Invest Wisely, Pay Less: How Property Can Reduce Your Tax
Navigating the world of taxes can be complex, but understanding how property investments can help reduce your tax burden is a game-changer. Here’s a breakdown of how you can leverage property to decrease your taxable income and potentially receive a tax return.
Income from Property and Your Taxable Income
The rent you receive from a property increases your taxable income. However, all the expenses associated with holding the property, including the ever-so-valuable ‘depreciation,’ are tax-deductible, reducing your taxable income and resulting in a potential tax return.
Practical Example
Let’s say you earn $100,000 per year and own an investment property worth $650,000 with a $585,000 mortgage. You rent the property for $650 per week (or $33,800 per year). The ATO will add the rent received to your income, making it $133,800.
Without deductions, you would pay tax on the additional $33,800 from rent. Fortunately, you have plenty of deductions to offset the rent received and reduce your taxable income.
Key Deductions
- Interest and Bank Fees: On a $585,000 loan at 6% interest, the yearly interest would be $35,100.
- Rental Management Fees: Assuming an 8.8% fee, management fees would total $2,974.
- Insurance, Rates, Maintenance & Miscellaneous: Including building and landlord insurance ($1,200), rates ($2,000), and maintenance ($500), these total $3,700.
- Depreciation: This ‘on-paper deduction’ doesn’t involve real cash expenditure. For this example, let’s use a figure of $20,000.
Adding Up These Deductions
- Interest & Bank Fees: $35,100
- Management Fees: $2,974
- Insurance, Rates, Maintenance: $3,700
- Depreciation: $20,000
Total Deductions: $61,774
While the rent increased your taxable income to $133,800, the $61,774 in deductions reduces it to $72,026. Since you initially paid tax on your $100,000 salary, you’re due a refund.
Calculating Your Tax Refund
For a taxable income of $72,026, the total tax would be:
- $4,288 plus 30 cents for each $1 over $45,000 = $4,288 + $0.3 * ($27,974) = $12,680
If you paid $20,787 tax (on $100,000) but should have paid only $12,680 (on $72,026), the tax office owes you a refund of $8,107!
Passive Income from Property Investments
Income from your investment property will look like this:
- $33,800 (rent) + $8,107 (tax return) = $41,907
- $41,774 (expenses) = $133 (profit)
That’s $2.56 of passive income per week, which will increase as rent climbs. If you bought in a booming area, you should see around an 80% increase within 5 years. This passive income can fund your fun activities like vacations or a new car, reinforcing the distinction between work income and passive income.
Wealthy individuals understand the importance of building a passive income stream. They respect their work income for necessities and use passive income for luxuries.
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