Yesterday we spoke about how the rent from your investment property increases your taxable income. Now, let’s take a look at the other side of the coin: your deductions.
Remember in our example, you are earning $90,000 per year and have a property worth $400,000 with a $360,000 loan.
Deduction 1: Interest and bank fees
The first deduction is the interest and bank fees on your $360,000 loan. At 4.8% interest the yearly interest would be $17,280. Add to that $500 in bank fees and you have $17,780.
Deduction 2: Management fees
The next deduction would be the management fees your rental manager charges. Let’s say they were taking 7.5% of the rent and charged you one week’s rent as a letting fee. The total rent was $20,800 per year, making their percentage $1,560 plus the letting fee of $400 gives you a total of $1,960.
Deduction 3: Insurance, rates, maintenance & miscellaneous
Next we have Insurance at $1000 ($600 for Building Insurance & $400 for Landlords’ Insurance), Rates at $2000, Maintenance at $1000 and other miscellaneous expenses of $500. This gives you a total of $5,500.
Deduction 4: Depreciation
Finally, we have possibly the most important deduction: the depreciation. For this example, let’s use a round figure of $10,000.
Let’s add up your total deductions:
$17,780 + $1,960 + $5,500 + $10,000 = $35,240.
Whilst the rent increased your taxable income to $110,800, the $35,240 in deductions has brought your income back down to $75,560 on paper in the eyes of the tax office. As such, because you paid tax on your original salary of $90,000, and should have only paid tax on $75,560, you are due a refund!
Going back to our tax tables, someone earning $75,560 would fall into the 32.5% tax bracket. Therefore, their total tax paid should be:
$5,092 plus 32.5 cents for each $1 over $45,000
= $5092 + $0.325 * (75,560-45,000)
= $15,024
So if we paid $19,717 and should have paid only $15,024, the tax office owes us a $4,693 refund! That’s almost another $100 per week that you wouldn’t be getting if you didn’t understand tax and in particular depreciation. This is why astute property investors get big tax returns.
You can imagine the result when you have multiple properties. Many property investors do get to the point where they don’t pay any tax at all! Wouldn’t that be nice?
Now of course, we are not accountants and the area of taxation is something that is constantly changing, so you should always speak to your accountant first before making any decisions on the basis of how they will benefit your tax situation.
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