How Does Your Investment Property Reduce Your Tax?
Want to pay less tax? Alrighty then, read on!
Most people know that owning an investment property can help them pay less tax, but not many people actually understand how it works… and worst of all, they miss the biggest opportunity of all to reduce their tax. So, let’s talk about that…
Rent is Taxable Income
Firstly, we have to take into account that any rent you receive is actually considered as taxable income. So, when we just look at your income, you’ll actually be owing more tax than what you paid in your day job.
But don’t stress, because that is all about to change…
Things We Can Claim
Basically any expenses that come with holding onto your property are claimable on tax. Here are some of the cash-deductions (things we paid for with money) we can claim against our income:
- Loan interest
- Rental management fees
Here’s the thing that a lot of investors don’t actually know they can claim – but it’s the magic factor that can make all of the difference. Depreciation! Depreciation is a non-cash deduction, or an on-paper deduction because although money doesn’t leave your bank account to pay for it, the building itself is technically worth less as time goes on.
It makes sense if you think about it – in every building, the curtains are degrading over time, the carpets are worth less than they were last year, and the structure itself is not retaining its face value. The magical part is that in real life, your property (in particular, the land) is going up in value.
How does this all apply in real life? Let’s look at the example below. Allow me to explain the situation…
- Your pay is $100,000 for the year, putting you in the 37% tax bracket
- You own a $500,000 property with a 90% loan, paying 5% interest
- Your property brings in $26,000 per year in rent, increasing your taxable income to $126,000
- Your property costs you $22,500 in loan interest, $2,000 on rates, $1,950 on rental management fees, and $1,000 in insurance
- In addition, your quantity surveyor has written off $15,000 in depreciation for this financial year
- This comes to $42,450 claimable expenses, bringing your taxable income down to $83,550
This means that we are entitled to a tax return, because we paid tax on $100,000 but our new taxable income is $16,450 lower than this. Doing the calculations at the different tax brackets shows that we should be owed a tax refund of $5,931 against that property.
And this extra cash at tax time can make all of the difference to your cashflow – that’s an extra $100 per week that you’re getting from your property if you average it throughout the year. And a great part of it is thanks to the depreciation!
How to Maximise Your Tax Return and Cashflow with the Right Property
So, it makes sense to try and purchase properties that are going to give you a good amount of depreciation. This can be the difference between a positive cash flow property and a negative cash flow property.
Smart property investors know that they can own an unlimited number of properties that pay for themselves. The best way to get a property to pay for itself is to have a decent amount of depreciation occurring. You can do that by purchasing new properties, that will have greater depreciation in those first few years.
If you want to be a successful property investor, you need to be looking at properties that have high depreciation in the early stages to cover the rent (as it will begin to rise over time) and have positive cash flow.
Daimien Patterson is the CEO of Integrity Investment Properties, a property investment company based in Australia. He regularly produces books, blogs, and videos on the topic of property investing. Head to [integrityinvestmentproperties.com.au] for your free copy of Daimien’s book, Safe as Houses.