise their tax, they want their heads read, because as a government, I can tell you you’re not spending it that well that we should be donating extra!’

I’m certain most people you ask on the street would agree the same could be said today. But that’s another opinion piece for another day…and another blog at that!

For the purposes of property investment, minimising tax is an effective way to maximise your portfolio’s cashflow, thereby maximising its long term sustainability and wealth producing potential.

Of course your decision to invest in an asset like property should never be based on related tax benefits alone – no one has ever become rich entirely as a result of saving tax!

However, you do need to recognise that this is another means by which you can get ahead sooner and more strategically.

Moreover, you strengthen your net position when you have a good capital/cashflow balance and better understand how that balance should look at various stages of your investment journey – i.e. depending on whether you’re accumulating actively or preparing to transition into retirement.

Getting too fancy

From time to time you might come across professionals who suggest fancy structures or products that can ‘help save tax’. My advice here is don’t be too aggressive when minimising tax. Stick well within the law.

Some professionals aim to exploit ‘gaps’ in legislation, which they believe they could ‘argue’ around.

However, the risk is that the ATO will question you in a process potentially requiring high-priced lawyers and accountants.

In the worst-case scenario you’ll also have to make up for the underpayment of tax, interest and penalties. An expensive exercise! The sceptic in me suggests these strategies are sold to the ‘greedy’ to line the professionals’ pockets.

Besides, there are many associated benefits that are above board, which can assist with the smart property investor’s incomings and outgoings. In this article we will explore a little thing called…

Depreciation

Investors may claim a tax deduction for depreciation of dwellings that were built after 17 July 1985. The building cost can be depreciated at a rate of 2.5% a year (4% if built between 18 July 1985 and 16 September 1987).

For investment properties acquired after 17 May 1997, the cost base will have to be reduced by the amount of depreciation you have claimed since owning the property (cost base is only relevant for calculating CGT when you sell an investment).

If you haven’t actually claimed depreciation, you will still have to reduce the cost base by the depreciation you could have claimed over the past four years (at the same time you can amend your past four years’ tax returns to include the depreciation deduction).

However, if there is no way to ascertain the deduction without obtaining a Quantity Surveyor’s (QS) report, then you may not have to reduce the cost base (although the rules are very tight in this regard).

In summary, if your property is built after 17 July 1985, you should claim a tax deduction for depreciation. If you don’t, you’re worse off.

How do I go about it?

The first step is to try to get information from the vendor of the property as to how much the dwelling cost to build (legislation requires vendors to provide you with this information per Subsection 262A (4AJA) of the 1936 Tax Act).

If you cannot obtain any information from the vendor, you can engage and rely on a QS report.

With regard to depreciation of improvements (referred to as capital works), these can only be claimed if you can obtain proof of:

  1. The scope of the work done
  2. When it was completed
  3. The cost of the work

To deal with the first two points above, you may be able to collect documentation such as architectural drawings, specifications of works, building contracts, council approvals and the like.

A documented conversation with the vendor might be sufficient evidence but the more documentation you can get, the better.

You can also claim depreciation on plant and equipment. The cost or value of plant and equipment is depreciated over its useful life. The QS can estimate the current value of plant and equipment items when you bought the property.

You can depreciate most furniture and fittings such as carpets, stoves, hot water systems, air conditioners, light fittings, fans, curtains, etc.

You can depreciate plant and equipment that costs less than $1000 at a faster rate. These items are allocated to a low value pool and depreciated at 18.75% in the first year (regardless of what time of year it was bought) and 37.5% for each year after that, at a diminishing rate.

You can claim depreciation only if the property is tenanted. Therefore, if the property is vacant for the whole year (maybe due to renovations), you will not be able to claim a tax deduction for depreciation.

For more information about QS services visit www.washingtonbrown.com.au – I use them for my QS reports.

If you would like more information on how you can profit from investing in Australia’s residential real estate sector by establishing clear investment strategies and structures, contact us or subscribe to receive regular post updates and industry insights.

Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: wealth@propertytycoonfinance.com.au

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