Many people invest in property with the aim of taking advantage of Australia’s negative gearing rules.
Gearing basically means borrowing to invest. Negative gearing is when the costs of investing are higher than the return you achieve. With an investment property, that’s when the annual net rental income is less than the loan interest plus the deductible expenses associated with maintaining the property (such as property management fees and repairs). When you’re negatively geared you can deduct the costs of owning your investment property from your overall income reducing your tax bill. High-income earners benefit the most, because they’re in the top tax bracket.
In addition, while you record a loss on the income from the property, in theory capital gains in the value of your property should make the investment worthwhile. Don’t over-commit to property just to get a tax deduction. Those tax benefits generally don’t come until the end of the financial year and you have to make your mortgage payments in the meantime.
That said, you can apply to have less tax deducted from your pay to take into account the impact on your overall income of expected losses on an investment property. Say you earn $45,000 a year, gross, in your day job but you can reliably estimate that you’ll make a $15,000 loss on an investment property. You can apply to have your tax payments calculated on an income of $30,000 rather than $45,000 giving you more cash in hand now, rather than a refund at the end of the year. Get your sums wrong, though, and you’ll owe the tax man money at the end of the year.
See www.ato.gov.au for information about pay-as-you-go (PAYG) withholding payments.
Remember, too, that a capital gain which will be taxed is never assured. What’s more, the benefits of negative gearing are smaller when interest rates and inflation are low and can be offset by charges such as the land tax levied in NSW (see www.osr.nsw.gov.au).
The owners of investment properties can also claim depreciation of items such as stoves, refrigerators and furniture. That involves writing off the cost of the item over a set number of years the effective life of the asset. The ATO sets out what it considers to be appropriate periods. The cost of a cooktop, for instance, is generally written off over 12 years you claim one-twelfth of its cost as an expense each year.
There are two different types of depreciation an allowance for assets such as the cooktop, and an allowance for capital works, such as the cost of construction. Its a good idea to talk to a quantity surveyor or other depreciation specialist right from the start, so you make full and correct use of the available depreciation allowances. The higher the depreciation bill, the higher the amount to offset against income when you’re negative gearing.
Capital gains tax
Capital gains tax (CGT) is the tax charged on capital gains that arise from the disposal of an asset including investment property, but not your place of residence acquired after September 19, 1985.
You’re liable for CGT if your capital gains exceed your capital losses in an income year. (If you’re smart, you’ll time asset disposals so that if you really must take a capital loss it’ll be at a time when it can offset a capital gain). The capital gain on an investment property acquired on or after October 1, 1999, and held for at least a year, is taxed at only half the rate otherwise. This means a maximum rate of 24.25 per cent if you’re in the highest tax bracket.
The capital gain is the profit you’ve made over and above the cost base the purchase price plus capital expenses such as subsequent renovations. Make sure you keep good records of these sorts of expenses. Capital gains tax is a complex area, so it pays to get specific advice about how it applies in your individual circumstances.
Making your investment pay
If you hold your investment property for long enough, hopefully you’ll reach the stage where losses start turning into gains. The rent you’re charging should have risen over time, and you’ll be steadily whittling away at the mortgage.
Once your rental income exceeds your mortgage repayments you’ll no longer be negatively geared, however. And no negative gearing means no tax advantages but that doesn’t mean you should rush to sell. Yes, you’ll have to pay more tax because the income you’re making is more than your losses but the fact is you’re making money, which is why you invested in the first place.
The temptation may be to take your profits and plough them into another property and that can be a perfectly reasonable strategy but don’t lose track of the costs involved in selling. Stamp duty alone is a big disincentive.